Can Decentralized Markets Be More Efficient?
Review of Financial Studies
53 Pages Posted: 11 Oct 2016 Last revised: 28 Aug 2022
Date Written: October 11, 2016
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
Suggested Citation: Suggested Citation