IDEAS home Printed from https://ideas.repec.org/p/cpr/ceprdp/18038.html
   My bibliography  Save this paper

The Technology of Decentralized Finance (DeFi)

Author

Listed:
  • Auer, Raphael
  • Haslhofer, Bernhard
  • Kitzler, Stefan
  • Saggese, Pietro
  • Friedhelm, Victor

Abstract

Decentralized Finance (DeFi) is a new financial paradigm that leverages distributed ledger technologies to offer services such as lending, investing, or exchanging cryptoassets without relying on a traditional centralized intermediary. A range of DeFi protocols implements these services as a suite of smart contracts, ie software programs that encode the logic of conventional financial operations. Instead of transacting with a counterparty, DeFi users thus interact with software programs that pool the resources of other DeFi users to maintain control over their funds. This paper provides a deep dive into the overall architecture, the technical primitives, and the financial functionalities of DeFi protocols. We analyse and explain the individual components and how they interact through the lens of a DeFi stack reference (DSR) model featuring three layers: settlement, applications and interfaces. We discuss the technical aspects of each layer of the DSR model. Then, we describe the financial services for the most relevant DeFi categories, ie decentralized exchanges, lending protocols, derivatives protocols and aggregators. The latter exploit the property that smart contracts can be “composed†, ie utilize the functionalities of other protocols to provide novel financial services. We discuss how composability allows complex financial products to be assembled, which could have applications in the traditional financial industry. We discuss potential sources of systemic risk and conclude by mapping out an agenda for research in this area.

Suggested Citation

  • Auer, Raphael & Haslhofer, Bernhard & Kitzler, Stefan & Saggese, Pietro & Friedhelm, Victor, 2023. "The Technology of Decentralized Finance (DeFi)," CEPR Discussion Papers 18038, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:18038
    as

    Download full text from publisher

    File URL: https://cepr.org/publications/DP18038
    Download Restriction: CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org
    ---><---

