On The Quality Of Cryptocurrency Markets: Centralized Versus Decentralized Exchanges

We compare decentralized blockchain-based venues (DEXs) to centralized crypto exchanges (CEXs) by assessing two key aspects of market quality: market liquidity and price efficiency.
A comprehensive analysis of transaction costs and deviations from the "triangular" no-arbitrage condition suggests that market liquidity in CEXs and DEXs is similar but DEX prices are less efficient.
While the main frictions for DEXs are high exchange fees and the gas cost of transactions stemming from proof-of-work blockchains, the superior price efficiency of CEXs involves significant risks and latency associated with delegated custody.
We propose and empirically validate a stylized model of DEX liquidity provision, linking trading volume, exchange fees, and liquidity in equilibrium.
Our theory identifies the quantitative conditions for DEXs to overtake CEXs in the future.