Returns from liquidity provision in cryptocurrency markets
Returns from liquidity provision in cryptocurrency markets
We examine the liquidity provision premium in cryptocurrency markets using the returns from the short reversal strategy. We show that returns from liquidity provision can be predicted using the volatility index, realized variance, risk aversion, crash risk, tail risk, and innovations of Tether liquidity. We also find that
an increase in the liquidity provision premium is associated with a decline in liquidity, trading volume, and transaction count, as well as more withdrawals, higher fees, and greater impermanent loss on Uniswap.
This suggests potential competition between centralized and decentralized exchanges. Further, the liquidity provision premium of stock markets in China and Japan positively predicts the premium of cryptocurrency markets (effect of a common shock), meanwhile that of stock markets in the US and Canada negatively predicts the premium of cryptocurrency markets (substitution effect).
Cryptocurrency, Liquidity Provision, Uncertainty
Farag, Hisham
895ad11c-f574-4e2e-9c38-9dc604431f37
Luo, Di
d6e61fed-fc5d-4aaf-a742-8e957344ee6d
Yarovaya, Larisa
2bd189e8-3bad-48b0-9d09-5d96a4132889
Zięba, Damian
573b2a9a-d67c-41e6-8e60-fa99000aea0f
4 April 2025
Farag, Hisham
895ad11c-f574-4e2e-9c38-9dc604431f37
Luo, Di
d6e61fed-fc5d-4aaf-a742-8e957344ee6d
Yarovaya, Larisa
2bd189e8-3bad-48b0-9d09-5d96a4132889
Zięba, Damian
573b2a9a-d67c-41e6-8e60-fa99000aea0f
Farag, Hisham, Luo, Di, Yarovaya, Larisa and Zięba, Damian
(2025)
Returns from liquidity provision in cryptocurrency markets.
Journal of Banking & Finance, 175, [107411].
(doi:10.1016/j.jbankfin.2025.107411).
Abstract
We examine the liquidity provision premium in cryptocurrency markets using the returns from the short reversal strategy. We show that returns from liquidity provision can be predicted using the volatility index, realized variance, risk aversion, crash risk, tail risk, and innovations of Tether liquidity. We also find that
an increase in the liquidity provision premium is associated with a decline in liquidity, trading volume, and transaction count, as well as more withdrawals, higher fees, and greater impermanent loss on Uniswap.
This suggests potential competition between centralized and decentralized exchanges. Further, the liquidity provision premium of stock markets in China and Japan positively predicts the premium of cryptocurrency markets (effect of a common shock), meanwhile that of stock markets in the US and Canada negatively predicts the premium of cryptocurrency markets (substitution effect).
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Accepted/In Press date: 9 February 2025
e-pub ahead of print date: 22 February 2025
Published date: 4 April 2025
Keywords:
Cryptocurrency, Liquidity Provision, Uncertainty
Identifiers
Local EPrints ID: 501151
URI: http://eprints.soton.ac.uk/id/eprint/501151
ISSN: 0378-4266
PURE UUID: 3d8f9d3c-3ad9-4877-bf89-f295139070ec
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Date deposited: 27 May 2025 16:53
Last modified: 03 Sep 2025 01:58
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Author:
Hisham Farag
Author:
Di Luo
Author:
Damian Zięba
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