Competitive dynamics between decentralized and centralized finance lending markets

Jaemin Son and Doojin Ryu

International Review of Financial Analysis, 2024, vol. 96, issue PB

Abstract: We analyze the competitive dynamics between a decentralized financial system, called a protocol for loanable funds (PLF), and a centralized financial system. A PLF primarily differs from traditional banks in terms of its purpose and its decentralized ledger. While traditional banks pursue profit maximization, the PLF with a decentralized ledger system liquidates borrowing demand in line with the supply of deposits. We provide a theoretical framework that incorporates the differences among the lending markets to outline their competitive dynamics and suggest an optimal design for the PLF's consensus algorithm. The traditional bank incurs a cost to secure market power that depends on its degree of heterogeneity from the PLF. Our results suggest channels through which monetary policy influences the interest rates of PLFs.

Keywords: Blockchain trilemma; Centralized finance; Decentralized finance; Financial stability; Protocol for loanable funds (search for similar items in EconPapers)
JEL-codes: E44 G21 G23 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:96:y:2024:i:pb:s1057521924006318

DOI: 10.1016/j.irfa.2024.103699

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