Measuring Arbitrage Losses and Profitability of AMM Liquidity

ArXiv ID: 2404.05803 “View on arXiv”

Authors: Unknown

Abstract

This paper presents the results of a comprehensive empirical study of losses to arbitrageurs (following the formalization of loss-versus-rebalancing by [“Milionis et al., 2022”]) incurred by liquidity providers on automated market makers (AMMs). We show that those losses exceed the fees earned by liquidity providers across many of the largest AMM liquidity pools (on Uniswap). Remarkably, we also find that the Uniswap v2 pools are more profitable for passive LPs than their Uniswap v3 counterparts. We also investigate how arbitrage losses change with block times. As expected, arbitrage losses decrease when block production is faster. However, the rate of the decline varies significantly across different trading pairs. For instance, when comparing 100ms block times to Ethereum’s current 12-second block times, the decrease in losses to arbitrageurs ranges between 20% to 70%, depending on the specific trading pair.

Keywords: Automated Market Makers (AMMs), Liquidity Providers, Loss-versus-Rebalancing, Arbitrage Losses, Uniswap, DeFi (Decentralized Finance)

Complexity vs Empirical Score

  • Math Complexity: 6.0/10
  • Empirical Rigor: 8.5/10
  • Quadrant: Holy Grail
  • Why: The paper builds upon a formal mathematical framework (Loss-versus-Rebalancing/LVR) requiring discrete-time modeling and numerical simulation, indicating substantial math, while its reliance on extensive historical trade data, Binance price feeds, and simulation of liquidity positions across multiple pools makes it highly data- and implementation-heavy.
  flowchart TD
    A["Research Question:<br>Do AMM liquidity providers<br>earn net positive returns?"]
    
    B["Data Collection<br>Uniswap v2/v3 Pool Historical Data<br>Block timestamps & Prices"]
    
    C["Computational Process<br>Calculate Loss-versus-Rebalancing<br>& Compare to LP Fees"]
    
    D{"Analysis Scenarios<br>Arbitrage Loss vs. Block Time<br>Current vs. Faster Block Production"}
    
    E["Key Findings<br>1. Arbitrage losses > Fees<br>2. v2 more profitable than v3<br>3. Faster blocks reduce losses 20-70%"]
    
    A --> B
    B --> C
    C --> D
    D --> E