Phantom Liquidity in Decentralized Lending

We investigate the efficacy of liquidity mining programs in decentralized lending protocols within the blockchain ecosystem. Our research addresses three main questions: whether these programs attract meaningful (and permanent) liquidity; whether the liquidity is real or ”phantom;” and whether the liquidity creates externalities for other platform users. Leveraging a novel dataset from the Ethereum blockchain, we find that liquidity mining programs successfully attract deposits and boost platform engagement. However, the end of such programs triggers fund outflows and increases borrowing rates. We further discover that yield-aggregation strategies in which an account borrows and lends the same stablecoin dominate market activities, constituting 18% of deposits and 31% of borrowing on average (peak rates are at 80+%). Despite concerns that their extensive borrowing could increase loan rates and create negative externalities, our analysis determines that yield seekers’ net effect is beneficial, as they decrease overall net interest payments