Drivers of asset returns in Decentralised Finance

Decentralised Finance (DeFi), a direct peer-to-peer financial system without intermediaries, has been gaining popularity in recent times and attracting attention from investors and regulators alike. The low entry barrier, together with

huge profit potentials, has made DeFi assets an attractive option for investors. However, participants in this market are also exposed to a high level of volatility and risk as prices can fluctuate strongly on a daily basis. To succeed in this environment, investors need to develop a solid understanding about different aspects of these digital assets.

Purpose & Aim

Return is one of the most fundamental aspects of financial assets in general and DeFi assets in particular. Investors are very interested in returns because they affect their performance directly. This project aims to explore, identify and analyse important drivers of DeFi asset returns. The starting point could be adapting well-known factors in other asset classes. For instance, we can consider DeFi market indices, similar to stock market indices in CAPM and Fama-French factor models, among others. We can also investigate factors specific to the DeFi market (e.g. related to blockchain).

Research questions

1. What are the key drivers of DeFi asset returns and how do they affect DeFi asset returns?

2. Are these drivers similar to or different from those in asset pricing of traditional assets (e.g. stock, bond)?

3. How do these drivers and their effects change over time?

4. How do these drivers and their effects change in different market conditions (e.g. bull vs bear market)?

Contribution

This project will contribute to the asset pricing literature, especially for the emerging DeFi market. Findings from this project have direct implications for market participants and practitioners. Understanding the return generating process will give investors an edge to achieve better results, maximising their profits while managing risks.