Automated Market Making and Loss-Versus-Rebalancing

Abstract

Automated Market Makers (AMMs) are both liquidity sources and investment vehicles for market participants. This paper analyzes the risks and returns of liquidity provision (LP) investments in AMMs. In a continuous-time model, we show that LP returns decompose into a beta-like component reflecting market risk exposure, and an alpha-like component reflecting microstructural forces: accrued fees minus losses to arbitrageurs. Applying our decomposition to the Uniswap v2 ETH-USDC pool, we find that over 99.991\% of LP return variance is driven by beta exposure to market risk

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