The DeFi market lacks decentralization: Why is this happening?

Liquidity on DEX is in the hands of a few large providers, which reduces the degree of democratization of access to the DeFi market.

Liquidity on decentralized exchanges is concentrated among a few large providers, reducing the democratization of access to the decentralized finance market, as Bank for International Settlements (BIS) analysts found in their report.

BIS analyzed the Ethereum blockchain and studied the 250 largest liquidity pools on Uniswap to test whether retail LPs can compete with institutional providers.

The study of the 250 largest liquidity pools on Uniswap V3 found that just a small group of participants hold about 80% of total value locked and make significantly higher returns than retail investors, who, on a risk-adjusted basis, often lose money.

“These players hold about 80% of total value locked and focus on liquidity pools with the most trading volume and are less volatile.”

BIS report

Retail LPs receive a smaller share of trading fees and experience low investment returns compared to institutions, who, according to BIS, lose money risk-adjusted. While the study focused on Uniswap only, the researchers noted that the findings could also apply to other DEXs. They recommended further research to understand the roles of retail and institutional participants in various DeFi applications, such as lending and borrowing.

According to BIS, the factors that drive centralization in traditional finance may be “heritable traits” of the financial system and, therefore, also apply to DeFi.

In 2023, experts from Gauntlet reported that centralization is growing in the DeFi market. They found that four platforms control 54% of the DEX market, and 90% of all liquid staking assets are concentrated in the four most significant projects.