Working Paper: NBER ID: w30006
Authors: Igor Makarov; Antoinette Schoar
Abstract: The paper provides an overview of cryptocurrencies and decentralized finance. The discussion lays out potential benefits and challenges of the new system and presents a comparison to the traditional system of financial intermediation. Our analysis highlights that while the DeFi architecture might have the potential to reduce transaction costs, similar to the traditional financial system, there are several layers where rents can accumulate due to endogenous constraints to competition. We show that the permissionless and pseudonymous design of DeFi generates challenges for enforcing tax compliance, anti-money laundering laws, and preventing financial malfeasance. We highlight ways to regulate the DeFi system which would preserve a majority of benefits of the underlying blockchain architecture but support accountability and regulatory compliance.
Keywords: cryptocurrencies; decentralized finance; DeFi; financial intermediation; blockchain
JEL Codes: G1; G2; G20; G21; G23; G3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| DeFi architecture (G21) | reduce transaction costs (D23) |
| DeFi architecture (G21) | challenges for enforcing tax compliance (H26) |
| challenges for enforcing tax compliance (H26) | negative externalities on the economy (D62) |
| DeFi architecture (G21) | systemic risk (E44) |