Does DeFi remove the need for trust? Evidence from a natural experiment in stablecoin lending

TL;DR

This paper investigates whether DeFi truly eliminates the need for trust by analyzing a natural experiment involving a DeFi protocol that exposed user identities, revealing that trust in individuals remains relevant due to smart contract limitations.

Contribution

The study provides empirical evidence that DeFi does not fully remove the need for trust, highlighting the importance of individual trust due to smart contract incompleteness.

Findings

DeFi does not fully eliminate trust in individuals.

Smart contracts are incomplete and susceptible to run risk.

Personal character remains relevant in DeFi transactions.

Abstract

Decentralized Finance (DeFi) is built on a fundamentally different paradigm: rather than having to trust individuals and institutions, participants in DeFi potentially only have to trust computer code that is enforced by a decentralized network of computers. We examine a natural experiment that exogenously stress tests this alternative paradigm by revealing the identities of individuals associated with a DeFi protocol, including a convicted criminal. We find that, in practice, DeFi does not (yet) fully remove the need for trust in individuals. Our findings suggest that that because smart contracts are incomplete, they are subject to run risk (Allen and Gale, 2004) and personal character and trust of individuals are still relevant in this alternative financial system.