We show that the infrastructure of decentralized exchanges subjects liquidity providers (LPs) to a “tragedy of the commons.” Liquidity providers lack incentives to exit liquidity pools to prevent arbitrage losses, as these are collectively shared, while withdrawal costs are borne individually. Arbitrage rents primarily flow to validators as infrastructure fees, with the median arbitrageur transferring 96% of profits. Proposed solutions—speed technology, alternative sequencing rules, and flexible pricing curves—fail to reduce these rents. Leveraging the Silicon Valley Bank crisis as a natural experiment, we show that LPs defensively adopt more convex pricing curves to mitigate adverse selection risks.

Decentralized exchanges (DEXs) allow traders to express their willingness to pay for quick execution through a public priority fee bidding mechanism. We provide evidence that high-fee DEX trades are more informative and contribute more to price discovery. Using address-level blockchain transaction data, we show that informed traders persistently bid higher fees to secure early execution, revealing a strong willingness to pay for execution priority. Further, analysis of Ethereum mempool data demonstrates that informed traders employ a “jump bidding” strategy, placing high initial bids to deter potential competitors.