How Fee Tiers Shape Liquidity Supply on Decentralized Exchanges

Summary

The document examines how liquidity providers choose between decentralized exchange pools with different fees when trades also incur a shared, fixed gas cost. It describes a tradeoff: high-fee pools can reduce exposure to adverse selection and the effort of maintaining positions, while low-fee pools offer lower trading fees and attract larger providers willing to manage positions more actively.

Uniswap data show that high-fee pools receive a majority of liquidity but handle a smaller share of volume. Large providers concentrate more in low-fee pools and adjust out-of-range positions in response to informed order flow; smaller providers tend toward high-fee pools. The authors argue that having multiple fee tiers can bring more providers into the market and encourage competition in low-fee pools. The evidence is venue-specific, and the brief description does not detail the study design or establish that the reported patterns generalize to other exchanges.

Key ideas

• Liquidity providers choose fee tiers while accounting for fixed gas costs and position-management effort.
• High-fee pools hold a larger share of liquidity than their share of executed volume.
• Large providers are more active in low-fee pools and adjust out-of-range positions in response to informed flow.
• Smaller providers tend toward high-fee pools to reduce adverse-selection exposure and management costs.
• The authors argue that fee-tier fragmentation can increase provider participation and competition.

Tags

# Fragmentation and optimal liquidity supply on decentralized exchanges


# Fragmentation and optimal liquidity supply on decentralized exchanges









We investigate how liquidity providers (LPs) choose between high- and low-fee trading venues, in the face of a fixed common gas cost. Analyzing Uniswap data, we find that high-fee pools attract 58% of liquidity supply yet execute only 21% of volume. Large LPs dominate low-fee pools, frequently adjusting out-of-range positions in response to informed order flow. In contrast, small LPs converge to high-fee pools, accepting lower execution probabilities to mitigate adverse selection and liquidity management costs. Fragmented liquidity dominates a single-fee market, as it encourages more liquidity providers to enter the market, while fostering LP competition on the low-fee pool.

Shown in full with attribution under the source's licence. Licence: abstract CC0

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.