Allocative Efficiency and Mispricing in Automated Market Maker (AMM) and Continuous Double Auction (CDA) Markets

Abstract

We use laboratory experiments to compare allocative efficiency and pricing accuracy in continuous double auction (CDA) and automated market making (AMM) markets. We implement private-value asset markets with a clearly defined competitive equilibrium price and allocation, and vary the trading institution (CDA vs. constant-product AMM), AMM pool size, transaction fees, and the distribution of buyer-seller surplus. We find that AMM markets calibrated to match CDA spreads achieve similar allocative efficiency. Smaller pools reduce liquidity providers' efficiency but leave traders' efficiency largely unaffected, while fees redistribute surplus from traders to liquidity providers and reduce aggregate allocative efficiency. Mispricing, predominantly underpricing in CDAs, is substantially lower in AMM markets and largely insensitive to fees, but increases with smaller pools and when equilibrium surplus is skewed toward buyers.