However, BIS research conducted in November 2024 revealed that large and sophisticated players most essentially control the liquidity pool of Uniswap V3, one of the biggest DEXs, and questioned the real decentralization of decentralized finance (DeFi).
Researchers Matteo Aquilina, Sean Foley, Leonardo Gambacorta, and William Krekel conducted the research using the Ethereum blockchain. The study examined the top 250 LPs on Uniswap V3 at the transaction level to better understand liquidity providers’ behavior. These pools accounted for 96% of the total trading volume on this platform.
This research also highlights that DeFi has not delivered its democratic finance system per the related concept, as liquidity provision has been dominated by a few ‘sophisticated agents’ in the Uniswap V3.
According to The Block Research, some of these players, equipped with sophisticated trading models and large amounts of capital, dominate about 80 percent of these pools’ total value locked (TVL). They are, for instance, inclined to target the most active trading pools. At the same time, excluding contracts with high price fluctuations puts them in a good position compared to ordinary investors.
BIS study highlights retail investor disadvantages in centralized DeFi liquidity
The evidence presented in the paper indicates that current and would-be retail participants suffer several disadvantages with over-the-counter derivatives and algorithmic trading: they are less likely to have access to and the know-how of these professional traders, and they get proportionately smaller slices of the trading fee and return on investment pie. Indeed, this study was conducted under the assumption that despite high returns, retail investors often operate at a loss on a risk-adjusted basis because of the obvious dominance of the larger players in these markets.
The report undermines the basis of DeFi, which sets out to empower every participant in the market. Thus, the BIS study implies that, as in standard finance, capital control and sophisticated trading policies contribute to the centralization of DeFi platforms, thus causing doubts about just how much DeFi popularises financial liberalization.
However, contrary to the BIS findings, other experts have a different opinion on this matter. Gordon Liao, Chief Economist and Head of Research at Circle, had a chance to read the study. He opposed it in the X (formerly Twitter) on Nov.19. According to the same, Liao commented that the BIS report could be misleading in assessing the degree of centralization in DeFi markets.
Liao agreed with them by noting that while such traders tend to manage a higher share of TVL and gain more fees, their edge is usually quite slight, less than 15 percent more than less-sophisticated customers. Liao indicates that this doesn’t necessarily point towards a massive inequality in the system.
Liao also pointed out retail investors‘ conditions are considerably worse in traditional centralized exchanges. Comparing the DeFi market to the CLOB markets, the latter, according to him, often features significantly wider bid-ask spreads, which are especially disadvantageous for retail traders.
Liao also refuted some of the criticisms leveled by the BIS study, including the role of just-in-time (JIT) liquidity and the fact that most liquidity is inside stablecoin pairs. He recommends that improving default conditions and using the vault may add value to the client’s experience and allow retail traders to manage liquidity more effectively.
The BIS study highlights a critical issue in the DeFi space: Although blockchain building is based on structural decentralization, most liquidity provision is located in the hands of several selected participants, contrary to the concept of a level playing field.
That said, the study’s results concerning centralization in DeFi raise corresponding concerns among the researchers, as reflected in Liao. The case may not be as bad as the current study depicts. In the course of the debate, one can conclude that further enhancement of liquidity provision and access to the market remain significant issues for most DeFi platforms in the future.
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