Decentralized finance (DeFi) is the term used to describe financial applications and services built on blockchain, the technology behind cryptocurrencies. DeFi uses blockchain as a trust mechanism, enabling unknown parties to transact with each other, removing unnecessary intermediaries, and lowering transaction costs. In order to seize the potential of blockchain technology in this particular industry and how it can be translated into other niches, it is necessary to understand its mechanics, implications, and particularities. This paper aims to present the operating principles, technologies, and security implications related to blockchain-based decentralized finance.
Son dönemlerde Bitcoin, bir yatırım ve ödeme aracı olarak yatırımcılar açısından oldukça popüler hale gelmiştir. Yatırımcıların dikkatle takip ettikleri bu sanal para biriminin finansal piyasalara etkisi açısından çalışmada Bitcoin ve BİST100 endeksi arasındaki eş bütünleşme ilişkisi incelenmiştir. Bu amaçla 14.08.2017-13.04.2021 dönemi günlük verileri kullanılmış ve Maki eş bütünleşme testi ile analiz gerçekleştirilmiştir. Elde edilen sonuçlar Bitcoin ve BİST100 endeksi arasında eş bütünleşme ilişkisinin olmadığını göstermektedir. Bunun yanında Hatemi-J nedensellik testi kullanılarak değişkenler arasında kısa dönemli asimetrik ilişkilerin varlığı test edilmiş ve test sonucuna göre yalnızca BİST100 endeksindeki pozitif bir şokun Bitcoin fiyatlarında pozitif bir şoka neden olduğu belirlenmiştir.
The Decentralized Finance (DeFi) ecosystem has recently been touted as a potential replacement for the existing financial system, with the monetary equivalent in this ecosystem based on various token concepts and infrastructural protocols. However, questions remain regarding the systemic risk of this ecosystem, and closer examination reveals interesting parallels to the concept of systemic risk in established financial systems. There is a need for research to examine important additional dimensions in relation to DeFi. This paper addresses systemic risk in DeFi, presenting the first holistic research framework on the topic, as well as the first empirical indications in order to create foundations for further research.
Zusammenfassung Die Finanzkrise von 2007/2008 gilt weithin als die schwerwiegendste globale Finanzkrise seit der Großen Depression. Während Akteure der etablierten Institutionen des Finanzsystems seinerzeit versucht haben, durch hektische Eingriffe den Kollaps des Finanzsystems abzuwenden, haben verschiedenen Protestbewegungen begonnen, über Alternativen nachzudenken. Dieser Beitrag befasst sich mit einem aktivistischen Alternativgeldexperiment, das uns seitdem besonders beschäftigt hat: Bitcoin. Dabei wird untersucht, wie sich Bitcoin seit seinen Anfängen entwickelt hat, welche Fragen es aufgeworfen hat und welche Implikationen sich aus den Erfahrungen mit diesem Experiment ergeben.
The former Chief Economist of the OCC discusses how FinTech innovators are developing new ways of improving banking services that promise to increase both the efficiency and soundness of the U.S. financial system. Most of these innovations are focused on either lending or payments, but not both, since FinTech providers, unlike traditional banks, tend to specialize in one of the two activities. This “unbundling” of payments from lending is particularly notable in block‐chain‐based coins used for payments. Although the greatest attention has been paid to Bitcoin in the debate over the future of blockchain‐based payments, the author notes that Bitcoin is not the most promising blockchain‐based payments technology, just the first. For one thing, Bitcoin is not a suitable substitute for the traditional system of checking accounts that execute payments via the centralized Fed‐managed network. Most obviously, account holders with checking accounts want to maintain significant balances in a stable store of value, and Bitcoin's value is anything but stable, owing to its lack of a connection to anything of intrinsic or derivative value. Stablecoins, by contrast, are a rapidly growing segment of blockchain‐based payments with the ability to offer faster, more complex, and more secure payment services, and a virtually riskless store of value. This combination of benefits should allow stablecoins to outcompete both Bitcoin and the existing bank to bank system in the long run. Furthermore, providing stablecoin issuers the option to be chartered as National Banks would, by ensuring their examination by reputable third parties, enable stablecoin issuers to make credible commitments to honest accounting practices—especially, regarding their reported cash resources—and credible disclosure of the algorithms that govern their operations. Despite the potential social gains from creating a blockchain‐based stablecoin payments network and permitting the chartering of stablecoin issuers, both the existence of stablecoin issuers and their prospective chartering as banks remain in doubt because of politics. Incumbent banks, the Federal Reserve, and constituents that benefit from transfers they receive under the current regulatory regime governing incumbent banks all stand to lose power and wealth from the disappearance of the existing system. And so the struggle over the future of payments is not just a matter of economic competition, but also of relative political influence in determining whether socially beneficial technological progress will be permitted.
