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Decentralised Finance and Automated Market Making: Execution and Speculation

Author

Listed:
  • 'Alvaro Cartea
  • Fayc{c}al Drissi
  • Marcello Monga

Abstract

Automated market makers (AMMs) are a new prototype of trading venues which are revolutionising the way market participants interact. At present, the majority of AMMs are constant function market makers (CFMMs) where a deterministic trading function determines how markets are cleared. A distinctive characteristic of CFMMs is that execution costs are given by a closed-form function of price, liquidity, and transaction size. This gives rise to a new class of trading problems. We focus on constant product market makers and show how to optimally trade a large position in an asset and how to execute statistical arbitrages based on market signals. We employ stochastic optimal control tools to devise two strategies. One strategy is based on the dynamics of prices in competing venues and assumes constant liquidity in the AMM. The other strategy assumes that AMM prices are efficient and liquidity is stochastic. We use Uniswap v3 data to study price, liquidity, and trading cost dynamics, and to motivate the models. Finally, we perform consecutive runs of in-sample estimation of model parameters and out-of-sample liquidation and arbitrage strategies to showcase the performance of the strategies.

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  • 'Alvaro Cartea & Fayc{c}al Drissi & Marcello Monga, 2023. "Decentralised Finance and Automated Market Making: Execution and Speculation," Papers 2307.03499, arXiv.org.
    • Handle: RePEc:arx:papers:2307.03499
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    References listed on IDEAS

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    1. Jonathan Chiu & Thorsten V Koeppl, 2019. "Blockchain-Based Settlement for Asset Trading," The Review of Financial Studies, Society for Financial Studies, vol. 32(5), pages 1716-1753.
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    3. Philippe Bergault & Fayçal Drissi & Olivier Guéant, 2022. "Multi-asset Optimal Execution and Statistical Arbitrage Strategies under Ornstein--Uhlenbeck Dynamics," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) hal-03680071, HAL.
    4. Philippe Bergault & Fayçal Drissi & Olivier Guéant, 2022. "Multi-asset Optimal Execution and Statistical Arbitrage Strategies under Ornstein--Uhlenbeck Dynamics," Post-Print hal-03680071, HAL.
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    Cited by:

    1. Roger Lee, 2023. "All AMMs are CFMMs. All DeFi markets have invariants. A DeFi market is arbitrage-free if and only if it has an increasing invariant," Papers 2310.09782, arXiv.org, revised Dec 2023.

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