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What Drives Liquidity on Decentralized Exchanges? Evidence from the Uniswap Protocol

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Listed:
  • Brian Z. Zhu
  • Dingyue Liu
  • Xin Wan
  • Gordon Liao
  • Ciamac C. Moallemi
  • Brad Bachu

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.

Suggested Citation

  • Brian Z. Zhu & Dingyue Liu & Xin Wan & Gordon Liao & Ciamac C. Moallemi & Brad Bachu, 2024. "What Drives Liquidity on Decentralized Exchanges? Evidence from the Uniswap Protocol," Papers 2410.19107, arXiv.org, revised Jan 2025.
    • Handle: RePEc:arx:papers:2410.19107
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    References listed on IDEAS

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    1. Michael J. Fleming, 2003. "Measuring treasury market liquidity," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 83-108.
    2. Amihud, Yakov & Mendelson, Haim, 1986. "Asset pricing and the bid-ask spread," Journal of Financial Economics, Elsevier, vol. 17(2), pages 223-249, December.
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