Layer 2 be or Layer not 2 be: Scaling on Uniswap v3

TL;DR

This study examines how cheaper and faster blockchain chains enhance Uniswap v3's efficiency, liquidity provider returns, and overall market structure, highlighting the impact of chain dynamics on decentralized exchange performance.

Contribution

It provides empirical evidence that lower gas fees and faster block times improve swap efficiency, liquidity provider returns, and reduce drawbacks of AMMs on alternative chains.

Findings

Cheaper chains yield better gas-adjusted swap execution.

Liquidity providers see increased fee returns due to more arbitrage.

Two-second block times may reduce liquidity provider profits.

Abstract

This paper studies the market structure impact of cheaper and faster chains on the Uniswap v3 Protocol. The Uniswap Protocol is the largest decentralized application on Ethereum by both gas and blockspace used, and user behaviors of the protocol are very sensitive to fluctuations in gas prices and market structure due to the economic factors of the Protocol. We focus on the chains where Uniswap v3 has the most activity, giving us the best comparison to Ethereum mainnet. Because of cheaper gas and lower block times, we find evidence that the majority of swaps get better gas-adjusted execution on these chains, liquidity providers are more capital efficient, and liquidity providers have increased fee returns from more arbitrage. We also present evidence that two second block times may be too long for optimal liquidity provider returns, compared to first come, first served. We argue that many of the current drawbacks with AMMs may be due to chain dynamics and are vastly improved with cheaper and faster transactions