Grasping de(centralized) fi(nance) through the lens of economic theory

by Jonathan Chiu, Charles M. Kahn and Thorsten V. Koeppl

In this article, we use a simple stylized model of collateralized lending to analyze the value proposition and limitations of decentralized finance (DeFi). DeFi uses a decentralized ledger to run smart contracts that automatically enforce the terms of a lending contract and safeguard the collateral. DeFi can lower the costs associated with intermediated lending and improve financial inclusion. Limitations are the volatility of the crypto collateral and stablecoins used for settlement, the possible incompleteness of smart contracts and the lack of a reliable oracle. A proper infrastructure reducing such limitations could improve the value of DeFi.

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Year of publication:	[2022] ; Last updated: October 11, 2022
Authors:	Chiu, Jonathan ; Kahn, Charles M. ; Koeppl, Thorsten V.
Publisher:	[Ottawa] : Bank of Canada
Subject:	Digital currencies and fintech \| Payment clearing and settlement systems \| Virtuelle Währung \| Virtual currency \| Kreditgeschäft \| Bank lending \| Kreditrationierung \| Credit rationing \| Kreditmarkt \| Credit market \| Theorie \| Theory