Decentralized Exchanges
Alfred Lehar and Christine Parlour
Discussion by Katya Malinova
DeGroote School of Business
McMaster University
SNB-CIF Conference on Cryptoassets and Financial Innovation 20–21 May 2021
- asset class
- common resource
Decentralized finance (DeFi): why exciting?
DeFi: provision of financial services without the necessary involvement of a traditional financial intermediary
blockchain
Decentralized Exchanges
Idea:
- use blockchain to exchange items
- fully decentralized
- → no single controlling entity, or location, everything runs with smart contracts
But how?
Q: how do you set the price?
- (Use an oracle)
- Use a hard-coded function
Basic idea is great! *Share* the common resource. Pool liquidity.
Price mechanism:
- T0= contract balance of "Token"
- E0= contract balance of ETH
- k= invariance factor
- key relation k=T× E
automated market maker
- send T1−T0= of "Token"
- → receive E0−E1 of ETH s.t.
- k=T0× E0=T1× E1
Does/can this pricing function work?
- "Unbundle" liquidity provision & price discovery
- very "non-standard" in finance/econ
- Capponi & Jia (2021):
- volatile exchange rates
- → exploitable arbitrage opportunities = losses to liq. providers
- → AMM are more likely to be used for "stable" pairs of coins
- volatile exchange rates
- Mechanical pricing + "tech details" → malicious behavior?
- The price computed using contract balances at settlement
- → opportunities for front-running while in mempool
- Buterin (2018 blog post); Park (2021)
- The price computed using contract balances at settlement
Possible issues with AMM?
a
b
c
d
e
f
g
Possible issues with AMM?
mempool → possibly profitable front-running
Figure 1 in Park (2021)
- Theory: LOB vs. Bonding Curve AMM DEX
- pooled liquidity & shared price impact → 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?)
- Re: does the pricing function work?
This paper
- Stronger connections between the many facts
- Theory → 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
@katyamalinova
malinovk@mcmaster.ca
slides.com/kmalinova
https://sites.google.com/site/katyamalinova/
Decentralized Exchanges Alfred Lehar and Christine Parlour Discussion by Katya Malinova DeGroote School of Business McMaster University SNB-CIF Conference on Cryptoassets and Financial Innovation 20–21 May 2021