The decentralization enigma in DeFi: Impact of U.S. federal funds rate changes

Abstract

This study investigates the effect of changes in the U.S. federal funds rate on the decentralized finance (DeFi) sector. Our findings reveal that changes in the central bank's policy rate have a statistically significant and economically important counter-cyclical effect on DeFi lending rates and DeFi asset growth. Specifically, an increase in the federal funds rate leads to a decline in DeFi asset growth. This outcome challenges the perceived independence of DeFi from traditional financial systems, suggesting the existence of a “decentralization illusion.” Notably, the results show that during periods of higher DeFi growth, the effects of the DeFi lending rate and investor attention on DeFi returns are significantly more pronounced. This is unlike the magnitude of the effect of the central bank's policy rate. The findings are robust to endogeneity tests.