Cyclic Arbitrage in Decentralized Exchanges

TL;DR

This paper systematically investigates cyclic arbitrage opportunities in decentralized exchanges, analyzing profitability, strategies, and market efficiency, revealing significant exploitable revenue and the role of smart contracts in mitigating losses.

Contribution

It introduces a theoretical framework for cyclic arbitrage, analyzes real market data, and highlights the potential for market inefficiencies and the use of smart contracts to reduce risks.

Findings

Traders executed over 292,606 cyclic arbitrages in eleven months.

More than 138 million USD in revenue was exploited from arbitrage.

Persistent arbitrage opportunities exceed 1 ETH (4,000 USD), indicating market inefficiency.

Abstract

Decentralized Exchanges (DEXes) enable users to create markets for exchanging any pair of cryptocurrencies. The direct exchange rate of two tokens may not match the cross-exchange rate in the market, and such price discrepancies open up arbitrage possibilities with trading through different cryptocurrencies cyclically. In this paper, we conduct a systematic investigation on cyclic arbitrages in DEXes. We propose a theoretical framework for studying cyclic arbitrage. With our framework, we analyze the profitability conditions and optimal trading strategies of cyclic transactions. We further examine exploitable arbitrage opportunities and the market size of cyclic arbitrages with transaction-level data of Uniswap V2. We find that traders have executed 292,606 cyclic arbitrages over eleven months and exploited more than 138 million USD in revenue. However, the revenue of the most profitable unexploited opportunity is persistently higher than 1 ETH (4,000 USD), which indicates that DEX markets may not be efficient enough. By analyzing how traders implement cyclic arbitrages, we find that traders can utilize smart contracts to issue atomic transactions and the atomic implementations could mitigate users' financial loss in cyclic arbitrage from the price impact.