• asset class
• common resource

Decentralized finance (DeFi): why exciting?

blockchain

Decentralized Exchanges

Basic idea is great! *Share* the common resource. Pool liquidity. 

Price mechanism:

• \(T_0=\) contract balance of "Token"
• \(E_0=\) contract balance of ETH
• \(k=\) invariance factor
• key relation \(k=T\times\ E\)

automated market maker

• send \(T_1-T_0=\) of "Token"
• \(\to\) receive \(E_0-E_1\) of ETH s.t.
• \(k=T_0\times\ E_0=T_1\times\ E_1\)

• "Unbundle" liquidity provision & price discovery 
  • very "non-standard" in finance/econ 
  • Capponi & Jia (2021):
    • volatile exchange rates
      • \(\to\) exploitable arbitrage opportunities = losses to liq. providers
    • \(\to\) AMM are more likely to be used for "stable" pairs of coins
       
• Mechanical pricing + "tech details" \(\to\) malicious behavior?
  • The price computed using contract balances at settlement
    • \(\to\) opportunities for front-running while in mempool
    • Buterin (2018 blog post); Park (2021)

Possible issues with AMM? 

Possible issues with AMM? 

mempool \(\to\) possibly profitable front-running

• Theory: LOB vs. Bonding Curve AMM DEX
  • pooled liquidity & shared price impact \(\to\) may be more liquidity on DEX
• Empirics: 
  • 36,958 liq pools on Uniswap; 43+ million transactions; 2.5 yrs
  • Many cool empirical observations
    • Re: does the pricing function work?
      • Prices on Uniswap & Binance are very close!
      • But: price impact always higher on Binance (and "spiky" on Binance?)

This paper

• Stronger connections between the many facts
• Theory \(\to\)  predictions/inform the empirical analysis?
  • Maybe on returns to liquidity providers?
  • Possibly from other theoretical works on AMM
    • Aoyagi & Ito (2021); Capponi & Jia (2021); Park (2021) 
• Pick & choose the empirical observations to zoom onto?
  • Drop some or have a clearer "why"?
  • E.g., the "core-periphery" structure on Uniswap
    • ETH = numeraire similar to USD = the reserve currency? 

This paper: suggestions