Auditing Decentralized Finance

47 Pages Posted: 9 Nov 2023 Last revised: 27 Nov 2023

See all articles by Siddharth Bhambhwani

Siddharth Bhambhwani

Arkansas Tech University

Allen H. Huang

Hong Kong University of Science and Technology - Department of Accounting

Date Written: July 28, 2023

Abstract

Decentralized finance (DeFi), which executes financial transactions using blockchain without an intermediary, has attracted over US$250 billion in total value locked (TVL) at its peak. However, little is known about how DeFi protocols assure users of the safety of their investments. This paper provides the first empirical evidence on DeFi audit services that check and verify the smart contracts underlying these protocols. Using data on 316 of the largest protocols, we find that those vetted by more smart contract auditors and by higher quality auditors have higher TVL and that these protocols have higher market capitalization (native token values). Using an event study approach, we document that TVL and token values significantly increase after a protocol's first audit, especially those involving a high-quality auditor. We also find that protocols with more auditors and higher audit quality exhibit a smaller drop in TVL and token values after the collapse of the TerraUSD stablecoin, which reduced aggregate DeFi TVL by almost 65%. Overall, our findings suggest that DeFi users and investors perceive audits as providing assurance regarding the safety of their deposits and investments.

Keywords: Blockchain, Cryptocurrency, DeFi, Ethereum, Smart Contracts

JEL Classification: M42, K22, G14, G20, G38, M13, M15

Suggested Citation

Bhambhwani, Siddharth and Huang, Allen H., Auditing Decentralized Finance (July 28, 2023). British Accounting Review, Forthcoming, HKUST Business School Research Paper No. 2023-123, Available at SSRN: https://ssrn.com/abstract=4613529 or http://dx.doi.org/10.2139/ssrn.4613529

Siddharth Bhambhwani

Arkansas Tech University ( email )

AR
United States

Allen H. Huang (Contact Author)

Hong Kong University of Science and Technology - Department of Accounting ( email )

LSK Business School Building
HKUST
Clear Water Bay, Kowloon
Hong Kong

HOME PAGE: http://www.AllenHuang.org

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