Illiquidity Risks in Lending Protocols (LPs): Evidence from Aave Protocol

Sun, Xiaotong

doi:10.2139/ssrn.3985105

Cited by 4 publications

(2 citation statements)

References 69 publications

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“…They found that deposits are often very concentrated which presents a significant liquidity risk. Sun et al [11] investigate liquidity risks focusing on Aave, a popular lending protocol. They analyse the behaviour of a small group of users who are both borrowers and depositors.…”

Section: Introductionmentioning

confidence: 99%

DeFi Lending Platform Liquidity Risk: The Example of Folks Finance

Häfner¹,

Luze²,

Greber³

et al. 2023

The JBBA

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Decentralised finance (DeFi) lending platforms may experience liquidity risk, which occurs when users are unable to withdraw their assets. Researchers and practitioners have found that the concentration of deposits among a small group of users is one of the main drivers of liquidity risk. Typically, lending platforms experience high concentration at the beginning of their operations. As a result, they face a significant liquidity risk that has not been investigated so far. This article closes this gap by investigating liquidity risk from the perspective of a new lending platform, describing the use case of Folks Finance. First, we describe the liquidity risk the lending protocol faces using platform economics. Second, we theoretically assess the efficacy of different liquidity risk measurements. Third, we investigate how a reward mechanism can reduce liquidity risk. We show that the liquidity risk is more pronounced for a new lending platform than for an incumbent protocol. In addition, we find that the Herfindahl-Hirschman index (HHI) outperforms other liquidity risk measurements. Finally, we show that if rewards are sufficient but not too large, a programme that incentivises depositors to lock their assets can reduce liquidity risk and increase liquidity bootstrapping. Several conclusions are drawn from the case study: First, new lending platforms should be particularly cautious regarding liquidity risk. Second, lending protocols should use HHI instead of other concentration measurements when calibrating their parameters. Third, rewards can be used to bootstrap liquidity and incentivise liquidity holdings but should not be overused.

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Section: Introductionmentioning

confidence: 99%

DeFi Lending Platform Liquidity Risk: The Example of Folks Finance

Häfner¹,

Luze²,

Greber³

et al. 2023

The JBBA

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“…Instances of illiquidity have been documented, especially in newly established platforms [13,15,27]. Our paper investigates whether liquidity pools are likely to become illiquid and explores how such an occurrence might propagate across Compound's network.…”

Section: Introductionmentioning

confidence: 99%

Contagion in Decentralized Lending Protocols: A Case Study of Compound

Tovanich,

Kassoul,

Weidenholzer

et al. 2023

Proceedings of the 2023 Workshop on Decentralized Finance and Security

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