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Simon Cousaert & Jiahua Xu & Toshiko Matsui, 2021. "SoK: Yield Aggregators in DeFi," Papers 2105.13891, arXiv.org, revised Mar 2022.
    2. Kanis Saengchote, 2022. "Decentralized lending and its users: Insights from Compound," Papers 2212.05734, arXiv.org.
    3. Jiahua Xu & Krzysztof Paruch & Simon Cousaert & Yebo Feng, 2021. "SoK: Decentralized Exchanges (DEX) with Automated Market Maker (AMM) Protocols," Papers 2103.12732, arXiv.org, revised Mar 2023.
    4. Lindner, Peter & Loeffler, Axel & Segalla, Esther & Valitova, Guzel & Vogel, Ursula, 2019. "International monetary policy spillovers through the bank funding channel," Journal of International Money and Finance, Elsevier, vol. 90(C), pages 161-174.
    5. Makarov, Igor & Schoar, Antoinette, 2020. "Trading and arbitrage in cryptocurrency markets," Journal of Financial Economics, Elsevier, vol. 135(2), pages 293-319.
    6. Diem, Christian & Pichler, Anton & Thurner, Stefan, 2020. "What is the minimal systemic risk in financial exposure networks?," Journal of Economic Dynamics and Control, Elsevier, vol. 116(C).
    7. Guillermo Angeris & Tarun Chitra, 2020. "Improved Price Oracles: Constant Function Market Makers," Papers 2003.10001, arXiv.org, revised Jun 2020.
    8. Thomas Ankenbrand & Denis Bieri & Roland Cortivo & Johannes Hoehener & Thomas Hardjono, 2020. "Proposal for a Comprehensive (Crypto) Asset Taxonomy," Papers 2007.11877, arXiv.org.
    9. Jiahua Xu & Nikhil Vadgama, 2021. "From banks to DeFi: the evolution of the lending market," Papers 2104.00970, arXiv.org, revised Dec 2022.
    10. Raphael Auer & Marc Farag & Ulf Lewrick & Lovrenc Orazem & Markus Zoss, 2022. "Banking in the shadow of Bitcoin? The institutional adoption of cryptocurrencies," BIS Working Papers 1013, Bank for International Settlements.
    11. Anil Donmez & Alexander Karaivanov, 2022. "Transaction fee economics in the Ethereum blockchain," Economic Inquiry, Western Economic Association International, vol. 60(1), pages 265-292, January.
    12. Robin Fritsch & Samuel Kaser & Roger Wattenhofer, 2022. "The Economics of Automated Market Makers," Papers 2206.04634, arXiv.org.
    13. Bhaskar Krishnamachari & Qi Feng & Eugenio Grippo, 2021. "Dynamic Curves for Decentralized Autonomous Cryptocurrency Exchanges," Papers 2101.02778, arXiv.org.
    14. Pietro Saggese & Alessandro Belmonte & Nicola Dimitri & Angelo Facchini & Rainer Böhme, 2021. "Who are the arbitrageurs? Empirical evidence from Bitcoin traders in the Mt. Gox exchange platform," Department of Economics University of Siena 860, Department of Economics, University of Siena.
    15. Kaihua Qin & Liyi Zhou & Pablo Gamito & Philipp Jovanovic & Arthur Gervais, 2021. "An Empirical Study of DeFi Liquidations: Incentives, Risks, and Instabilities," Papers 2106.06389, arXiv.org, revised Oct 2021.
    16. Agostino Capponi & Ruizhe Jia & Ye Wang, 2022. "The Evolution of Blockchain: from Lit to Dark," Papers 2202.05779, arXiv.org.
    17. Makarov, Igor & Schoar, Antoinette, 2020. "Trading and arbitrage in cryptocurrency markets," LSE Research Online Documents on Economics 100409, London School of Economics and Political Science, LSE Library.
    18. Teng Andrea Xu & Jiahua Xu, 2022. "A Short Survey on Business Models of Decentralized Finance (DeFi) Protocols," Papers 2202.07742, arXiv.org, revised Jul 2023.
    19. Masaaki Fukasawa & Basile Maire & Marcus Wunsch, 2023. "Weighted variance swaps hedge against impermanent loss," Quantitative Finance, Taylor & Francis Journals, vol. 23(6), pages 901-911, June.
    20. Alex Evans & Guillermo Angeris & Tarun Chitra, 2021. "Optimal Fees for Geometric Mean Market Makers," Papers 2104.00446, arXiv.org.
    21. Briola, Antonio & Vidal-Tomás, David & Wang, Yuanrong & Aste, Tomaso, 2023. "Anatomy of a Stablecoin’s failure: The Terra-Luna case," Finance Research Letters, Elsevier, vol. 51(C).
    22. Johannes Rude Jensen & Victor von Wachter & Omri Ross, 2021. "How Decentralized is the Governance of Blockchain-based Finance: Empirical Evidence from four Governance Token Distributions," Papers 2102.10096, arXiv.org, revised Feb 2021.
    23. Matthieu Nadini & Laura Alessandretti & Flavio Di Giacinto & Mauro Martino & Luca Maria Aiello & Andrea Baronchelli, 2021. "Mapping the NFT revolution: market trends, trade networks and visual features," Papers 2106.00647, arXiv.org, revised Sep 2021.
