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Behavior of Liquidity Providers in Decentralized Exchanges

Author

Listed:
  • Lioba Heimbach
  • Ye Wang
  • Roger Wattenhofer

Abstract

Decentralized exchanges (DEXes) have introduced an innovative trading mechanism, where it is not necessary to match buy-orders and sell-orders to execute a trade. DEXes execute each trade individually, and the exchange rate is automatically determined by the ratio of assets reserved in the market. Therefore, apart from trading, financial players can also liquidity providers, benefiting from transaction fees from trades executed in DEXes. Although liquidity providers are essential for the functionality of DEXes, it is not clear how liquidity providers behave in such markets. In this paper, we aim to understand how liquidity providers react to market information and how they benefit from providing liquidity in DEXes. We measure the operations of liquidity providers on Uniswap and analyze how they determine their investment strategy based on market changes. We also reveal their returns and risks of investments in different trading pair categories, i.e., stable pairs, normal pairs, and exotic pairs. Further, we investigate the movement of liquidity between trading pools. To the best of our knowledge, this is the first work that systematically studies the behavior of liquidity providers in DEXes.

Suggested Citation

  • Lioba Heimbach & Ye Wang & Roger Wattenhofer, 2021. "Behavior of Liquidity Providers in Decentralized Exchanges," Papers 2105.13822, arXiv.org, revised Oct 2021.
    • Handle: RePEc:arx:papers:2105.13822
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    File URL: http://arxiv.org/pdf/2105.13822
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    References listed on IDEAS

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    1. Alex Evans & Guillermo Angeris & Tarun Chitra, 2021. "Optimal Fees for Geometric Mean Market Makers," Papers 2104.00446, arXiv.org.
    2. Alex Evans, 2020. "Liquidity Provider Returns in Geometric Mean Markets," Papers 2006.08806, arXiv.org, revised Jul 2020.
    3. Ye Wang & Yan Chen & Haotian Wu & Liyi Zhou & Shuiguang Deng & Roger Wattenhofer, 2021. "Cyclic Arbitrage in Decentralized Exchanges," Papers 2105.02784, arXiv.org, revised Jan 2022.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Arman Abgaryan & Utkarsh Sharma, 2023. "Dynamic Function Market Maker," Papers 2307.13624, arXiv.org.
    2. Deborah Miori & Mihai Cucuringu, 2024. "Clustering Uniswap v3 traders from their activity on multiple liquidity pools, via novel graph embeddings," Digital Finance, Springer, vol. 6(1), pages 113-143, March.
    3. Annetta Ho & Cosmin Cazan & Andrew Schrumm, 2024. "The Ecology of Automated Market Makers," Discussion Papers 2024-12, Bank of Canada.
    4. Pietro Saggese & Michael Frowis & Stefan Kitzler & Bernhard Haslhofer & Raphael Auer, 2025. "Towards Verifiability of Total Value Locked (TVL) in Decentralized Finance," Papers 2505.14565, arXiv.org.
    5. Thanos Drossos & Daniel Kirste & Niclas Kannengie{ss}er & Ali Sunyaev, 2025. "Automated Market Makers: Toward More Profitable Liquidity Provisioning Strategies," Papers 2501.07828, arXiv.org.
    6. Erhan Bayraktar & Asaf Cohen & April Nellis, 2024. "DEX Specs: A Mean Field Approach to DeFi Currency Exchanges," Papers 2404.09090, arXiv.org.
    7. Jan Arvid Berg & Robin Fritsch & Lioba Heimbach & Roger Wattenhofer, 2022. "An Empirical Study of Market Inefficiencies in Uniswap and SushiSwap," Papers 2203.07774, arXiv.org, revised May 2022.
    8. Lioba Heimbach & Eric Schertenleib & Roger Wattenhofer, 2022. "Risks and Returns of Uniswap V3 Liquidity Providers," Papers 2205.08904, arXiv.org, revised Sep 2022.
    9. Andrea Canidio & Robin Fritsch, 2023. "Arbitrageurs' profits, LVR, and sandwich attacks: batch trading as an AMM design response," Papers 2307.02074, arXiv.org, revised Feb 2025.
    10. 'Alvaro Cartea & Fayc{c}al Drissi & Marcello Monga, 2023. "Decentralised Finance and Automated Market Making: Execution and Speculation," Papers 2307.03499, arXiv.org, revised Jul 2024.
    11. Marcello Monga, 2024. "Automated Market Making and Decentralized Finance," Papers 2407.16885, arXiv.org.
    12. Deborah Miori & Mihai Cucuringu, 2022. "DeFi: data-driven characterisation of Uniswap v3 ecosystem & an ideal crypto law for liquidity pools," Papers 2301.13009, arXiv.org, revised Jan 2023.

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