Paper: arXiv 2311.18164

Authors: Agostino Capponi, Ruizhe Jia, Brian Zhu

Abstract

We study Just-in-time (JIT) liquidity provision in blockchain-based decentralized exchanges. A JIT liquidity provider (LP) monitors pending swap orders in public mempools of blockchains to sandwich orders of their choice with liquidity, depositing right before and withdrawing right after the order. Our game-theoretic model with asymmetrically informed agents reveals that a JIT LP’s presence does not always enhance liquidity pool depth, as one might expect. While passive LPs face adverse selection by informed arbitrageurs, a JIT LP’s ability to detect pending orders for toxic order flow prior to liquidity provision lets them avoid being adversely selected. JIT LPs thus only provide liquidity to uninformed orders and crowd out passive LPs when order volume is not sufficiently elastic to pool depth, possibly reducing overall market liquidity. We show that using a two-tiered fee structure which transfers a part of a JIT LP’s fee revenue to passive LPs or allowing for JIT LPs to compete à la Cournot are potential solutions to mitigate the negative effects of JIT liquidity.

Complexity vs Empirical Score

  • Math Complexity: 7.5/10
  • Empirical Rigor: 4.0/10
  • Quadrant: Lab Rats — theoretically deep, empirically untested

Why this score: The paper provides a strong theoretical and game-theoretic framework to model Just-in-Time (JIT) liquidity and adverse selection in DEXs. While mathematically rigorous with novel mechanism design proposals, it primarily relies on theoretical modeling rather than extensive empirical backtesting or on-chain data validation.

Research Flowchart

  flowchart TD
    A[Research Goal: Impact of JIT Liquidity on DEX Pool Depth] --> B[Model Setup: Game Theory with Asymmetrically Informed Agents]
    B --> C[Inputs: Mempool Order Flow, Passive LPs, JIT LPs, Informed Arbitrageurs]
    C --> D[Process: JIT LP Detects & Sandwiches Uninformed Swaps to Avoid Adverse Selection]
    D --> E[Process: Evaluate Passive LP Crowding Out & Volume Elasticity]
    E --> F[Key Finding: JIT LPs Can Reduce Overall Liquidity Unless Inelastic or Mitigated]
    F --> G[Solutions: Two-Tiered Fee Structure or Cournot JIT Competition]

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0 of 81 cited works are in the corpus; resolved via arXiv source bundles, Semantic Scholar and OpenAlex. Corpus-wide: 2518 linked papers.