    24. Jiahua Xu & Yebo Feng, 2022. "Reap the Harvest on Blockchain: A Survey of Yield Farming Protocols," Papers 2210.04194, arXiv.org, revised Dec 2022.
    25. Ariah Klages-Mundt & Andreea Minca, 2019. "(In)Stability for the Blockchain: Deleveraging Spirals and Stablecoin Attacks," Papers 1906.02152, arXiv.org, revised Mar 2021.
    26. Ye Wang & Yan Chen & Haotian Wu & Liyi Zhou & Shuiguang Deng & Roger Wattenhofer, 2021. "Cyclic Arbitrage in Decentralized Exchanges," Papers 2105.02784, arXiv.org, revised Jan 2022.
    27. Sirio Aramonteand & Wenqian Huang & Andreas Schrimpf, 2021. "DeFi risks and the decentralisation illusion," BIS Quarterly Review, Bank for International Settlements, December.
    28. Lewis Gudgeon & Sam M. Werner & Daniel Perez & William J. Knottenbelt, 2020. "DeFi Protocols for Loanable Funds: Interest Rates, Liquidity and Market Efficiency," Papers 2006.13922, arXiv.org, revised Oct 2020.
    29. Agostino Capponi & Ruizhe Jia, 2021. "The Adoption of Blockchain-based Decentralized Exchanges," Papers 2103.08842, arXiv.org, revised Jul 2021.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Rainer Alt & Gilbert Fridgen & Younghoon Chang, 2024. "The future of fintech — Towards ubiquitous financial services," Electronic Markets, Springer;IIM University of St. Gallen, vol. 34(1), pages 1-13, December.
    2. João Almeida & João Alves & Carlos Bettencourt & Maria Bettencourt & Madalena Borges & Filipa Castilho & Sónia Correia & Gisela Fonseca & Mariana Júdice & André Leal & Afonso Marques & Carla Marques &, 2024. "Occasional paper on Decentralised Finance," Working Papers o202402, Banco de Portugal, Economics and Research Department.
    3. Dion Bongaerts & Thomas Lambert & Daniel Liebau & Peter Roosenboom, 2025. "Vote Delegation in DeFi Governance," Papers 2503.11940, arXiv.org.
    4. Saengchote, K & Castro-Iragorri, C, 2023. "Network Topology in Decentralized Finance," Documentos de Trabajo 20782, Universidad del Rosario.
    5. Junliang Luo & Stefan Kitzler & Pietro Saggese, 2024. "Investigating Similarities Across Decentralized Financial (DeFi) Services," Papers 2404.00034, arXiv.org.
    6. Chemaya, Nir & Cong, Lin William & Joergensen, Emma & Liu, Dingyue & Zhang, Luyao, 2023. "Uniswap Daily Transaction Indices by Network," OSF Preprints ube2z, Center for Open Science.
    7. Peplluis R. Esteva & Andrés El-Fakdi & Alberto Ballesteros-Rodríguez, 2023. "Invoice Discounting Using Kelly Criterion by Automated Market Makers-like Implementations," Mathematics, MDPI, vol. 11(7), pages 1-37, March.
    8. Saengchote, Kanis & Putniņš, Talis & Samphantharak, Krislert, 2023. "Does DeFi remove the need for trust? Evidence from a natural experiment in stablecoin lending," Journal of Behavioral and Experimental Finance, Elsevier, vol. 40(C).
    9. Pietro Saggese & Esther Segalla & Michael Sigmund & Burkhard Raunig & Felix Zangerl & Bernhard Haslhofer, 2023. "Assessing the Solvency of Virtual Asset Service Providers: Are Current Standards Sufficient?," Papers 2309.16408, arXiv.org, revised Apr 2024.
    10. Tristan Lim, 2024. "Predictive crypto-asset automated market maker architecture for decentralized finance using deep reinforcement learning," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 10(1), pages 1-29, December.
    11. Nir Chemaya & Lin William Cong & Emma Jorgensen & Dingyue Liu & Luyao Zhang, 2023. "A Dataset of Uniswap daily transaction indices by network," Papers 2312.02660, arXiv.org, revised Sep 2024.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Bhambhwani, Siddharth M. & Huang, Allen H., 2024. "Auditing decentralized finance," The British Accounting Review, Elsevier, vol. 56(2).
    2. Jiahua Xu & Yebo Feng, 2022. "Reap the Harvest on Blockchain: A Survey of Yield Farming Protocols," Papers 2210.04194, arXiv.org, revised Dec 2022.
    3. Pietro Saggese & Esther Segalla & Michael Sigmund & Burkhard Raunig & Felix Zangerl & Bernhard Haslhofer, 2023. "Assessing the Solvency of Virtual Asset Service Providers: Are Current Standards Sufficient?," Papers 2309.16408, arXiv.org, revised Apr 2024.
