Trust in DeFi: An Empirical Study of the Decentralized Exchange

Abstract

We provide empirical evidence that the decentralized cryptocurrency exchange helps reveal the consensus on the value of the cryptocurrency. By examining how investors on Binance (the largest centralized cryptocurrency exchange) trade in response to prices on Binance and Uniswap (the largest decentralized cryptocurrency exchange), we find the increase in the Uniswap userbase induces Binance investor trading towards the Uniswap price. In particular, the effect gets more pronounced when Binance exhibits “wash trading” or when investors have more concerns about “wash trading.” We do not find Binance userbase affecting Binance investor trading. Using the launch of the “yield-farming” program as a quasi-natural experiment, we establish the causal impact of Uniswap userbase on Binance investor trading. Our results suggest that Uniswap, a decentralized exchange built on blockchain and smart contracts, can gain investors’ trust in its ability to aggregate the consensus of the cryptocurrency’s value. Our findings shed light that the blockchain and smart contracts powered decentralized infrastructure has the potential to provide an alternative solution to organize trading, when the trading structure underwritten by a credible central party, e.g., a centralized exchange, is not feasible or too costly to obtain.

Keywords: blockchain, cryptocurrency, DeFi, smart contracts, wash trading, fake volume

JEL Classification: G12, G14