Liquidity Fragmentation on Decentralized Exchanges
52 Pages Posted: 17 Nov 2022 Last revised: 3 Oct 2023
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: Suggested Citation