DeFi, short for decentralized finance, is a new paradigm that enjoys increasing popularity in the financial world. DeFi posits that financial services should not rely on centralized intermediaries but should be provided by users for users. This is done by deploying software components to a decentralized peer-to-peer system which is grounded on blockchain technology. This introductory text discusses the origins of DeFi and delineates DeFi characteristics from those of traditional finance. Several examples of DeFi applications are given, the disadvantages resulting from this paradigm are discussed, and an outlook is provided.
Central Bank Digital Currency (CBDC) is a digital version of domestic currency with the unit of account equivalent to its domestic currency. Blockchain can be used to implement CBDC to execute and settle peer-to-peer transactions. With the emergence of private money such as cryptocurrencies and stable coins and the growing use of digital payments to lessen the global pandemic spread, CBDC is an active research area among the central banks worldwide. Many central banks started their CBDC projects by building proofs of concept (PoCs) to replicate wholesale payment systems and expand their investigation into other use cases such as delivery versus Payment (DvP) and cross-border remittance. PBoC, China Central Bank, has already started a pilot testing of their digital currency. This paper discusses the application of blockchain for CBDC by presenting CBDC projects by central banks. Moreover, this paper analyses issues, identify challenges, and discusses future works in this rapidly evolving field.
Pablo de Andrés, David Arroyo, Ricardo Correia, Álvaro Rezola
This article analyzes the main problems and the solutions adopted in the market for Initial Coin Offerings (ICO), to anticipate the future of this market and determine implications for issuers, investors and regulators. ICOs represent an alternative and innovative financing solution that has experienced spectacular growth and notoriety in recent years. ICOs rely on Blockchain protocols and the ICO market is, therefore, characterized as decentralized, disintermediated and unregulated. Our results show that although the ICO market is innovative, it already displays many of the problems of traditional financial markets, and that these problems were at the genesis of the last financial crisis. Our analysis of the problems and solutions adopted shows a tension between what the Blockchain technology offers, and the problems associated with the financing of innovation. Considering the problems and solutions adopted, we no longer expect the ICO market to be characterized as disintermediated, unregulated or even decentralized in the near future. Furthermore, it is a real possibility that ICOs may end up being a progressor model eventually replaced by similar but more specialized financing models, some of which may already exist. With respect to the particular solutions of the ICO market, while some represent the realization of the potential of Blockchain, others such as forks have important Governance implications with the potential to create as many problems as the ones they address.
