Main Conference Day OneTuesday, 17 November 2026 - GMT (Greenwich Mean Time, GMTZ)

We analyse liquidity risk in decentralised finance (DeFi) lending protocols, focusing on bad debt arising from toxic liquidations and liquidity pool depletion caused by large-scale liquidations or bank-run-like dynamics. We examine how inadequate liquidity management can generate systemic vulnerabilities and pro-cyclical feedback effects, even in systems that appear robust under normal conditions. Although over-collateralisation is intended to protect lending platforms, it remains unclear whether this mechanism alone is sufficient to prevent bad debt accumulation or liquidity shortages capable of triggering contagion across the wider DeFi ecosystem. To address these issues, the paper develops an agent-based model of an Aave-like decentralised lending protocol to analyse the incidence, scale, and dynamics of liquidity risk events. Particular attention is given to the interaction between liquidation mechanisms, protocol parameters, and user incentives in generating instability and pro-cyclical behaviour.