Liquidity Risks in Lending Protocols (LPs): Evidence from Aave Protocol
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Decentralized Finance (DeFi) can replicate most traditional financial activities. Among various DeFi, Lending Protocols (LPs) resemble banks, allowing users to borrow and lend cryptocurrencies. By analysing stablecoin loans in Aave protocol, we find a small group of users with dual roles, i.e., borrowers and depositors, and these users account for significant loans and deposits. Therefore, potential liquidity risks can occur if these users collectively withdraw deposits and initiate loans, and potential liquidity risks can affect both loan-specific factors and status of Aave protocol. Surprisingly, liquidity risks in Aave are related to other LPs, implying illiquidity is infectious in DeFi.
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