DeFi Leveraged Trading: Inequitable Costs of Decentralization

44 Pages Posted: 18 Oct 2022

See all articles by Peter Mueller

Peter Mueller

University of Oklahoma - Michael F. Price College of Business

Date Written: September 24, 2022

Abstract

Decentralized Financial (DeFi) lending applications allow users to take leveraged positions in risky cryptoassets without the use of a financial intermediary, mimicking the functionality of a margin trading account without a centralized broker. This decentralization comes at a cost; leveraged traders must pay blockchain transaction fees to miners/validators and, absent an intermediary, third parties must be incentivized to perform liquidation transactions on positions with insufficient collateral. I provide evidence suggesting that volatile blockchain transaction fees can effectively “price out” a significant portion of market participants engaged in DeFi leveraged trading, forcing these traders to temporarily abandon their leveraged positions. Meanwhile, I show that the market liquidation incentive effectively disciplines leveraged traders with riskier positions, inducing them to take more conservative positions. These results highlight the limitations of blockchain/DeFi technologies in their current state and have interesting policy implications concerning the regulation of leveraged traders.

Keywords: Blockchain, DeFi, FinTech, Decentralized Lending, Compound

JEL Classification: G10, G20, G23

Suggested Citation

Mueller, Peter, DeFi Leveraged Trading: Inequitable Costs of Decentralization (September 24, 2022). Available at SSRN: https://ssrn.com/abstract=4241356 or http://dx.doi.org/10.2139/ssrn.4241356

Peter Mueller (Contact Author)

University of Oklahoma - Michael F. Price College of Business ( email )

307 West Brooks
Norman, OK 73019-4004
United States

HOME PAGE: http://petercmueller.com

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