Smart Contracts and Decentralized Finance

We explain the mechanics of smart contracts. We then highlight benefits of smart contracts such as overcoming commitment problems. We also discuss limitations such as the difficulty for smart contracts to access information external to the blockchain and the difficulty of integrating smart contract code with traditional legal enforcement. We further highlight how the absence of a trusted intermediary inflates implementation costs for blockchain applications. We conclude with a discussion of the most prominent smart contract applications in Decentralized Finance (DeFi): token issuance (e.g., ICOs, NFTs), decentralized exchanges (DEXs) and protocols for loanable funds (PLFs). Our survey covers both institutional details and relevant literature.

Keywords: Smart Contracts, Decentralized Finance, DeFi, Decentralized Exchanges, DEX, Protocols for Loanable Funds, PLF, Tokens, Stablecoins, Oracle Problem, ICOs, NFTs, Ethereum

JEL Classification: A20, A30, B26, G00

Suggested Citation: Suggested Citation

John, Kose and Kogan, Leonid and Saleh, Fahad, Smart Contracts and Decentralized Finance (September 19, 2022). MIT Sloan Research Paper No. 6800-22, Available at SSRN: https://ssrn.com/abstract=4222528 or http://dx.doi.org/10.2139/ssrn.4222528