Solution to Liquidity Fragmentation in DeFi

Decentralized Finance (DeFi) has emerged as a rival to the traditional finance economy; this nascent crypto niche made a hallmark debut in the summer of 2020 following the launch of governance tokens and yield farming incentives. Two years down the line, a total of 4.8 Million unique wallets have interacted with DeFi, according to Dune Analytics. Meanwhile, the total value locked (TVL) in various DeFi protocols stands at $76 Billion.

Looking at these metrics, it is pretty obvious that DeFi has performed quite well over its short period of existence. However, the same cannot be said for on-chain liquidity; in its current state, the DeFi market is highly fragmented. What does this mean? Most DeFi protocols operate within a limited Blockchain environment, making it hard to transfer liquidity from one ecosystem to another. 

Furthermore, the liquidity fragmentation in DeFi has been one of the leading causes of price slippage. More often than not, DeFi natives have to account for the probability that the price of a particular token will change before their order is executed. While it may seem like a small inconvenience, price slippages have resulted in higher transaction costs in the past, given that a trader has to initiate the transaction again should the price deviate significantly.

So, what is the DeFi community doing to solve liquidity fragmentation? One of the main approaches toward building a single umbrella for the DeFi ecosystem has been the introduction of cross-chain infrastructures. Ideally, this crypto architecture enables interoperability between two or more Blockchain networks.

Connecting the DeFi Ecosystem

Cross-chain solutions have become necessary given the DeFi market’s growing needs. Back in 2020, most DeFi projects were hosted on Ethereum, so users did not have to switch chains to access yield farming or staking opportunities. Well, that is no longer the case; we now have multiple Layer-1 and Layer-2 Blockchains, with the likes of Solana, Avalanche, and Polygon challenging Ethereum’s market share. 

Luckily, things are always moving at the speed of lighting in the DeFi innovation space. In recent months, stakeholders have become obsessed with cross-chain solutions, which is justified given the diversity of today’s DeFi protocols. As a user, one of the primary areas of concern should be whether you can seamlessly transfer value or utility from one smart contract Blockchain to another. 

To this end, we have a couple of cross-chain infrastructures that have already been rolled out, including Polkadot, Wanchain, and the Cosmos Blockchain networks. While these ecosystems leverage different core architectures, the end goal is pretty much the same; enabling DeFi natives to interact with multiple Blockchain networks.

“The debate about which smart-contract-enabled Blockchain ecosystem will prevail has slowly ended in 2021. The prevailing opinion is that we will live in a multi-chain world in which multiple Blockchains can transfer information and value between each other.” noted a recent prediction article by Forbes. 

Besides interconnected Blockchain networks, it will soon be possible for crypto traders to swap DeFi tokens on DEX Agnostic liquidity protocols such as Primex. This cross-margin trading platform is not limited to a specific DEX; unlike the pioneer DEXs, Primex will allow DeFi traders to open and close leveraged margin positions on different DEXs without leaving the platform. Big relief for DeFi traders who prefer taking on high-risk positions. 

Going by the rate of innovation in cross-chain infrastructures, we are closer to having a unified DeFi market. This progress will solve the underlying liquidity issues and increase DeFi’s value proposition as a potential challenger of the centralized financial markets model. 

What started as an experiment for incentivized economies is likely to grow into the next era of finance; after all, the ongoing geopolitical and social tensions all point towards the possibility of a decentralized (people-governed) economy. 

Conclusion

The rise of DeFi has unarguably been meteoric; a close resemblance to the traditional finance economy has made it one of the most discussed topics within the entire tech space. However, this article highlights that liquidity issues significantly threaten DeFi’s longevity. It is about time the industry’s innovators come together to provide tangible interoperability solutions that will allow users to have a better experience.