Cyclic Arbitrage in Decentralized Exchange Markets

In May 2020, Uniswap V2 was officially launched on Ethereum. Uniswap V2 allows users to create trading pools between any pair of cryptocurrencies, without the need for ETH as an intermediary currency. Uniswap V2 introduces new arbitrage opportunities: Traders are now able to trade cryptocurrencies cyclically: A trader can exchange currency A for B, then B for C, and finally C for A again through different trading pools. Almost surely, the three floating exchange rates are not perfectly in sync, which opens up arbitrage possibilities for cyclic trading. In this paper, we study cyclic arbitrages in Decentralized Exchanges (DEXes) of cryptocurrencies with transaction-level data on Uniswap V2, observing 285,127 cyclic arbitrages over eight months. We conduct a theoretical analysis and an empirical evaluation to understand cyclic arbitrages systematically. We study the market size (the revenue and the cost) of cyclic arbitrages, how cyclic arbitrages change market prices, how cyclic arbitrageurs influence other participants, and the implementations of cyclic arbitrages. Beyond the understanding of cyclic arbitrages, this paper suggests that with the smart contract technology and the replicated state machine setting of Ethereum, arbitrage strategies are easier implemented in DEXes than in Centralized Exchanges (CEXes). We find that deploying private smart contracts to implement cyclic arbitrages is more resilient to front-running attacks than applying cyclic arbitrages through public (open-source) smart contracts.