Coexisting Exchange Platforms: Limit Order Books and Automated Market Makers

Abstract

Blockchain-based decentralized exchanges have adopted automated market makers—algorithms that pool liquidity and make it available to liquidity takers by automatically determining prices. We develop a theoretical framework to analyze coexisting market-making structures: a traditional centralized limit-order market and a decentralized automated market. Traders face asymmetric information and endogenously choose trading venues. We show that liquidity on the automated market complements that on the limit-order market. A unique and stable general equilibrium exists with endogenous liquidity on both platforms, and we investigate the impact of adopting automated market makers on asset prices and traders' behavior.

Keywords: decentralized exchanges, automated market makers, limit order books, liquidity, asymmetric information

JEL Classification: G1, D4