Market Efficiency Improvements from Technical Developments of Decentralized Crypto Exchanges

A decentralized exchange (DEX) records every transaction on a blockchain, so it is much slower than a centralised exchange (CEX) which is only linked to a blockchain via a wallet, so no trades are recorded directly on the chain. While all CEXs use a traditional limit order book, most DEXs use a different, automated market making approach. Uniswap is the largest DEX for general crypto, especially for ether (ETH) this being the native token of the dominant smart contract blockchain, Ethereum. Using minute-level ETH spot prices, we examine the price discovery and informational efficiency of Uniswap-v2 and the recent updated automated market maker version, Uniswap-v3. We compare them with two CEXs that are dominant in ether spot trading, i.e. Coinbase and Bitstamp. We find that Uniswap-v3 is much improved relative to Uniswap- v2, even approaching Bitstamp in its price discovery ability. This is strong support for the significant financial influences of the technical advances implemented by Uniswap-v3. Yet our results still raise two concerns, first about the poor market efficiency of Uniswap-v3 and secondly about a complete change of long-memory patterns in ETH spot returns obtained from Uniswap- v3 relative to Uniswap-v2. These findings indicate there is yet further technical development required for DEXs to attract more ordinary investors. The lack of efficiency means there are many arbitrage opportunities on Uniswap, which professional traders can take advantage of at the expense of less experienced players