Coexisting Exchange Platforms: Limit Order Books and Automated Market Makers

Abstract

Blockchain-based decentralized exchanges have adopted automated market makers (AMM)—algorithms that aggregate liquidity and automatically set asset prices. This paper analyzes coexisting market structures, a limit-order book (LOB) and an AMM, to investigate their interactions in terms of liquidity. Based on their fundamental design differences, we show that fluctuations in liquidity in the AMM stimulate disproportionate reactions from informed and noise traders, leading to a positive spillover effect on liquidity in the LOB market. Furthermore, unlike models that primarily focus on the AMM, the coexisting environment leads to a hump-shaped reaction of liquidity supply in the AMM to asset volatility.

Keywords: decentralized exchanges, automated market makers, limit order books, liquidity, asymmetric information JEL code: G1, D4

JEL Classification: G1, D4