Opportunities and Risks in Decentralized Lending

Chuck Fang, PhD Candidate, The Wharton School

Abstract: Decentralized finance (DeFi) refers to blockchain innovations that propose a brand new alternative to the current financial system. Decentralized lending is a key building block of this vision. Currently, the amount of outstanding loans on the top 3 decentralized lending platforms are over $15 billion – this reflects phenomenal growth, as the space was nonexistent five years ago. What is decentralized lending? And what are the opportunities and risks associated with it? These are the questions that I propose to address. To be concrete, I focus on a particular kind of risk, the fire sale risk, in this proposal. The fire sale risk may arise because liquidators are given a fixed discount to purchase collateral, a key design that make the decentralization possible. Whether this fire sale risk does exist empirically and how to mitigate this risk are essential for the viability of decentralized lending.