The interconnectedness of decentralized finance with the traditional financial system and potential implications for systemic risk

• Autor(a) principal: Gomes, Hugo Miguel de Araújo Veloso
• Data de Publicação: 2022
• Tipo de documento: Dissertação
• Idioma: eng
• Título da fonte: Repositório Científico de Acesso Aberto de Portugal (Repositórios Cientìficos)
• Texto Completo: http://hdl.handle.net/10400.1/19470
• topic: Decentralized finance; Interconnectedness; Systemic risk; Traditional financial system; Financial stability; Stablecoins; Domínio/Área Científica::Ciências Sociais::Outras Ciências Sociais

Decentralized Finance (DeFi) was introduced to replicate the traditional financial system in a more open and transparent way by removing intermediaries and enabling peer-to-peer interaction in a way that was not possible until now. However, with innovation, unknown risks and concerns always arise, and the case of DeFi is no different. The main objectives of this research are as follows: to understand how the DeFi ecosystem works; examine if this new technology can bring innovation to the financial system; analyze if it can be a potential threat to the global financial system stability; and understand which aspects of interconnectedness can exist between DeFi and the traditional financial system, how prone can DeFi be to systemic risk, and how this could impact the global financial system. The analysis shows that DeFi has traits that have the potential to bring great innovations to the financial system, although it also has several risks. The study shows that some of the main characteristics of DeFi are already creating a bridge between both markets; the interconnectedness between both markets is growing with the growth of the financial institutions participating in the DeFi markets. Whenever the level of interconnectedness is high, the systems tend to be more prone to systemic risk. The case of DeFi is no different. Systemic risk is present within both markets, and potential spillovers are more likely to happen with the continuous growth of interconnectedness. Regulators and policy makers will need to explore and create new ways to enforce the regulations needed to create a space where users are protected and global financial stability is assured without compromising the innovation happening within this ecosystem.