Stefan Kitzler, Friedhelm Victor, Pietro Saggese, Bernhard Haslhofer
We present a measurement study on compositions of Decentralized Finance (DeFi) protocols, which aim to disrupt traditional finance and offer services on top of distributed ledgers, such as Ethereum. Understanding DeFi compositions is of great importance, as they may impact the development of ecosystem interoperability, are increasingly integrated with web technologies, and may introduce risks through complexity. Starting from a dataset of 23 labeled DeFi protocols and 10,663,881 associated Ethereum accounts, we study the interactions of protocols and associated smart contracts. From a network perspective, we find that decentralized exchange (DEX) and lending protocol account nodes have high degree and centrality values, that interactions among protocol nodes primarily occur in a strongly connected component, and that known community detection methods cannot disentangle DeFi protocols. Therefore, we propose an algorithm to decompose a protocol call into a nested set of building blocks that may be part of other DeFi protocols. This allows us to untangle and study protocol compositions. With a ground truth dataset that we have collected, we can demonstrate the algorithm’s capability by finding that swaps are the most frequently used building blocks. As building blocks can be nested, that is, contained in each other, we provide visualizations of composition trees for deeper inspections. We also present a broad picture of DeFi compositions by extracting and flattening the entire nested building block structure across multiple DeFi protocols. Finally, to demonstrate the practicality of our approach, we present a case study that is inspired by the recent collapse of the UST stablecoin in the Terra ecosystem. Under the hypothetical assumption that the stablecoin USD Tether would experience a similar fate, we study which building blocks — and, thereby, DeFi protocols — would be affected. Overall, our results and methods contribute to a better understanding of a new family of financial products.
This study proposes a simple two-period model to consider consumers’ borrowing behaviour in a decentralised consensus and information distribution platform. Based on this model, we develop a bank risk mitigation framework and find that decentralised digital identity and encryption technology are the most important factors for attaining market equilibrium between decentralised consensus and information distribution. Specifically, the greater the scope of digital identity construction and the more blockchain consensus records there are, the less likely the borrower will default. Our study provides meaningful practical implications for bankers and policy regulators to help them better understand consumers’ borrowing behaviour and decisions to default.
Over the last decade, Bitcoin has attracted a great deal of public interest and Bitcoin market has grown rapidly. One of the main characteristics of the market is that it often undergoes some events or incidents that cause outlying observations. To obtain reliable results in the statistical analysis of Bitcoin data, these outlying observations need to be carefully treated. In this study, we are interested in change point analysis for Bitcoin return series having such outlying observations. Since these outlying observations can affect change point analysis undesirably, we use a robust test for parameter change to locate change points. We report some significant change points that are not detected by the existing tests and demonstrate that the model allowing for parameter changes is better fitted to the data. Finally, we show that the model with parameter change can improve the forecasting performance of Value-at-Risk.
We review different classes of cryptocurrencies with emphasis on their economic properties. Pure-asset coins such as Bitcoin, Ethereum and Ripple are characterized by not being a liability of any economic agent and most resemble commodities such as gold. Central bank digital currencies, at the other end of the economic spectrum, are liabilities of a Central Bank and most resemble cash. In between, there exist a range of so-called stable coins, with varying degrees of economic complexity. We use balance sheet operations to highlight the properties of each class of cryptocurrency and their potential uses. In addition, we propose the basic structure for a macroeconomic model incorporating all the different types of cryptocurrencies under consideration.
Christine R. Martell, Tima T. Moldogaziev, Salvador Espinosa
Abstract Chapter 1 introduces the book by presenting the main arguments that information resolution is a necessary component of SNG capital market development and access to external financing. It also argues that local policy and management agency vis-à-vis financial sector firms is critical to achieve SNG governance tasks in the face of decentralized governance and growing local service pressures. This chapter defines the key terminology of information problems, information institutions, and information resolution. It situates the focus on SNGs, and more narrowly on policy makers at the city level, that are embedded within the national contexts and financial markets. Finally, the chapter identifies the book’s contributions and details the organization of the book’s remaining chapters.
