The Bank for International Settlements’ ( BIS ) study , November 2024, has cast doubts on the decentralized nature of decentralized finance (DeFi).
Researchers analyzed the Ethereum Blockchain to understand the inner workings of Uniswap V3, which is one of the largest DEXs .
The study concentrated on the top 250 liquidity pool (LPs), who collectively account approximately 96% for the total trading volume of Uniswap v3. Researchers Matteo Aquilina (left), Leonardo Gambacorta (right), and William Krekel (left) were able gain insight into both the retail and institutional liquidity providers by reconstructing the state at the transactional level of these pools.
Uniswap V3 Liquidity: A Centralized Reality?
The study revealed that only a few “sophisticated” agents control a large portion of liquidity pools. The report stated that “these players have about 80% total value locked up and they focus on liquidity pools with the highest trading volume and the lowest volatility.” These players are often using advanced trading strategies, and leverage significant capital to outcompete retail investors.
Retail participants who lack the expertise and resources of sophisticated players are left with lower returns and a smaller share of trading costs. The study revealed that retail investors often lose money when they adjust for risk.
Retail LPs lose money on a risk-adjusted basis in more than half of the days. Retail LPs lost money in more than half the days of our sample.
DeFi’s Centralization Tendencies
BIS’s study shows that centralization is driven by economic forces similar to traditional finance. This applies even to the DeFi world, which is decentralized. Researchers claim that this revelation puts into question DeFi’s core principle, which is “to democratize finance” and “provide equality of opportunity for all participants”.
Our findings show that the ability to provide liquidity is being consolidated into the hands of only a few sophisticated players, leaving retail participants unable compete effectively with them. It does not seem that allowing everyone to access a protocol will eliminate these forces. Nor has it resulted – so far – in a disintermediated market .”
Expert: BIS Study may overstate degree of centralization
Gordon Liao is the Chief Economist at Circle, and previously Head of Research for Uniswap Labs. He offered a contrasting view in of his X Post dated Nov. 19,
Liao suggested that the BIS study could overstate the degree of centralization. Experts point out that “sophisticated traders” identified in the BIS study earn a higher percentage of fees and are responsible for a greater share of the total value locked (TVL), but only marginally better than less-sophisticated users. Liao says that this does not necessarily mean a significant advantage.
Liao argues further that the situation of retail investors on traditional central limit order books (CLOBs) is much worse. He cites , a research article, published on ScienceDirect. He argues that the tick ranges of CLOB markets can be much larger than the 1-2% quoted in the BIS report, and that liquidity in stablecoin pairs can even be more concentrated.
Liao acknowledges some of the BIS findings, including the limited impact of Just-in-Time (JIT), but he emphasizes the importance of default range in influencing the provision of liquidity. He suggests that the user experience and liquidity positions can both be improved by optimizing defaults and using vaults.
