Paper: arXiv 2410.19107

Abstract

We study liquidity on decentralized exchanges (DEXs), identifying factors at the platform, blockchain, token pair, and liquidity pool levels with predictive power for market depth metrics. We introduce the v2 counterfactual spread metric, a novel criterion which assesses the degree of liquidity concentration in pools using the ``concentrated liquidity’’ mechanism, allowing us to decompose the effect of a factor on market depth into two channels: total value locked (TVL) and concentration. We further explore how external liquidity from competing DEXs and private inventory on DEX aggregators influence market depth. We find that (i) gas prices, returns, and a DEX’s share of trading volume affect liquidity through concentration, (ii) internalization of order flow by private market makers affects TVL but not the overall market depth, and (iii) volatility, fee revenue, and markout affect liquidity through both channels.

Complexity vs Empirical Score

  • Math Complexity: 6.0/10
  • Empirical Rigor: 7.5/10
  • Quadrant: Holy Grail

Why this score: The paper introduces a novel mathematical metric (v2 counterfactual spread) and employs regression analysis on a comprehensive dataset spanning multiple blockchains over three years, demonstrating significant empirical rigor.

Research Flowchart

  flowchart TD
  A["Research Goal:<br>Identify drivers of liquidity on DEXs"]
  B["Data & Methodology:<br>Uniswap v3 pool data & novel<br>v2 counterfactual spread metric"]
  C["Computational Process:<br>Decompose effects into<br>TVL and Concentration channels"]
  D["Key Findings 1:<br>Gas, Returns, Volume share →<br>Concentration channel"]
  E["Key Findings 2:<br>Internalized flow →<br>TVL channel only"]
  F["Key Findings 3:<br>Volatility, Fee Revenue, Markout →<br>Both TVL & Concentration"]

  A --> B
  B --> C
  C --> D
  C --> E
  C --> F

Cited References (47)

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  6. Liquidity and stock returns (1986)
  7. Toxicity-Competitiveness Trade-off in Concentrated Liquidity Provision (2024)
  8. Uniswap v2 Core (2020)
and 39 more
  1. Just-in-time Liquidity on the Uniswap Protocol (2020)
  2. Uniswap v3 Core (2021)
  3. The 1inch network releases a major upgrade, fusion (2022)
  4. Introducing the UniswapX Protocol (2022)
  5. General faq.
  6. Flash boys 2.0: Frontrunning, transaction reordering, and consensus instability in decentralized exchanges (2019) — link
  7. Don’t Let MEV Slip: The Costs of Swapping on the Uniswap Protocol — → 2309.13648
  8. Decentralized Exchange: The Uniswap Automated Market Maker (2024)
  9. On the quality of cryptocurrency markets: Centralized versus decentralized exchanges (2021) — link
  10. Price discovery on decentralized exchanges (2023)
  11. Liquidity Provision on Blockchain-based Decentralized Exchanges (2025)
  12. Improved price oracles: constant function market makers (2020)
  13. Formal specification of constant product (xy= k) market maker model and implementation (2018)
  14. Finding the right curve: Optimal design of constant function market makers (2023)
  15. An axiomatic characterization of cfmms and equivalence to prediction markets (2023) — link
  16. Risks and Returns of Uniswap V3 Liquidity Providers (2022)
  17. A Comparison of Impermant Loss for Various CFMMs (2024)
  18. Automated Market Making and Loss-Versus-Rebalancing (2022) — link
  19. Automated Market Making and Arbitrage Profits in the Presence of Fees — → 2305.14604
  20. Does Market Efficiency Impact Capital Allocation Efficiency? The Case of Decentralized Exchanges (2024)
  21. Decentralised Finance and Automated Market Making: Predictable Loss and Optimal Liquidity Provision (2024)
  22. Strategic Liquidity Provision in Uniswap V3 (2023)
  23. Price Discovery in Cryptocurrencies: Trades versus Liquidity Provision (2023)
  24. The Power of Default: Measuring the Effect of Slippage Tolerance in Decentralized Exchanges (2023)
  25. Fragmentation and Optimal Liquidity Supply on Decentralized Exchanges — → 2307.13772
  26. Learning Financial Innovations: Experience from Automated Market Makers (2024)
  27. Yield Farming for Liquidity Provision (2024)
  28. Implied Impermanent Loss: A Cross-Sectional Analysis of Decentralized Liquidity Pools (2024)
  29. How to measure the liquidity of cryptocurrency markets? (2021)
  30. A study of blockchain-based liquidity cross-chain model (2024)
  31. The Paradox of Just-in-Time Liquidity in Decentralized Exchanges: More Providers Can Lead to Less Liquidity (2023)
  32. Competition in the Cryptocurrency Exchange Market (2024)
  33. Just-in-time Liquidity on the Uniswap Protocol (2022)
  34. Quantifying Price Improvement in Order Flow Auctions — → 2405.00537
  35. Market Liquidity and Funding Liquidity (2009)
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  37. Market Liquidity and Trading Activity (2001)
  38. Measuring treasury market liquidity (2001)
  39. Understanding FX liquidity (2015)

4 of 47 cited works are in the corpus; resolved via arXiv source bundles, Semantic Scholar and OpenAlex. Corpus-wide: 2518 linked papers.