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Decentralized Finance (DeFi): Transformative Potential & Associated Risks

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Abstract

Decentralized finance (DeFi) refers to a set of newly emerging financial products and services that operate on decentralized platforms using blockchains to record and share data. DeFi products and services are conducted without a trusted central intermediary such as a bank, and they include payments, lending and borrowing, trading and investments, capital raising (crowdfunding), and insurance. An important innovation that allowed for the development of DeFi was the growth of programming capability on blockchains. This innovation allows for the creation of computer code called smart contracts that can be invoked by users without going through a centralized intermediary. DeFi may pose financial stability risks, that are exacerbated by the fact that both are currently largely outside the prudential regulatory perimeter, which we discuss.

Suggested Citation

  • Francesca Carapella & Nathan Swem, 2022. "Decentralized Finance (DeFi): Transformative Potential & Associated Risks," Finance and Economics Discussion Series 2022-057, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2022-57
    DOI: 10.17016/FEDS.2022.057
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    References listed on IDEAS

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    Cited by:

    1. Saengchote, Kanis & Samphantharak, Krislert, 2024. "Digital money creation and algorithmic stablecoin run," Finance Research Letters, Elsevier, vol. 64(C).
    2. Tim Weingärtner & Fabian Fasser & Pedro Reis Sá da Costa & Walter Farkas, 2023. "Deciphering DeFi: A Comprehensive Analysis and Visualization of Risks in Decentralized Finance," JRFM, MDPI, vol. 16(10), pages 1-25, October.
    3. Anton Badev & Cy Watsky, 2023. "Interconnected DeFi: Ripple Effects from the Terra Collapse," Finance and Economics Discussion Series 2023-044, Board of Governors of the Federal Reserve System (U.S.).
    4. Iveta Grigorova & Aleksandar Karamfilov & Radostin Merakov & Aleksandar Efremov, 2023. "Simulation of Dynamic Performance of DeFi Protocol Based on Historical Crypto Market Behavior," Risks, MDPI, vol. 12(1), pages 1-20, December.
    5. Lioba Heimbach & Wenqian Huang, 2024. "DeFi leverage," BIS Working Papers 1171, Bank for International Settlements.

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    Keywords

    Blockchain; Crypto; DeFi; Financial stability and risk;
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