DeFi : Mirage or reality? Unveiling wealth centralization risk in Decentralized Finance

This study examines centralization risk in decentralized finance (DeFi), with a focus on the impact of wealth concentration on risk exposure across its key components. An analysis of the top 58,600 wallet addresses from 586 projects among the top 1,000 DeFi tokens reveals significant centralization, particularly within layer-3 tokens. Using value at risk and expected shortfall measures, the analysis reveals heightened risk for stablecoins and decentralized autonomous organization (DAO) tokens, while oracles, smart contracts, and governance tokens remain largely unaffected by wealth centralization. Further analysis with the standard GARCH model and time-varying parameter vector autoregression (TVP-VAR) scaled by the wealth concentration ratio (WCR) reveals that DAOs generate much of their risk internally. Stablecoins, serving as critical stabilizing agents within DeFi, absorb systemic risk without transmitting it back, unlike oracle tokens. This reliance on stablecoins during volatile conditions underscores their unique risk absorber role. The internal risk dynamics of DAOs, driven by the wealthiest stakeholders, amplify vulnerabilities within DeFi and extend their influence to Bitcoin. These findings challenge the traditional understanding of DeFi, showing how wealth concentration reshapes risk exposure beyond the DeFi ecosystem, with far-reaching consequences.