We model a simple market setting in which fragmentation of trade of the same asset across multiple exchanges improves allocative efficiency. Fragmentation reduces the inhibiting effect of price-impact avoidance on order submission. Although fragmentation reduces market depth on each exchange, it also isolates cross-exchange price impacts, leading to more aggressive overall order submission and better rebalancing of unwanted positions across traders. Fragmentation also has implications for the extent to which prices reveal traders’ private information. While a given exchange price is less informative in more fragmented markets, all exchange prices taken together are more informative.
That is a new American Economic Review piece by Daniel Chen and Darrell Duffie. My slight rewording of their argument is this: with market fragmentation, you can split up your order across exchanges and thus submit more total orders, with less fear of the prices moving against you. Fair enough, but what does this mean for the supposed greater efficiency of a single medium of exchange? Might there be reasons why a multitude of exchange/payment media, including foreign currencies and crypto, could give you further liquidity?