Can simple markets survive? Exploring the tradeoffs of AMM complexity

Abstract

Decentralized exchanges emphasize their simplicity and accessibility as compared to traditional financial markets, yet Uniswap V3 adds complexity with concentrated liquidity and flexible fee-tiers. Our analysis reveals that pools transitioning to V3 exhibit enhanced overall liquidity and trading volume. Notably, liquidity providers in V3 achieve higher fee returns per dollar invested, while liquidity takers benefit from reduced transaction costs compared to V2. However, these advantages disproportionately favor sophisticated liquidity providers, disadvantaging less sophisticated participants. When markets are turbulent, V2 acts as the market of last resort. These findings highlight the trade-offs between V3's enhanced functionality and its uneven impact across participants and varying market conditions.

Keywords: Market Design, Market Making, Liquidity, Cryptocurrency, Decentralized Finance, G14, Uniswap, Automated Market Maker, Blockchain, D47

JEL Classification: D47, G10