Is Decentralized Finance (DeFi) Efficient?

53 Pages Posted: 3 May 2022

See all articles by Paul P. Momtaz

Paul P. Momtaz

University of California, Los Angeles (UCLA) - Anderson School of Management; University College London Center for Blockchain Technologies

Multiple version iconThere are 3 versions of this paper

Date Written: April 27, 2022

Abstract

How efficient is Decentralized Finance (DeFi)? To answer this question, we study the efficiency and the role of intermediation in a large DeFi segment, namely, the market for Initial Coin Offerings (ICOs). In particular, we advance a search-related theory of DeFi, in which search frictions partly offset the efficiency gains from reduced transaction costs thanks to blockchain technology and smart contracts. The intensity of search, i.e. the process of identifying valuable projects, is increasing in market granularity. Blockchain technology increases market granularity through lower entry barriers. Lower-end entrants, however, increase aggregate search intensity but lack search skills. The resulting search-related inefficiency creates a niche for DeFi intermediaries. Consistent with this theory, our findings suggest that DeFi intermediaries reduce search frictions and extract economic rents for their services. Relative to the Walrasian equilibrium, DeFi is relatively inefficient, and search frictions reduce the welfare for society almost by half. The evidence indicates that perfectly decentralized finance markets would not be optimal for society.

Keywords: Decentralized Finance (DeFi), Initial Coin Offering (ICO), blockchain-based crowdfunding, tokens, entrepreneurial finance, crypto funds, intermediation, search

JEL Classification: G23, G24, L26

Suggested Citation

Momtaz, Paul P., Is Decentralized Finance (DeFi) Efficient? (April 27, 2022). Available at SSRN: https://ssrn.com/abstract=4095397 or http://dx.doi.org/10.2139/ssrn.4095397

Paul P. Momtaz (Contact Author)

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

University College London Center for Blockchain Technologies ( email )

UCL CBT UCL Computer Science
Malet Place London WC
London, London
United Kingdom

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