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

ArXiv ID: 2410.19107 “View on arXiv”

Authors: Unknown

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.

Keywords: Decentralized Exchange (DEX), Liquidity Provision, Concentrated Liquidity, Market Depth, Automated Market Maker, Cryptocurrency

Complexity vs Empirical Score

  • Math Complexity: 6.0/10
  • Empirical Rigor: 7.5/10
  • Quadrant: Holy Grair
  • Why: The paper introduces a novel mathematical metric (v2 counterfactual spread) and employs regression analysis on a comprehensive dataset spanning multiple blockchains over three years, demonstrating significant empirical rigor.
  flowchart TD
    A["Research Goal:<br>Identify drivers of liquidity on DEXs"]
    B["Data & Methodology:<br>Uniswap v3 pool data & novel<br>v2 counterfactual spread metric"]
    C["Computational Process:<br>Decompose effects into<br>TVL and Concentration channels"]
    D["Key Findings 1:<br>Gas, Returns, Volume share →<br>Concentration channel"]
    E["Key Findings 2:<br>Internalized flow →<br>TVL channel only"]
    F["Key Findings 3:<br>Volatility, Fee Revenue, Markout →<br>Both TVL & Concentration"]

    A --> B
    B --> C
    C --> D
    C --> E
    C --> F