Liquidity Fragmentation on Decentralized Exchanges

48 Pages Posted: 17 Nov 2022

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: November 14, 2022

Abstract

Liquidity providers (LPs) on decentralized exchanges pay a fixed transaction cost (gas price) whenever they update their positions. Different economies of scale across LPs lead in equilibrium to the fragmentation of liquidity supply between low- and high-fee pools. Using data on liquidity updates from Uniswap, we document that while high-fee pools attract 56% of liquidity supply, they only execute 35% of trading volume. Low-fee pools cater to large (institutional) LPs, who update positions frequently in response to large trading volume. In contrast, small (retail) LPs converge to high-fee pools, trading off lower execution probabilities against a smaller liquidity management cost.

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 (November 14, 2022). 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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