Federal Reserve Bank Researcher Suggests DeFi May Lead To A More Robust and Transparent Financial Infrastructure

In a recent research paper published by the Research Division of the Federal Reserve Bank of St. Louis (regarded as the top 1% of all economic research departments worldwide ¹), suggests that Decentralised Finance (DeFi) could potentially lead to a paradigm shift in the financial industry.

The research includes an in-depth, highly technical analysis of the main areas of DeFi technology including smart contracts, the use of stablecoins and opportunities and risks.

What is DeFi

The paper explains DeFi as “The term generally refers to an open, permissionless, and highly interoperable protocol stack built on public smart contract platforms, such as the Ethereum blockchain. It replicates existing financial services in a more open and transparent way. In particular, DeFi does not rely on intermediaries and centralized institutions.”.

We have recently seen the DeFi marketcap surpass $10 Billion and some DeFi coins go parabolic in price during our market analysis news articles.

Opportunities

DeFi may increase the efficiency, transparency, and accessibility of the financial infrastructure. Moreover, the system’s composability allows anyone to combine multiple applications and protocols, thereby creating new and exciting services.

Risks

DeFi also has certain risks, namely, smart contract execution risk, operational security, and dependencies on other protocols and external data.

DeFi Applications

The paper explains DeFi applications: “DeFi already offers a wide variety of applications. For example, one can buy U.S. dollar (USD)-pegged assets (so-called stablecoins) on decentralized exchanges, move these assets to an equally decentralized lending platform to earn interest, and subsequently add the interest-bearing instruments to a decentralized liquidity pool or an on-chain investment fund.”

DeFi Architecture

DeFi uses a multi-layered architecture, as seen below.

The paper then goes onto explain the following topics in great detail:

• Decentralized Exchange Protocols
• Smart Contract-Based Reserve Aggregation
• Peer-to-Peer Protocols
• Decentralized Lending Platforms
• Collateralized Debt Positions
• Decentralized Derivatives
• On-Chain Asset Management

Conclusion

It’s great to see this type of research being done, as it explains everything in tremendous detail. And also takes into account both sides of the risks and potential use cases of DeFi in the future. Find out more about Economic Research at the St. Louis Fed.

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[1] As determined by the citation ranking tracked by the independent, volunteer-run RePEc service