On The Quality Of Cryptocurrency Markets

Centralized Versus Decentralized Exchanges

Working Paper

Despite the growing adoption of decentralized exchanges, not much is yet known about their market quality. To shed some light on this issue, we study cryptocurrencies by comparing decentralized blockchain-based venues (DEX) to centralized crypto exchanges (CEX) by assessing two key aspects of market quality: price efficiency and market liquidity. Using a novel and comprehensive data set, we find that overall CEX provide better market quality but CEX becomes competitive if transaction costs exceed 100,000$. Further, the main determinant of the lower price-efficiency of DEX is the high gas price stemming from proof-of- work blockchains. We propose and empirically validate a stylized theory of DEX liquidity provision, which links trading volumes, protocol fees, and liquidity in equilibrium. Our model prefigures the possible scenarios of efficiency paths for DEX to overtake CEX.

Last Revision: 2021-12-13

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