Kushal Babel, Philip Daian, Mahimna Kelkar, Ari Juels
We introduce the Clockwork Finance Framework (CFF), a general purpose, formal verification framework for mechanized reasoning about the economic security properties of composed decentralized-finance (DeFi) smart contracts. CFF features three key properties. It is contract complete, meaning that it can model any smart contract platform and all its contracts--Turing complete or otherwise. It does so with asymptotically constant model overhead. It is also attack-exhaustive by construction, meaning that it can automatically and mechanically extract all possible economic attacks on users' cryptocurrency across modeled contracts. Thanks to these properties, CFF can support multiple goals: economic security analysis of contracts by developers, analysis of DeFi trading risks by users, fees UX, and optimization of arbitrage opportunities by bots or miners. Because CFF offers composability, it can support these goals with reasoning over any desired set of potentially interacting smart contract models. We instantiate CFF as an executable model for Ethereum contracts that incorporates a state-of-the-art deductive verifier. Building on previous work, we introduce extractable value (EV), a new formal notion of economic security in composed DeFi contracts that is both a basis for CFF and of general interest. We construct modular, human-readable, composable CFF models of four popular, deployed DeFi protocols in Ethereum: Uniswap, Uniswap V2, Sushiswap, and MakerDAO, representing a combined 24 billion USD in value as of March 2022. We use these models along with some other common models such as flash loans, airdrops and voting to show experimentally that CFF is practical and can drive useful, data-based EV-based insights from real world transaction activity. Without any explicitly programmed attack strategies, CFF uncovers on average an expected $56 million of EV per month in the recent past.
Purpose This study aims to explore the opportunities and challenges in activating a Smart Contract to enhance the efficiency and effectiveness of Ṣukūk offerings in the Islamic capital market. Design/methodology/approach The study adopts a mono-method qualitative approach. Data were obtained from survey interviews of two issuances on the fusion of smart contracts in Ṣukūk structures that were Sharīʿah-compliant. A thematic approach was further used to analyze the interview data based on the onion research method while opportunities and challenges of activating the Smart Ṣukūk (SṢ) relied on doctrinal evidence. Findings The results from the issuances across two jurisdictions showed that deployment of SṢ can resolve contractual ambiguities arising from Sharīʿah interpretations, jurisdictional policies and legal regime issues, which affect Ṣukūk origination and issuances especially on the right of investors in the event of Ṣukūk defaults. Although SṢ is automated, the third party’s presence is not eliminated as the blockchain platform still relies on the validators who are usually blockchain developers functioning as a third party in the Ṣukūk chain. Research limitations/implications The study relies on doctrinal literature to explain the features and requirements of SṢ. The empirical approach is limited to interview data based on local SṢ issuances. Future studies need to explore regulators’ role and global standards in cross-border issuance of SṢ with multiple jurisdictions/laws. Practical implications The paper concludes that the offering of SṢ using local currency has been successful in the two issuances because of the facilitative regulatory environment. However, addressing Ṣukūk’s challenges in cross-border offerings would require guidance from international standard-setters such as the Accounting and Auditing Organization for Islamic Financial Institutions and the Islamic Financial Services Board. Originality/value This study is an advanced application of smart contracts to alleviate the related Ṣukūk challenges in the Islamic capital market.
In this paper, we construct a decentralized clearing mechanism which endogenously and automatically provides a claims resolution procedure. This mechanism can be used to clear a network of obligations through blockchain. In particular, we investigate default contagion in a network of smart contracts cleared through blockchain. In so doing, we provide an algorithm which constructs the blockchain so as to guarantee the payments can be verified and the miners earn a fee. We, additionally, consider the special case in which the blocks have unbounded capacity to provide a simple equilibrium clearing condition for the terminal net worths; existence and uniqueness are proven for this system. Finally, we consider the optimal bidding strategies for each firm in the network so that all firms are utility maximizers with respect to their terminal wealths. We first look for a mixed Nash equilibrium bidding strategies, and then also consider Pareto optimal bidding strategies. The implications of these strategies, and more broadly blockchain, on systemic risk are considered.
Blockchain technology facilities multi-party applications that do not require the parties to trust each other, that are failure-resistant due to their decentralized nature, and that provide a consistent view on the transaction history. These properties make blockchains attractive for decentralized finance (DeFi), and in particular for trade finance, where parties do not necessarily trust each other and aim at reducing their financial risks.Traditionally, intermediaries like banks or fiduciaries provide such services – along with several inconveniences like the increased risk of fraud due to antiquated systems and processes, considerable settlement delays, and high costs.In this work, we focus on the financial instrument Letter of Credit (L/C), which is used to secure payments in international trade. We propose a method for evaluating blockchains for DeFi based on this use case. We adapt existing catalogues of criteria for platform evaluation to fit the development and operation of DeFi applications. After discussing and designing a prototype of a typical L/C workflow, we implement it on selected blockchain platforms. The evaluation rates the feasibility and usability of the development process.
