Cryptocurrencies and Decentralized Finance (DeFi)

From Igor Makarov and Antoinette Schoar

The financial system performs a wide array of functions that are important for economic growth and stability, such as allocating resources to their most productive use, moving capital from agents with surpluses to those with deficits, and providing efficient means for moving wealth across time and states, see for example Merton (1995) or Allen et al. (2019). To achieve these goals, the US financial system, and similarly most other countries, have traditionally relied on a set of intermediaries such as banks, brokers, exchanges etc. that are connected by payment systems. These intermediaries serve as centralized nodes that guard the access to the financial system and provide customers with essential services such as record keeping, verification of transactions, settlement, liquidity, and security. This architecture implies that intermediaries perform many of the core functions in the system, and also help with the implementation of regulatory goals such as tax reporting, anti-money-laundering laws or consumer financial protection. As a result, however, these intermediaries can hold significant power, based on their preferential access to customers and data. This centralized position, if not properly harnessed and regulated, can be a source of outsized economic rents and can lead to considerable inefficiencies. It can also lead to inherent fragility and systematic risk if core intermediaries become corrupted or investors lose trust in the system.

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Current Cryptocurrency projects from the Consumer Finance Initiative cover topics including the Terra Luna crash, crypto arbitrage and bitcoin and blockchain technology. Find more Cryptocurrency research here.