The Dynamics of Cryptocurrency Liquidity Pools

We assess the dynamics of the cryptocurrency liquidity pools at the heart of Decentralised Finance (DeFi). We distinguish between liquidity provision and liquidity demand, and show that yields, rather than risks, are the primary factor in determining liquidity provision to these pools. While, for liquidity demand there is an additional importance of relative price fluctuation as a risk factor. We further show that price shocks in leading cryptocurrencies cause persistent shocks across liquidity pools. The initial findings from this first exploration of decentralized cryptocurrency liquidity pool dynamics are suggestive of reasonably well-functioning markets