An Empirical Study of DeFi Liquidations: Incentives, Risks, and Instabilities

Kaihua Qin, Liyi Zhou, Pablo Gamito, Philipp Jovanovic and Arthur Gervais

Papers from arXiv.org

Abstract: Financial speculators often seek to increase their potential gains with leverage. Debt is a popular form of leverage, and with over 39.88B USD of total value locked (TVL), the Decentralized Finance (DeFi) lending markets are thriving. Debts, however, entail the risks of liquidation, the process of selling the debt collateral at a discount to liquidators. Nevertheless, few quantitative insights are known about the existing liquidation mechanisms. In this paper, to the best of our knowledge, we are the first to study the breadth of the borrowing and lending markets of the Ethereum DeFi ecosystem. We focus on Aave, Compound, MakerDAO, and dYdX, which collectively represent over 85% of the lending market on Ethereum. Given extensive liquidation data measurements and insights, we systematize the prevalent liquidation mechanisms and are the first to provide a methodology to compare them objectively. We find that the existing liquidation designs well incentivize liquidators but sell excessive amounts of discounted collateral at the borrowers' expenses. We measure various risks that liquidation participants are exposed to and quantify the instabilities of existing lending protocols. Moreover, we propose an optimal strategy that allows liquidators to increase their liquidation profit, which may aggravate the loss of borrowers.

Date: 2021-06, Revised 2021-10
New Economics Papers: this item is included in nep-ban and nep-pay
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

Downloads: (external link)
http://arxiv.org/pdf/2106.06389 Latest version (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:2106.06389

Access Statistics for this paper

More papers in Papers from arXiv.org
Bibliographic data for series maintained by arXiv administrators ().