Price Discovery in Constant Product Markets

Abstract

I study how manual, algorithmic, and arbitrage trading, alongside liquidity provision,
contribute to price discovery on the leading constant product market, Uniswap.
Arbitrageurs, known as MEV searchers, akin to high-frequency traders in
traditional markets, are pivotal in correcting transitory pricing errors, contributing
to over 50% of price discovery. This underscores a positive aspect of this trading
group, otherwise infamous for its adverse selection. In contrast, algorithmic trading
accounts for 8% of price discovery, while manual trading
and liquidity provision have no impact.

Keywords: Price discovery, Constant product market, Automated market maker, Decentralized exchange, Cryptocurrency, Decentralized finance, Blockchain, Ethereum, MEV

JEL Classification: C55, C57, E42, G12, G14, G23