Since Bitcoin’s inception in 2008, the spotlight has increasingly been towards its underlying blockchain technology (Campbell, 2016, Yermack, 2017, Cong and He, 2019, Chiu and Koeppl, 2019, Gan, Tsoukalas, and Netessine, 2021). The introduction of smart contracts in 2015 marked a pivotal shift, transforming blockchain from a mere payment infrastructure into a cornerstone for decentralized finance (DeFi) services, a domain where decentralized exchanges (DEXs) play a critical role. The book "DeFi and the Future of Finance" by Harvey, Ramachandran, and Santoro, 2021 presents a vision of a financial system dominated by DeFi, arguing that its decentralized nature could lead to more efficient, cost-effective financial systems than traditional centralized systems. However, transitioning from potential to reality necessitates a critical examination of the underlying market structures, particularly as they pertain to trading on DEXs. By focusing on the market microstructure of DEXs, the research presented in my thesis seeks to uncover existing inefficiencies, understand their origins, and propose solutions for more effective market designs.
Chapter 1 sets the stage by exploring the background and foundational principles of blockchainand DEXs, preparing the reader for a deeper dive into their complexities. Chapter 2 highlights the challenges of the current DEX infrastructure, such as exposure to arbitrage losses for liquidity providers, and evaluates the effectiveness of design changes. Empirical evidence from the Silicon Valley Bank collapse illustrates the impact of arbitrageurs on liquidity provision.
In Chapter 3, the focus shifts to the mechanics of price discovery in blockchain-based trading platforms. The study delves into how DEXs’ unique infrastructure, such as gas fee bidding and priority sequencing rules, impacts trading strategies and information dissemination. We delve into the trading strategies of informed traders within DEXs, revealing a preference for high-fee bids to signal information, employing a "jump bidding" strategy to limit competition.
Finally, Chapter 4 challenges the current information settings of public blockchains, highlighting their inadequacies for trading due to issues like information leakage, frontrunning, and inefficient blockspace allocation. It evaluates the introduction of private transaction pools as a remedy to these challenges, examining their effects on allocative efficiency and overall welfare. It suggests that private transaction submission pools could enhance welfare and mitigate frontrunning risk, without eliminating it. In summary, this thesis aims to bridge the gap between the theoretical promise of DeFi and the practical challenges it faces. By investigating the market microstructure of DEXs, it provides insights into the design of more robust, efficient, and equitable financial systems operating over blockchain technologies.
| Identifer | oai:union.ndltd.org:columbia.edu/oai:academiccommons.columbia.edu:10.7916/spvr-6a17 |
| Date | January 2024 |
| Creators | Jia, Ruizhe |
| Source Sets | Columbia University |
| Language | English |
| Detected Language | English |
| Type | Theses |
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