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DeFi Protocols for Loanable Funds: Interest Rates, Liquidity and Market Efficiency

Published: 26 October 2020 Publication History

Abstract

We coin the term Protocols for Loanable Funds (PLFs) to refer to protocols which establish distributed ledger-based markets for loanable funds. PLFs are emerging as one of the main applications within Decentralized Finance (DeFi), and use smart contract code to facilitate the intermediation of loanable funds. In doing so, these protocols allow agents to borrow and save programmatically. Within these protocols, interest rate mechanisms seek to equilibrate the supply and demand for funds. In this paper, we review the methodologies used to set interest rates on three prominent DeFi PLFs, namely Compound, Aave and dYdX. We provide an empirical examination of how these interest rate rules have behaved since their inception in response to differing degrees of liquidity. We then investigate the market efficiency and inter-connectedness between multiple protocols, examining first whether Uncovered Interest Parity holds within a particular protocol and second whether the interest rates for a particular token market show dependence across protocols, developing a Vector Error Correction Model for the dynamics.

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  1. DeFi Protocols for Loanable Funds: Interest Rates, Liquidity and Market Efficiency

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    cover image ACM Conferences
    AFT '20: Proceedings of the 2nd ACM Conference on Advances in Financial Technologies
    October 2020
    275 pages
    ISBN:9781450381390
    DOI:10.1145/3419614
    Permission to make digital or hard copies of all or part of this work for personal or classroom use is granted without fee provided that copies are not made or distributed for profit or commercial advantage and that copies bear this notice and the full citation on the first page. Copyrights for components of this work owned by others than the author(s) must be honored. Abstracting with credit is permitted. To copy otherwise, or republish, to post on servers or to redistribute to lists, requires prior specific permission and/or a fee. Request permissions from [email protected].

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    Published: 26 October 2020

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    Author Tags

    1. Borrowing
    2. Cryptocurrencies
    3. DeFi Blockchain
    4. Ethereum
    5. Lending
    6. Protocols for Loanable Funds

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    • (2025)Option Contracts in the DeFi Ecosystem: Opportunities, Solutions, and Technical ChallengesInternational Journal of Network Management10.1002/nem.7000535:2Online publication date: 16-Feb-2025
    • (2024)Integration of Artificial Intelligence in DeFiDecentralized Finance and Tokenization in FinTech10.4018/979-8-3693-3346-4.ch009(148-170)Online publication date: 21-Jun-2024
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