According to Cointelegraph, the Bank for International Settlements (BIS) has raised concerns about the decentralization of liquidity providers (LPs) on decentralized exchanges (DEXs), particularly focusing on Uniswap v3. In a working paper published on November 19, the BIS examined whether DEXs truly democratize financial markets or if they are dominated by a few large players, similar to traditional financial markets.
The BIS conducted an analysis of the Ethereum blockchain, specifically looking at the top 250 liquidity pools in Uniswap. The study aimed to determine if retail LPs can compete effectively with institutional providers. The findings revealed that liquidity provision in DeFi is not as decentralized as its technological framework suggests. The report highlighted that a small number of sophisticated players hold about 80% of the total value locked in these pools, focusing on those with high trading volumes and lower volatility.
Retail LPs, according to the BIS, earn a smaller share of trading fees and experience lower relative investment returns. The study also noted that retail providers tend to lose money on a risk-adjusted basis. Although the research centered on Uniswap, the BIS suggested that these findings could be applicable to other DEXs. The paper recommended further research into the roles of retail and institutional participants across various DeFi applications, such as lending and borrowing.
The BIS concluded that the dominance of institutional LPs challenges the foundational ethos of DEXs, which is to democratize financial systems. The concentration of liquidity provision capabilities leaves retail investors at a disadvantage. The researchers argued that many economic forces leading to centralization in traditional finance are likely inherent in the financial system, including DeFi. They contended that merely allowing participation does not result in a truly disintermediated market.
Despite these criticisms, the BIS acknowledged that DeFi faces fewer regulatory, operational, and technological barriers compared to traditional finance. In response to the paper, economist Gordon Liao, who previously led research for Uniswap, argued that the data could be interpreted differently. He noted that sophisticated traders, who earn 80% of the fees, only achieve a marginal improvement in fee earnings compared to less-sophisticated passive users. Liao cited a study from the Journal of Financial Economics, suggesting that the situation for liquidity providers is "much worse" in traditional finance.
