WEMIX (wemix) 
Liquidity on Decentralized Exchanges: The Role of Large Providers
Liquidity on decentralized exchanges is concentrated among a few large providers, reducing the democratization of access to the decentralized finance market. This was found in a report by analysts from the Bank for International Settlements (BIS).
Findings from BIS Report
The BIS analyzed the Ethereum blockchain and studied the 250 largest liquidity pools on Uniswap to determine if retail liquidity providers (LPs) can compete with institutional providers. The study revealed that a small group of participants holds about 80% of the total value locked (TVL) and earns significantly higher returns compared to retail investors, who often lose money on a risk-adjusted basis.
“These players hold about 80% of total value locked and focus on liquidity pools with the most trading volume and are less volatile.”
Retail LPs receive a smaller share of trading fees and experience low investment returns compared to institutions. While the study focused on Uniswap, the researchers noted that similar trends could apply to other decentralized exchanges (DEXs). Further research is recommended to understand the roles of retail and institutional participants in various DeFi applications, such as lending and borrowing.
Factors Driving Centralization
According to BIS, the factors that drive centralization in traditional finance may also apply to DeFi. In 2023, experts from Gauntlet reported growing centralization in the DeFi market, with four platforms controlling 54% of the DEX market and 90% of all liquid staking assets concentrated in the four most significant projects.
Comparisons with Traditional Finance
Economist Gordon Liao believes that a 15% increase in fee revenue is a negligible advantage compared to less sophisticated users. He noted that sophisticated traders, who are responsible for about 70% of TVL, earn 80% of fees—a mere 15% improvement in earnings. Liao also disputed claims of order manipulation, pointing out that the distribution of price ranges is typically well above 1-2%. However, BIS researchers noted that DeFi has fewer regulatory, operational, and technological barriers than traditional finance.
Liquidity Controlled by Big Players
According to the report, sophisticated participants who actively manage their positions provide about 65-85% of liquidity. These participants typically place orders closer to the market price, similar to how traditional market makers set their offers. Retail providers, however, are less active in managing liquidity and interact with fewer pools on average, receiving a significantly smaller share of trading fees (only 10-25%).
Professional liquidity providers demonstrated a higher success rate in market volatility conditions, highlighting their ability to adapt to economic conditions and anticipate risks. The study also shows that retail liquidity providers lose significantly in profits during high volatility, while more sophisticated participants benefit. For instance, only 7% of participants identified as sophisticated control about 80% of the total liquidity and fees.
Centralization in DeFi
In 2021, the head of the U.S. Securities and Exchange Commission (SEC), Gary Gensler, questioned the decentralization of the DeFi industry. Gensler called DeFi a misnomer, noting that existing platforms are decentralized in some ways but very centralized in others, especially those that incentivize participants with digital tokens or similar means.
“If they actually try to enforce this and go after the devs and founders, it will just push all the teams to move outside of the U.S. permanently and encourage more anon development. Not much more they can do honestly.”
According to Gensler, certain DeFi projects have characteristics similar to those of organizations regulated by the SEC. Some of them can be compared to peer-to-peer lending platforms. Analyst Larry Cermak also believes that if the SEC decides to pursue DeFi project founders and developers, they will leave the U.S. or pursue projects anonymously.
Addressing DeFi’s Challenges
Economic forces promoting the dominance of a few participants are increasing competition and questioning the idea of fully democratizing liquidity in decentralized financial systems. The future of DEXs and DeFi itself depends on how these issues of unequal access and liquidity are addressed. A closer look at these trends can guide the development of decentralized systems, creating a more sustainable and inclusive financial landscape.
#Blockchain #Decentralization #DigitalAssets
