Can Decentralized Markets Be More Efficient?

Abstract

Decentralized markets attract large amounts of trade volume, even though they exhibit frictions absent in centralized exchanges. We develop a model with asymmetric information and expertise acquisition where some traders try to exploit any market structure to inefficiently screen their counterparties. In this environment, frictions characteristic of decentralized markets, such as time consuming search, can promote higher efficiency. First, screening behavior may be less aggressive when traders reach fewer counterparties. Second, for asset classes where information improves allocative efficiency, decentralized markets with predictable trading encounters may dominate by encouraging expertise acquisition. In contrast, when information causes adverse selection, centralized markets dominate.

JEL Classification: D82, G23, L10