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Decentralized Exchanges: The Profitability Frontier of Constant Product Market Makers

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  • Tobias Bitterli
  • Fabian Schar

Abstract

In this paper we analyze constant product market makers (CPMMs). We formalize the liquidity providers' profitability conditions and introduce a concept we call the profitability frontier in the xyk-space. We study the effect of mint and burn fees on the profitability frontier, consider various pool types, and compile a large data set from all Uniswap V2 transactions. We use this data to further study our theoretical framework and the profitability conditions. We show how the profitability of liquidity provision is severely affected by the costs of mint and burn events relative to the portfolio size and the characteristics of the trading pair.

Suggested Citation

  • Tobias Bitterli & Fabian Schar, 2023. "Decentralized Exchanges: The Profitability Frontier of Constant Product Market Makers," Papers 2302.05219, arXiv.org, revised Mar 2023.
    • Handle: RePEc:arx:papers:2302.05219
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    References listed on IDEAS

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    1. Jiahua Xu & Krzysztof Paruch & Simon Cousaert & Yebo Feng, 2021. "SoK: Decentralized Exchanges (DEX) with Automated Market Maker (AMM) Protocols," Papers 2103.12732, arXiv.org, revised Mar 2023.
    2. Guillermo Angeris & Alex Evans & Tarun Chitra, 2020. "When does the tail wag the dog? Curvature and market making," Papers 2012.08040, arXiv.org.
    3. Mohsen Pourpouneh & Kurt Nielsen & Omri Ross, 2020. "Automated Market Makers," IFRO Working Paper 2020/08, University of Copenhagen, Department of Food and Resource Economics.
    4. Jason Milionis & Ciamac C. Moallemi & Tim Roughgarden & Anthony Lee Zhang, 2022. "Automated Market Making and Loss-Versus-Rebalancing," Papers 2208.06046, arXiv.org, revised Nov 2023.
    5. Andreas A. Aigner & Gurvinder Dhaliwal, 2021. "UNISWAP: Impermanent Loss and Risk Profile of a Liquidity Provider," Papers 2106.14404, arXiv.org.
    6. Alex Evans, 2020. "Liquidity Provider Returns in Geometric Mean Markets," Papers 2006.08806, arXiv.org, revised Jul 2020.
    7. Agostino Capponi & Ruizhe Jia, 2021. "The Adoption of Blockchain-based Decentralized Exchanges," Papers 2103.08842, arXiv.org, revised Jul 2021.
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    Cited by:

    1. Daniel Kirste & Niclas Kannengie{ss}er & Ricky Lamberty & Ali Sunyaev, 2023. "How Automated Market Makers Approach the Thin Market Problem in Cryptoeconomic Systems," Papers 2309.12818, arXiv.org, revised Sep 2023.

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