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Decentralized Finance: On Blockchain- and Smart Contract-Based Financial Markets (by Fabian Schär)


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https://research.stlouisfed.org/publications/review/2021/02/05/decentralized-finance-on-blockchain-and-smart-contract-based-financial-markets

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The term decentralized finance (DeFi) refers to an alternative financial infrastructure built on top of the Ethereum blockchain. DeFi uses smart contracts to create protocols that replicate existing financial services in a more open, interoperable, and transparent way. This article highlights opportunities and potential risks of the DeFi ecosystem. I propose a multi-layered framework to analyze the implicit architecture and the various DeFi building blocks, including token standards, decentralized exchanges, decentralized debt markets, blockchain derivatives, and on-chain asset management protocols. I conclude that DeFi still is a niche market with certain risks but that it also has interesting properties in terms of efficiency, transparency, accessibility, and composability. As such, DeFi may potentially contribute to a more robust and transparent financial infrastructure.

Fabian Schär is a professor for distributed ledger technologies and fintech at the University of Basel and the managing director of the Center for Innovative Finance at the Faculty of Business and Economics, University of Basel. The author thanks two anonymous reviewers for their valuable comments and especially Florian Bitterli, Raphael Knechtli, and Tobias Wagner for their support with data collection and visualization and Emma Littlejohn and Amadeo Brands for proofreading.

 

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