Intro
When assessing the performance of a decentralized exchange (DEX), one of the clearest indicators is its trading volume. A DEX without a significant volume is merely a mall without any sales. It’s a common conception that the driving force of the trading volume is the liquidity of a DEX, hence the most notable innovations in this sector — liquidity mining, the concentrated liquidity automated market maker (CLAMM), and the voting escrow model — have all been centered around incentivizing liquidity. However, can we ensure that these breakthroughs are actually effective?
TL;DR:
- A high positive correlation of ≈ 0.80 between the TVL and trading volume exists.
- After Uniswap implemented concentrated liquidity in V3, the additional capital required to increase the trading volume decreased by 2.91 times than only supporting regular AMM.
Methodology
By running a regression analysis using the data from Uniswap, specifically on the Ethereum blockchain, we analyze the trend between the changes in the TVL and the daily volume. The rationale behind choosing this data set is that Uniswap being the oldest and the largest exchange by both TVL & volume gives us rich samples that are relatively less affected by abnormal volume coming from wash trading that can mess with the data.
Steps
- Obtain the desired data set: the TVL and daily volume of Uniswap from October 2019 to October 2023. (Data source: Defillama)
- Create a graph where the x-axis is the daily volume and the y-axis is the TVL, and plug in the values from our data set.
- Draw a trendline on the scatterplot.
- Calculate the correlation coefficient by dividing the covariance of two variables by the product of their standard deviations. This value is a quantification of the strength and direction of the relationship between the TVL and the volume.
Results
The correlation coefficient for the all-time data is ≈ 0.80, and the trendline graph looks like the following:
Drawing Conclusions
Based on the correlation coefficient matrix below, the value of ≈ 0.8 indicates a high positive correlation, meaning that the liquidity IS actually highly correlated to the volume.
Next, we analyze the trends before and after the V3 implementation (May 2021) to see the effects of CLAMM. We split the data into two graphs on the same scale which gave us the following results:
By comparing the range of Y values in each graph, we can see that the TVL has remained rather constant. However, the range of X values in Graph 3 has stretched further compared to Graph 2, meaning that the V3 model was able to attract higher trading volumes for a similar range of TVL. Lastly, the slope of the trendline is 2.91 times lower in Graph 3, which indicates that the additional capital required to increase the trading volume decreased by 2.91 times when compared to V2.
Closing
The purpose of this research was to find the correlation between liquidity and trading volume. By analyzing the correlation coefficient and the trendlines from the historical data set of Uniswap, we found 1) a close, direct relationship between the TVL and daily volume, and 2) a decrease in additional required capital for more trading volume in CLAMM compared with AMM, which proves that CLAMM is an effective model for achieving higher capital efficiency.
Liquidity is a limited resource, which is why CLAMM is essential to the blockchain ecosystem despite the extra complexities and resources involved in its mechanism. By actively researching and experimenting with CLAMM, the Gnoswap Team will aim to contribute to the growth of the DeFi industry.
