Price discovery on decentralized exchanges

• Main Authors: CAPPONI, Agostino, JIA, Ruizhe, YU, Shihao
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2024
• Subjects: price discovery; blockchain fees; decentralized exchanges; informed traders; private information; Finance and Financial Management; Portfolio and Security Analysis
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/7508; https://ink.library.smu.edu.sg/context/lkcsb_research/article/8507/viewcontent/ssrn_4236993.pdf
• Institution: Singapore Management University

Decentralized exchanges (DEXs) allow traders to express their willingness to pay for quick execution through a public priority fee bidding mechanism. This influences the trading strategy of informed traders and creates a distinct price discovery process on DEXs compared to centralized exchanges. We present empirical evidence that high-fee DEX trades contain more private information. Informed traders bid high fees not only to avoid execution risk from blockchain congestion, but also to compete for execution priority. Using a dataset of Ethereum mempool orders, we demonstrate that informed traders employ a ``jump bidding'' strategy, placing high initial bids to deter potential competitors.