Department of Industrial Engineering & Decision Analysis [Joint IEDA / MATH seminar] - Design Liquidity Pools on Automated Market Makers
Automated market makers are a popular type of decentralized exchanges in which users trade assets with each other directly and automatically through a liquidity pool and a fixed pricing function. The liquidity provider contributes to the liquidity pool by supplying assets to the pool and in return they earn transaction fees from traders who trade through the pool. We propose a model of optimal liquidity provision in which the risk-averse liquidity provider decides the investment proportion of wealth she would like to supply to the pool, trade in an centralized market, and consume in multiple periods. We derive the liquidity provider’s optimal strategy by dynamic programming and numerically find the optimal liquidity pool that maximizes the liquidity provider’s utility. Our findings indicate that the exchange rate volatility on the centralized market exerts a positive effect on optimal transaction fee. Moreover, the optimal constant mean pricing formula is found to be related to the relative performance of the underlying assets on the centralized market.
This is a joint work with Xuedong He and Yutian Zhou.
Chen Yang received a B.Sc. degree in Mathematics and Applied Mathematics from Zhejiang University in 2008, and his Ph.D. degree in Financial Mathematics from National University of Singapore in 2017. Prior to joining the Chinese University of Hong Kong, he was a postdoctoral researcher at ETH Zurich from 2017 to 2019.
Chen Yang’s research interests include optimal investment with market frictions, financial technology, mathematical finance, and market microstructure. One of his papers was published in the leading journal The Review of Financial Studies.