Risks and Returns of Uniswap V3 Liquidity Providers
Author
Lioba Heimbach, Eric Schertenleib, Roger Wattenhofer
Date Updated
2022/05/19
Category
q-fin.RM
Date Published
2022/05/18
Date Retrieved
2022/05/19
Description
Trade execution on Decentralized Exchanges (DEXes) is automatic and does not
require individual buy and sell orders to be matched. Instead, liquidity
aggregated in pools from individual liquidity providers enables trading between
cryptocurrencies. The largest DEX measured by trading volume, Uniswap V3,
promises a DEX design optimized for capital efficiency. However, Uniswap V3
requires far more decisions from liquidity providers than previous DEX designs.
In this work, we develop a theoretical model to illustrate the choices faced
by Uniswap V3 liquidity providers and their implications. Our model suggests
that providing liquidity on Uniswap V3 is highly complex and requires many
considerations from a user. Our supporting data analysis of the risks and
returns of real Uniswap V3 liquidity providers underlines that liquidity
providing in Uniswap V3 is incredibly complicated, and performances can vary
wildly. While there are simple and profitable strategies for liquidity
providers in liquidity pools characterized by negligible price volatilities,
these strategies only yield modest returns. Instead, significant returns can
only be obtained by accepting increased financial risks and at the cost of
active management. Thus, providing liquidity has become a game reserved for
sophisticated players with the introduction of Uniswap V3, where retail traders
do not stand a chance.
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URL
https://arxiv.org/abs/2205.08904
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