Price Discovery on Decentralized Exchanges
51 Pages Posted: 17 Oct 2022 Last revised: 16 Jun 2023
Date Written: June 15, 2023
In contrast to centralized exchanges, decentralized exchanges (DEXs) process orders in discrete time and require traders to bid a priority fee to determine the execution priority. We employ a structural vector-autoregressive model to provide evidence that the priority fee reveals the private information of a DEX trade, contributing to price discovery. A one standard deviation shock in the high-fee DEX trade flow leads to a permanent price impact between 4.27 and 8.16 basis points. We show that informed traders bid high fees not only to reduce execution risk but also to compete with each other. Using a unique dataset of Ethereum mempool orders, we lend support to the hypothesis that informed traders primarily compete on DEXs following a jump-bidding strategy.
Keywords: price discovery, blockchain fees, decentralized exchanges, informed traders, private information
JEL Classification: G10, G23, G14
Suggested Citation: Suggested Citation