    4. Marcin Wk{a}torek & Marcin Kr'olczyk & Jaros{l}aw Kwapie'n & Tomasz Stanisz & Stanis{l}aw Dro.zd.z, 2024. "Approaching multifractal complexity in decentralized cryptocurrency trading," Papers 2411.05951, arXiv.org.
    5. Peplluis R. Esteva & Andrés El-Fakdi & Alberto Ballesteros-Rodríguez, 2023. "Invoice Discounting Using Kelly Criterion by Automated Market Makers-like Implementations," Mathematics, MDPI, vol. 11(7), pages 1-37, March.
    6. Andrea Barbon & Angelo Ranaldo, 2021. "On The Quality Of Cryptocurrency Markets: Centralized Versus Decentralized Exchanges," Papers 2112.07386, arXiv.org, revised Sep 2024.
    7. Son, Jaemin & Ryu, Doojin, 2024. "Competitive dynamics between decentralized and centralized finance lending markets," International Review of Financial Analysis, Elsevier, vol. 96(PB).
    8. Bernhard Haslhofer & Burkhard Raunig & Pietro Saggase & Esther Segalla & Michael Sigmund & Felix Zangerl, 2023. "Assessing the Solvency of Virtual Asset Service Providers: Are Current Standards Sufficient? (Pietro Saggese, Esther Segalla, Michael Sigmund, Burkhard Raunig, Felix Zangerl, Bernhard Haslhofer)," Working Papers 248, Oesterreichische Nationalbank (Austrian Central Bank).
    9. Saggese, Pietro & Belmonte, Alessandro & Dimitri, Nicola & Facchini, Angelo & Böhme, Rainer, 2023. "Arbitrageurs in the Bitcoin ecosystem: Evidence from user-level trading patterns in the Mt. Gox exchange platform," Journal of Economic Behavior & Organization, Elsevier, vol. 213(C), pages 251-270.
    10. Teng Andrea Xu & Jiahua Xu & Kristof Lommers, 2022. "DeFi vs TradFi: Valuation Using Multiples and Discounted Cash Flow," Papers 2210.16846, arXiv.org.
    11. Marcin Wk{a}torek & Stanis{l}aw Dro.zd.z & Jaros{l}aw Kwapie'n & Ludovico Minati & Pawe{l} O'swik{e}cimka & Marek Stanuszek, 2020. "Multiscale characteristics of the emerging global cryptocurrency market," Papers 2010.15403, arXiv.org, revised Mar 2021.
    12. Bennett, Donyetta & Mekelburg, Erik & Williams, T.H., 2023. "BeFi meets DeFi: A behavioral finance approach to decentralized finance asset pricing," Research in International Business and Finance, Elsevier, vol. 65(C).
    13. Philippe Bergault & Louis Bertucci & David Bouba & Olivier Gu'eant, 2022. "Automated Market Makers: Mean-Variance Analysis of LPs Payoffs and Design of Pricing Functions," Papers 2212.00336, arXiv.org, revised Nov 2023.
    14. Nikolaus Hautsch & Christoph Scheu & Stefan Voigt, 2024. "Building trust takes time: limits to arbitrage for blockchain-based assets," Review of Finance, European Finance Association, vol. 28(4), pages 1345-1381.
    15. Kensuke Ito, 2024. "Cryptoeconomics and Tokenomics as Economics: A Survey with Opinions," Papers 2407.15715, arXiv.org.
    16. Ms. Natasha X Che & Alexander Copestake & Davide Furceri & Tammaro Terracciano, 2023. "The Crypto Cycle and US Monetary Policy," IMF Working Papers 2023/163, International Monetary Fund.
    17. Xue Dong He & Chen Yang & Yutian Zhou, 2024. "Optimal Design of Automated Market Makers on Decentralized Exchanges," Papers 2404.13291, arXiv.org, revised Nov 2024.
    18. Lennart Ante & Aman Saggu, 2024. "Time-Varying Bidirectional Causal Relationships between Transaction Fees and Economic Activity of Subsystems Utilizing the Ethereum Blockchain Network," JRFM, MDPI, vol. 17(1), pages 1-28, January.
    19. Estelle Sterrett & Waylon Jepsen & Evan Kim, 2022. "Replicating Portfolios: Constructing Permissionless Derivatives," Papers 2205.09890, arXiv.org, revised Jun 2022.
    20. Junliang Luo & Stefan Kitzler & Pietro Saggese, 2024. "Investigating Similarities Across Decentralized Financial (DeFi) Services," Papers 2404.00034, arXiv.org.

    More about this item

    Keywords

    Cryptocurrencies; Blockchain; Ethereum; Stablecoins;
    All these keywords.

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G19 - Financial Economics - - General Financial Markets - - - Other
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • L50 - Industrial Organization - - Regulation and Industrial Policy - - - General
    • O33 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Technological Change: Choices and Consequences; Diffusion Processes

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:cpr:ceprdp:18038. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://www.cepr.org .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.