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Competitive dynamics between decentralized and centralized finance lending markets

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  • Son, Jaemin
  • Ryu, Doojin

Abstract

We analyze the competitive dynamics between a decentralized financial system, called a protocol for loanable funds (PLF), and a centralized financial system. A PLF primarily differs from traditional banks in terms of its purpose and its decentralized ledger. While traditional banks pursue profit maximization, the PLF with a decentralized ledger system liquidates borrowing demand in line with the supply of deposits. We provide a theoretical framework that incorporates the differences among the lending markets to outline their competitive dynamics and suggest an optimal design for the PLF's consensus algorithm. The traditional bank incurs a cost to secure market power that depends on its degree of heterogeneity from the PLF. Our results suggest channels through which monetary policy influences the interest rates of PLFs.

Suggested Citation

  • Son, Jaemin & Ryu, Doojin, 2024. "Competitive dynamics between decentralized and centralized finance lending markets," International Review of Financial Analysis, Elsevier, vol. 96(PB).
    • Handle: RePEc:eee:finana:v:96:y:2024:i:pb:s1057521924006318
    DOI: 10.1016/j.irfa.2024.103699
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    Keywords

    Blockchain trilemma; Centralized finance; Decentralized finance; Financial stability; Protocol for loanable funds;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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