Risk-Free Interest Rates in Decentralized Finance
27 Pages Posted: 27 Apr 2022 Last revised: 28 Aug 2022
Date Written: August 12, 2022
Decentralized Finance (DeFi) aims to use advancements in both computation and cryptography to tackle standard economic problems. It must, therefore, operate within the intersection of constraints required by both the computer science and economic domains. We explore a foundational question at the junction of those fields: is it possible to synthesize variable market-clearing risk-free yield for native tokens via smart contracts? We show using a stylized model representing a large class of existing decentralized consensus algorithms that this is not possible. This places strong bounds on what decentralized financial products can be built and constrains the shape of future developments in DeFi. Among other limitations, our results reveal that markets in DeFi are incomplete.
Keywords: DeFi, cryptocurrency
JEL Classification: G12, E42, E43, E51, E52
Suggested Citation: Suggested Citation