BIS Study Explores Borrower Behavior in DeFi and Its Impact on Collateralized Borrowing Platforms

According to CoinDesk, a study by the Bank for International Settlements (BIS) has found that the behavior of borrowers in decentralized finance (DeFi) is crucial when considering the design of collateralized borrowing platforms with emerging tokenized assets. The authors of the study claim to be the first to document individual DeFi wallets' leverage, which is relevant to understanding financial stability concerns. Financial institutions worldwide are increasingly experimenting with tokenizing traditional assets such as bonds and securities. The workings of DeFi lending platforms offer useful insight into the risks associated with tokenization and the potential disruption of traditional finance, according to the technical study by the central bank group. The study found that DeFi borrowers generally avoid leveraging too much, as they face substantial losses upon automatic liquidation, where collateral is automatically sold when borrowers' positions become too risky. Borrowers take a conservative approach with a sizeable buffer, and DeFi users tend to deposit more if they have higher past returns. The study's authors, Lioba Heimbach and Wenqian Huang, conducted the study using data from the Ethereum blockchain, focusing on lending resilience and strategic substitution behavior. The BIS has been exploring the DeFi space for some time, working with the central banks of France, Singapore, and Switzerland to successfully test cross-border trading of wholesale central bank digital currencies and DeFi elements, specifically automated market makers. In 2022, two BIS papers said that DeFi could lead to bumpier financial markets and may not fix the problem of large intermediaries dominating. The latest study was conducted between January 2021 and March 2023 to specifically look at the largely unexplored 'intricacies of user behavior and pool dynamics within DeFi lending.' The importance of conducting the study was based on the recognition that DeFi protocols have been facilitating collateralized borrowing on an 'economically significant scale' with highs of over $35 billion in deposits and $25 billion in outstanding debt, the study said.