Decentralized Exchange: Theory and Market Design

University Of Wisconsin-Madison, Madison WI

Investigators

Abstract

Over the last couple of decades, markets have seen a dramatic shift of trade toward new types of trading exchanges being created along with traditional, centralized, public trading venues. The shift in trade away from centralized exchanges towards these new types of decentralized trading platforms is common not only for assets and goods with units as heterogeneous as real estate, but also for assets that are similar in nature. Most bonds, foreign exchange, and more recently stocks, are traded over the counter. In addition, new types of securities such as bespoke (personalized) products are being introduced, which do not exist in centralized exchanges. The small but growing research on decentralized trading has emphasized frictions that arise due to decentralization of trade - associated with search for trading partners, information asymmetries amongst traders, or counterparty risk. The proposed project has two broad objectives. The first is to understand the potential for decentralized markets to improve efficiency, compared to centralized trading environments. What are the economic mechanisms in decentralized markets that do not have centralized market counterparts? The second is to develop general principles for market design and product (security) design in decentralized trade settings. The intellectual merit of this project is a deeper understanding of the functioning of decentralized markets. This research will introduce a flexible framework and equilibrium analysis for relationships and market structures that cannot be studied as graphs (bilateral links) without loss, and are more appropriately represented by a generalization of graphs known as hypergraphs. It is expected that the techniques produced by this project will enhance practical design in high-stake applications and facilitate research by theorists studying networks as well as applied economists, statisticians, and other social scientists (academics and practitioners), and policymakers. In particular, the proposed research will develop specific recommendations concerning the functioning and regulation of markets that policymakers and market designers face in implementation of the post-crisis changes in over-the-counter markets mandated by the Dodd-Frank act.