IDEAS home Printed from https://ideas.repec.org/p/osf/socarx/dvuxw.html
   My bibliography  Save this paper

Toxicity-Competitiveness Trade-off in Concentrated Liquidity Provision

Author

Listed:
  • Aoyagi, Jun
  • Ip, Wang-Hei
  • Kawaguchi, Kohei
  • Kuramoto, Wataru
  • Tsuchida, Shinya

Abstract

Decentralized exchanges (DEXs) adopt automated market makers (AMM) as an alternative to the traditional limit-order book (LOB), which is too costly to implement with blockchain technology. To protect liquidity providers (LPs) against toxic trades by arbitrageurs, Uniswap v3, the leading DEX, has introduced a concentrated liquidity mechanism that allows LPs to restrict the price range accepting trades. We define a liquidity provision game of this setting and characterize the optimal strategy and equilibrium liquidity allocation. We demonstrate that LP profits consist of the competitive and non-competitive parts. Crucially, the non-competitive components arise from toxic trades by arbitrageurs. Consequently, liquidity provision involves a toxicity-competitiveness tradeoff as opposed to the literature understanding them as two independent factors. By incorporating this tradeoff, we derive a novel guideline and implications for liquidity provision in the decentralized financial market.

Suggested Citation

  • Aoyagi, Jun & Ip, Wang-Hei & Kawaguchi, Kohei & Kuramoto, Wataru & Tsuchida, Shinya, 2024. "Toxicity-Competitiveness Trade-off in Concentrated Liquidity Provision," SocArXiv dvuxw, Center for Open Science.
    • Handle: RePEc:osf:socarx:dvuxw
    DOI: 10.31219/osf.io/dvuxw
    as

    Download full text from publisher

    File URL: https://osf.io/download/65fa79b9bafcc800a3441c8d/
    Download Restriction: no
    File URL: https://libkey.io/10.31219/osf.io/dvuxw?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Chang, Sanders S. & Wang, F. Albert, 2015. "Adverse selection and the presence of informed trading," Journal of Empirical Finance, Elsevier, vol. 33(C), pages 19-33.
    2. Gur Huberman & Dominika Halka, 2001. "Systematic Liquidity," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 24(2), pages 161-178, June.
    3. Chakrabarty, Bidisha & Cox, Justin & Upson, James E., 2022. "Tick Size Pilot Program and price discovery in U.S. stock markets," Journal of Financial Markets, Elsevier, vol. 59(PB).
    4. Portniaguina, Evgenia & Bernhardt, Dan & Hughson, Eric, 2006. "Hybrid markets, tick size and investor trading costs," Journal of Financial Markets, Elsevier, vol. 9(4), pages 433-447, November.
    5. Gehrig, Thomas & Jackson, Matthew, 1998. "Bid-ask spreads with indirect competition among specialists," Journal of Financial Markets, Elsevier, vol. 1(1), pages 89-119, April.
    6. Richard K. Lyons, 1996. "Foreign Exchange Volume: Sound and Fury Signifying Nothing?," NBER Chapters, in: The Microstructure of Foreign Exchange Markets, pages 183-208, National Bureau of Economic Research, Inc.
    7. Bruno Biais & Fany Declerck & Sophie Moinas, 2016. "Who supplies liquidity, how and when?," BIS Working Papers 563, Bank for International Settlements.
    8. Krassimira Naydenova, 2018. "Built-In Problems in the New European Regulations for the Bulgarian Capital Market," Economic Studies journal, Bulgarian Academy of Sciences - Economic Research Institute, issue 5, pages 106-134.
    9. Doureige J. Jurdi, 2020. "Intraday Jumps, Liquidity, and U.S. Macroeconomic News: Evidence from Exchange Traded Funds," JRFM, MDPI, vol. 13(6), pages 1-19, June.
    10. Ding, Mingfa, 2014. "Political Connections and Stock Liquidity: Political Network, Hierarchy and Intervention," Knut Wicksell Working Paper Series 2014/7, Lund University, Knut Wicksell Centre for Financial Studies.
    11. Baruch, Shmuel & Panayides, Marios & Venkataraman, Kumar, 2017. "Informed trading and price discovery before corporate events," Journal of Financial Economics, Elsevier, vol. 125(3), pages 561-588.
    12. Gerhard, Frank & Hess, Dieter & Pohlmeier, Winfried, 1998. "What a Difference a Day Makes: On the Common Market Microstructure of Trading Days," CoFE Discussion Papers 98/01, University of Konstanz, Center of Finance and Econometrics (CoFE).
    13. Katsuhiko Muramiya & Tomomi Takada, 2015. "Cross-Shareholdings and Information Environment," Discussion Papers in Economics and Business 15-20, Osaka University, Graduate School of Economics.
    14. Jones, Charles M. & Lipson, Marc L., 1999. "Execution Costs of Institutional Equity Orders," Journal of Financial Intermediation, Elsevier, vol. 8(3), pages 123-140, July.
    15. Qiu, Jiaping & Yu, Fan, 2012. "Endogenous liquidity in credit derivatives," Journal of Financial Economics, Elsevier, vol. 103(3), pages 611-631.
    16. Jacob Gyntelberg & Mico Loretan & Tientip Subhanij & Eric Chan, 2010. "Private information, stock markets, and exchange rates," BIS Papers chapters, in: Bank for International Settlements (ed.), The international financial crisis and policy challenges in Asia and the Pacific, volume 52, pages 186-210, Bank for International Settlements.
    17. Corò, Filippo & Dufour, Alfonso & Varotto, Simone, 2013. "Credit and liquidity components of corporate CDS spreads," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 5511-5525.
    18. Guillaume Rocheteau & Pierre‐Olivier Weill, 2011. "Liquidity in Frictional Asset Markets," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43(s2), pages 261-282, October.
    19. Thomas Henker & Martin Martens, 2010. "Spread decomposition with common spread components," International Journal of Managerial Finance, Emerald Group Publishing Limited, vol. 6(2), pages 88-115, April.
    20. Yang, Qing-Qing & Ching, Wai-Ki & Gu, Jia-Wen & Siu, Tak-Kuen, 2018. "Market-making strategy with asymmetric information and regime-switching," Journal of Economic Dynamics and Control, Elsevier, vol. 90(C), pages 408-433.

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:osf:socarx:dvuxw. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: OSF (email available below). General contact details of provider: https://arabixiv.org .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.