1. DECENTRALIZED FINANCE (DEFI)
Understanding Risks in an Emerging Financial Paradigm
Bernhard Haslhofer
Annual Conference of the Austrian Blockchain Center (ABC)
2021-03-23

2. SOME CONTEXT

3. GOAL FOR TODAY
3
What is DeFi?
What are the risks
in DeFi?
What can we do?

4. TRADITIONAL VS. DECENTRALIZED FINANCE
[inspired by Zetzsche et al., 2020]
Investment Banking
Derivatives & Forex
Private Banking
Insurance
Traditional Finance Decentralized Finance
Loans Assets Derivatives Exchanges
Distributed Ledger
Smart Contracts

5. • Non-custodial: pseudo-anonymous actors have full control over
their funds at any time
• Permissionless: anyone can interact with DeFi services
• Transparent: anyone can investigate and audit the state of
protocols
• Composable: financial services can be arbitrarily composed into
new financial produces and services (“Financial Lego”)
DEFI | PROPERTIES
5
[based on Werner et al., 2021]
Loans Assets Derivatives Exchanges
Distributed Ledger
Smart Contracts

6. DEFI PROTOCOLS | SELECTION
Source: https://defipulse.com/
Project Locked (USD) Blockchain
Lending Maker
Compound
Aave
7.05 B
6.73 B
5.12 B
Ethereum
DEX SushiSwap
Uniswap
Curve Finance
4.60 B
4.26 B
4.21 B
Ethereum
Derivatives Synthetix
Nexus Mutual
HEGIC
2.19 B
292 M
75 M
Ethereum
Assets Badger DAO
RenVM
Vesper
1.39 B
774.7 M
739.1 M
Ethereum
(March 19th, 2021)

7. DEFI PROTOCOLS | EVOLUTION
7
Source: https://defipulse.com/

8. EXAMPLE | COMPOUND LENDING
8
Borrowing Agent Compound
Comptroller
Escrow collateral asset (ETH, ERC20)
Borrow asset (CErc20, CEther)
Redeem collateral asset (ETH, ERC20)
Repay borrowed asset (CErc20, CEther)

9. GOAL FOR TODAY
9
What is DeFi?
What are the risks
in DeFi?
What can we do?

10. TECHNICAL RISKS | OVERVIEW
10
[inspired by Werner et al., 2021]
P2P Overlay Network
Distributed Ledger
(Consensus + State Replication)
Applications
(Smart Contracts)
Nodes
Smart Contract Vulnerabilities
Transaction Ordering
Attacks
Network Congestion
An adversarial agent can
gain profits by exploiting the
technical structure and design
of a blockchain system

11. EXAMPLE | FRONT RUNNING
11
Everyone and everything has a partial view of the mempool (order book)
…. also, non-mining nodes and bots.
Inspired by Matteo Romiti, 2021

12. EXAMPLE | FRONT RUNNING
12
Traditional Finance Decentralized Finance
Entering a trade or contract
with advance knowledge of a transaction that
will influence the price of the underlying security
to capitalize on the trade.
This practice is expressly forbidden by the SEC.
Traders are not allowed to act on nonpublic
information to trade ahead of customers lacking
that knowledge.
Submit a transaction which is intended to be
executed before some other transaction.
An agent may financially benefit from front-running
one or more victim transactions.
This common practice is not forbidden by anyone.
Bots act on public information to trade ahead of
other user lacking the technical skills and/or
understanding.

13. Oracles
SOCIO-ECONOMIC RISKS | OVERVIEW
13
P2P Overlay Network
Distributed Ledger
(Consensus + State Replication)
Applications
(Smart Contracts)
Nodes
Incentive Models
Governance Models Miner Behavior
Oracle
Manipulation
Miner Extracted
Value
Under-
collateralization
Governance
Attacks

14. SYSTEMIC RISKS
14
DeFi protocols can be composed to construct complex, inter-connected
financial systems and services (“Financial Lego”).
P1 P3
P2
P4 P5
P6

15. SYSTEMIC RISKS
15
DeFi protocols can be composed to construct complex, inter-connected
financial systems and services (“Financial Lego”).
P1 P3
P4
P5
P6

16. GOAL FOR TODAY
16
What is DeFi?
What are the risks
in DeFi?
What can we do?

17. UNDERSTANDING DEFI PROTOCOLS
17

18. UNDERSTANDING DEFI COMPOSITIONS
18
P1
P3
P2
P4
P5
P6

19. FURTHER INFORMATION
19
https://graphsense.info
https://www.csh.ac.at/complexity-science/Cryptofinance/
bernhard.haslhofer@ait.ac.at
contact@graphsense.info

20. • [Böhme., 2019]: A Primer on Economics for Cryptocurrencies (https://bdlt.school/files/slides/talk-rainer-
b%C3%B6hme-a-primer-on-economics-for-cryptocurrencies.pdf)
• [Zetzsche et al., 2020]: Decentralized Finance (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3539194)
• [Gudgeon et al., 2020]: The Decentralized Financial Crisis: Attacking DeFi (https://arxiv.org/pdf/2002.08099.pdf)
• [Werner et al., 2021]: SoK: Decentralized Finance (DeFi) (https://arxiv.org/abs/2101.08778)
REFERENCES