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Library > Strategic Liquidity Provision in Uniswap v3


STRATEGIC LIQUIDITY PROVISION IN UNISWAP V3

Zhou Fan,Francisco Marmolejo Cossío,Daniel Moroz,Michael Neuder,Rithvik
Rao,David C. Parkes

October/2023, AFT '23

DECENTRALISED FINANCE

Uniswap v3 is the largest decentralized exchange for digital currencies, and
allows a liquidity provider (LP) to allocate liquidity to one or more closed
intervals of the price of an asset. An LP earns fee rewards proportional to the
amount of its liquidity allocation when prices move in this interval. This
induces the problem of strategic liquidity provision: smaller intervals result
in higher concentration of liquidity and correspondingly larger fees when the
price remains in the interval, but with higher risk as prices may exit the
interval leaving the LP with no fee rewards. Although reallocating liquidity to
new intervals can mitigate this loss, it comes at a cost, as LPs must expend gas
fees to do so. We formalize the dynamic liquidity provision problem, and focus
on a general class of strategies for which we provide a neural network-based
optimization framework for maximizing LP earnings. We model a single LP that
faces an exogenous sequence of price changes that arise from arbitrage and
non-arbitrage trades in the decentralized exchange. We present experimental
results informed by historical price data that demonstrate large improvements in
LP earnings over existing allocation strategy baselines. Moreover we provide
insight into qualitative differences in optimal LP behavior in different
economic environments.

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