Financial Intermediation and Risk in Decentralized Lending Protocols

39 Pages Posted: 28 Jul 2021 Last revised: 1 Feb 2022

See all articles by Carlos Castro-Iragorri

Carlos Castro-Iragorri

Universidad del Rosario

Julian Ramirez

affiliation not provided to SSRN

Sebastian Velez

affiliation not provided to SSRN

Date Written: January 31, 2022

Abstract

We provide an overview of decentralized protocols Compound, Aave and MakerDAO that offer collateralized loans for crypto asset investors. Using publicly available information on rates, income, supply and borrow activity, we estimate net interest margins and provide a comprehensive view of the cost of financial intermediation. We find that margins are on average below 1%, which is significantly lower than traditional banking. In addition, we derive a theoretical model for financial intermediation for the protocols and identify the drivers of performance in these new decentralized markets. We test the model empirically and determine the relative importance of market power, risk factors and utilization in the protocol’s financial performance. The results indicate that market power and the volatility in the price of crypto assets have a positive effect on margins. The downward trend observed in margins during the sample period is related to the entrance of new lending protocols.

Keywords: Decentralized finance, Compound, Aave, MakerDAO, collateralize loans, intermediation margins, market power

JEL Classification: C63, C80, E51, G21, G23, G51, O16, O33

Suggested Citation

Castro-Iragorri, Carlos and Ramirez, Julian and Velez, Sebastian, Financial Intermediation and Risk in Decentralized Lending Protocols (January 31, 2022). Available at SSRN: https://ssrn.com/abstract=3893278 or http://dx.doi.org/10.2139/ssrn.3893278

Carlos Castro-Iragorri (Contact Author)

Universidad del Rosario ( email )

Bogota
Colombia

Julian Ramirez

affiliation not provided to SSRN

Sebastian Velez

affiliation not provided to SSRN

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