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Fragmentation and optimal liquidity supply on decentralized exchanges

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  • Alfred Lehar
  • Christine Parlour
  • Marius Zoican

Abstract

We investigate how liquidity providers (LPs) choose between trading venues with high and low fees, in the face of a fixed common gas cost. Analyzing Uniswap data, we find that high-fee pools attract 58% of liquidity supply but execute only 21% of trading volume. Large LPs dominate low-fee pools, frequently adjusting positions in response to substantial trading volume. In contrast, small LPs converge to high-fee pools, accepting lower execution probabilities to mitigate smaller liquidity management costs. Fragmented liquidity dominates a single-fee market, as it encourages more liquidity providers to enter the market, while enhancing LP competition on the low-fee pool.

Suggested Citation

  • Alfred Lehar & Christine Parlour & Marius Zoican, 2023. "Fragmentation and optimal liquidity supply on decentralized exchanges," Papers 2307.13772, arXiv.org, revised Feb 2024.
    • Handle: RePEc:arx:papers:2307.13772
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    References listed on IDEAS

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