Measuring Arbitrage Losses and Profitability of AMM Liquidity

Abstract

This paper presents the results of a comprehensive empirical study of losses to arbitrageurs (following the formalization of loss-versus-rebalancing by [Milionis et al., 2022]) incurred by liquidity on automated market makers (AMMs). Through a systematic comparison between historical earnings from trading fees and losses to arbitrageurs, our findings indicate an insufficient compensation from fees for arbitrage losses across many of the largest AMM liquidity pools (on Uniswap). Remarkably, we identify a higher profitability among less capital-efficient Uniswap v2 pools compared to their Uniswap v3 counterparts. Moreover, we investigate a possible LVR mitigation by quantifying how arbitrage losses reduce with shorter block times. We observe notable variations in the manner of decline of arbitrage losses across different trading pairs. For instance, when comparing 100ms block times to Ethereum's current 12-second block times, the decrease in losses to arbitrageurs ranges between 20% to 70%, depending on the specific trading pair.