Financial intermediation and risk in decentralized lending protocols

TL;DR

This paper analyzes decentralized lending protocols like Compound and Aave, estimating margins and risk indicators to understand their financial intermediation characteristics compared to traditional banking.

Contribution

It provides the first comprehensive analysis of ex-post margins and risk metrics in DeFi lending protocols, bridging DeFi and traditional financial analysis methods.

Findings

Ex-post margins are approximately 1% across all markets.

Stablecoin markets have lower margins than other markets.

Quarterly risk indicators resemble traditional banking metrics.

Abstract

We provide an overview of decentralized protocols like Compound and Aave that offer collateralized loans for cryptoasset investors. Compound and Aave are two of the most important application in the decentralized finance (DeFi) ecosystem. Using publicly available information on rates, supply and borrow activity, and accounts we analyze different elements of the protocols. In particular, we estimate ex-post margins that give a comprehensive account of the cost of financial intermediation. We find that ex-post margins considering all markets are 1% and lower for stablecoin markets. In addition, we estimate quarterly indicators regarding solvency, asset quality, earnings and market risk similar to the ones used in traditional banking. This provides a first look at the use of these metrics and a comparison between the similarities and challenges to our understanding of financial intermediation in these protocols based on tools used for traditional banking.