Distributed Ledger Technologies provide a mechanism to achieve ordering among transactions that are scattered on multiple participants with no prerequisite trust relations. This mechanism is essentially based on the idea of new transactions referencing older ones in a chain structure. Recently, DAG-type Distributed Ledgers that are based on directed acyclic graphs (DAGs) were proposed to increase the system scalability through sacrificing the total order of transactions. In this paper, we develop a mathematical model to study the process that governs the addition of new transactions to the DAG-type Distributed Ledger. We propose a simple model for DAG-type Distributed Ledgers that are obtained from a recursive Young-age Preferential Attachment scheme, i.e. new connections are made preferably to transactions that have not been in the system for very long. We determine the asymptotic degree structure of the resulting graph and show that a forward component of linear size arises if the edge density is chosen sufficiently large in relation to the `young-age preference' that tunes how quickly old transactions become unattractive.
The issuance of a Central Bank Digital Currency (CBDC) is a very important step towards a fully digital economic environment and the consequences of such a direction are under debate by many policymakers around the world. There is a clear interest within the space as governments around the world are exploring the viability of a digital currency and according to the latest Bank for International Settlements (2021) report: 86% of the world's central banks have begun to conceptualize and research the potential of CBDC, 60% are developing Proof-of-Concepts (PoC) and 14% are implementing pilot projects. This paper provides a comprehensive overview for finance and investment participants about the topic of Central Bank Digital Currencies. The recent international exploration into the future of Central Bank money is complex as it is interconnected with two equally dynamic entities: Digital Currencies and Blockchain/Distributed Ledger Technology.
Wisnu Uriawan, Agung Wahana, Cepy Slamet, Vemy Suci Asih
A DApp is a software interacting with it through transactions, user communications, store activity, executing smart contracts, and Ethereum-based on the Blockchain. Many banks or financial institution systems were applying this technology to support customer needs, i.e., in the lending system. When proposing a loan from a bank or other financial institution, it’s generally secured or unsecured. A secured loan offers some form of collateral in return and possibly borrow without any collateral to back the loan (unsecured loan). It all depends on the lender’s requirements. The borrowers can pay installments on time or equal to the guarantees provided. The excellent borrowers’ candidate is very influential in lending activities to minimize financial losses and damage their reputation. Most borrowers are rejected because they are unable to pay back the loan. In this paper, we propose a DApp lending architecture design. The architectural design has been adapted to meet borrowers’ and lenders’ requirements, easy to access and use, simple way for the transaction. We present the advantages of DApp lending architecture is customizable with stakeholders’ needs (Borrowers and Lenders side).
Abstract Currency is the fundamental economic technology that makes promises credible among actors within and across societies. From shells, to metals, to paper, the technology of money has continually evolved to meet the changing needs of human society. The twenty-first century is witnessing yet another evolution in the technology of money: digital currencies. Although political economy scholarship has begun to focus on digital currencies, this research has largely focused on single early examples like Bitcoin. I argue that this generally narrow focus has obscured important degrees of variation among digital currencies and, by extension, has omitted important lines of research on digital currencies as a familiar evolution in the technology of money. In this article, I revisit the history of digital currencies with explicit attention to not only economic inefficiencies but also political power structures and offer a new typology for theoretically organizing digital currencies along dimensions relevant to practitioners of political economy. I illustrate that variation along these typological dimensions produces important differences among different digital currencies and, relatedly, I explore the implications this has for digital currencies’ externalities and governance demands. Drawing on this typology, I conclude with a proposed research agenda for the political economy of digital currencies.