A new report from decentralized exchange aggregator 1inch has shown a growing crisis in decentralized finance (DeFi): the vast majority of capital deployed in major DeFi liquidity pools is not being used effectively.
According to data presented at Devconnect Buenos Aires, between 83% and 95% of liquidity in top pools, including Uniswap v2, v3, and v4, as well as Curve, remains idle for most of the year. That means billions of dollars sit in smart contracts without earning fees or generating meaningful returns.
In Uniswap v2 alone, only 0.5% of liquidity typically falls within active trading price ranges, rendering nearly $1.8 billion ineffective according to the report.
This inefficiency hits retail participants the hardest. Research cited in the report shows that 50% of liquidity providers (LPs) are losing money when factoring in impermanent loss, with net liquidity provider deficits exceeding $60 million. In one notable example, a single Uniswap v3 pool saw over $30 million in lost profits due to Just-in-Time liquidity manipulation.
Part of the problem stems from the sheer number of fragmented pools, with more than seven million across the ecosystem. This complexity not only dilutes liquidity but also makes it harder to route trades efficiently, further reducing returns for liquidity providers.
‘New approach’
To 1inch, the solution is its Aqua protocol, which is designed to let DeFi applications share the same capital base across multiple strategies without compromising user custody.
“We address this problem by introducing a new approach,” 1inch cofounder Segej Kunz told CoinDesk in an interview at Devconnect Buenos Aires. “We allow people to just keep assets in the wallet, and we allow people to create virtual trading positions.”
To Kunz, the current situation constitutes a “DeFi liquidity crisis.”
The protocol also aims to lower the barrier to entry for developers who want to utilize this deep liquidity. “Any existing DEX right now can be implemented under 10 lines of code,” Kunz added, noting that the goal is to provide “a foundation to build on top” so that liquidity providers can “hold assets in the wallet” rather than locking them inside complex protocol contracts.