Liquidity Fragmentation on Decentralized Exchanges

52 Pages Posted: 17 Nov 2022 Last revised: 3 Oct 2023

See all articles by Alfred Lehar

Alfred Lehar

University of Calgary - Haskayne School of Business

Christine A. Parlour

University of California, Berkeley - Finance Group

Marius Zoican

University of Toronto at Mississauga - Department of Management; University of Toronto - Rotman School of Management

Date Written: October 3, 2023

Abstract

We study economies of scale in liquidity provision on decentralized exchanges, focusing on the impact of fixed transaction costs such as gas prices on liquidity providers (LPs). Small LPs are disproportionately affected by the fixed cost, resulting in liquidity supply fragmentation between low- and high-fee pools. Analyzing Uniswap data, we find that high-fee pools attract 58% of liquidity supply but execute only 21% of trading volume. Large (institutional) LPs dominate low-fee pools, frequently adjusting positions in response to substantial trading volume. In contrast, small (retail) LPs converge to high-fee pools, accepting lower execution probabilities to mitigate smaller liquidity management costs.

Keywords: FinTech, decentralized exchanges (DEX), liquidity, fragmentation

JEL Classification: G11, G12, G14

Suggested Citation

Lehar, Alfred and Parlour, Christine A. and Zoican, Marius, Liquidity Fragmentation on Decentralized Exchanges (October 3, 2023). Available at SSRN: https://ssrn.com/abstract=4267429 or http://dx.doi.org/10.2139/ssrn.4267429

Alfred Lehar

University of Calgary - Haskayne School of Business ( email )

2500 University Drive, NW
Calgary, Alberta T2N 1N4
Canada
403-220-4567 (Phone)

HOME PAGE: http://homepages.ucalgary.ca/~alehar/

Christine A. Parlour

University of California, Berkeley - Finance Group ( email )

Haas School of Business
545 Student Services Building
Berkeley, CA 94720
United States
510-643-9391 (Phone)

Marius Zoican (Contact Author)

University of Toronto at Mississauga - Department of Management ( email )


Canada

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

HOME PAGE: http://www.mariuszoican.com

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