Impacts of Protocol Updates on Uniswap Decentralized Crypto Exchanges
31 Pages Posted: 5 Jul 2023 Last revised: 7 May 2024
Date Written: June 29, 2023
Abstract
A decentralized exchange records every transaction on a blockchain, which leads to much slower transaction speed than centralized exchanges. Unlike traditional limit order book trading design, decentralized exchanges offer token swaps in liquidity pools operated by automated market making protocols. For the largest decentralized exchange, Uniswap, we examine the operational efficiencies of its v2 and v3 protocols, and compare the price discovery ability in these two markets. We also compare their market efficiency with the two main centralized exchanges for ether spot trading, Coinbase and Bitstamp. Using minute-frequency data from the two Uniswap USDC-ETH pools of v2 and v3, our empirical study shows that v3 reduces price slippage, which enhances price leadership relative to centralized exchanges Coinbase and Bitstamp, although impermanent loss is greater on v3 than on v2. Furthermore, the market efficiency of Uniswap v3 is much improved relative to v2, and it is approaching Bitstamp in its price discovery ability. The technical advances implemented in the Uniswap protocol upgrade results in significant improvements in market conditions like liquidity provision and trading volume. Regressions show that such improvements are important in determining the better price discovery and market efficiency of v3. This is a strong support for the technical advances already made by Uniswap, but we argue that further development is required to attract more traders.
Keywords: Decentralized Exchanges, Information Efficiency, Price Discovery, Uniswap, Automated Market Making
JEL Classification: G14, D47
Suggested Citation: Suggested Citation