Unlocking Liquidity For A New Generation of Assets

Liquidity.  In the world of DeFi, the word elicits both excitement and concern:  Excitement when you have it, concern when you’re running low.

Liquidity is what powers the DeFi protocols of Web3, ensuring that trading is fast, efficient, and minimizes slippage among other negative consequences.  Exchanges are always looking for ways to build up a strong community, and part of what makes a strong community is the willingness to provide liquidity, support the protocol, and create a beneficial situation for all.

So how are DeFi platforms working to manage their liquidity, and what best practices are on the horizon?  Let’s take a look to see how the power of liquidity is helping to drive Web3’s future.

Before You Can Manage It, You Have to Get It

Finding advanced ways to optimize liquidity is well and good, but if you don’t have any to begin with it makes it difficult to operate.  One of the biggest challenges platforms face is building up a critical mass of community members willing to participate as liquidity providers (LPs).  While some platform visions are truly inspiring, what really inspires the majority of people in Web3 is the ability to turn your holdings into more holdings.  As a result, liquidity providers don’t just lock in their funds out of the goodness of their hearts.  Liquidity mining, or offering rewards to LPs, is a must for platforms building up liquidity pools for trading to occur.  The LP structure can occur in different ways, offering providers different levels of commitment, risk, and rewards to offset what they are putting into the system.  Having this balance of liquidity ensures that trades can be made more efficiently, creating a higher quality trading environment for participants and reducing problems with delayed transactions.

Assuming a platform can find enough liquidity, balancing out the risks, rewards, and costs can be a delicate dance.  The keys to optimizing this are creating a strong tokenomics doctrine that is clear on how the token is treated, how rewards are delivered, and how other elements like inflation and distribution are handled on the platform; and building up a strong and capable DAO that can collectively adapt and make wise decisions that maximize liquidity and keep trading activity strong and efficient.

Let’s say, though, that even if you have a strong DAO, good tokenomics, and a good LP rewards system in place, the required liquidity just isn’t coming through.  What options do Web3 platforms have?  With Web3 growing, the industry is building and attracting more people who are adopting it.  However, it also means that many new Web3 companies are building up, and are competing for a limited supply over overall liquidity in the market.  For those platforms who are working hard to incentivize LPs but still falling short, there are other alternatives available.  Some platforms can find partners that either have complimentary business models, or may even be competitors but are forced to merge in order to make the most of the collective liquidity found in both communities.  Other platforms may not want to merge completely, but might use existing technology to create interoperability with other platforms and exchanges, allowing users to dip into other platforms’ liquidity.  This can also take the form of full cross-chain bridging, preventing the effects of liquidity dilution as the Web3 industry grows.

Working Smarter, Not Harder

The brute force of simply adding more liquidity in order to operate a platform isn’t a bad idea.  If you can simply force more liquidity into the platform and it helps to boost the quality, speed, and minimize ill effects, then by all means, let’s do it!  However, this doesn’t always get the job done, and platforms need to make the most of what they have.  Consolidating how they use that liquidity is critical, making sure that the liquidity is exactly where it is needed most, dynamically adjusting to fit what the community needs.  To this end, shifting the way that markets are handled can greatly improve how liquidity is optimized.  A key adopter of this method has been dYdX with its MegaVault concept. As part of their planned dYdX Unlimited release in the fall, and different from a typical liquidity pool, the platform has set up the MegaVault as a supercharged, collective liquidity battery that drives its unique “permissionless market listings” feature.  With this, a user can set up nearly any new market without governance approval, and launch the market on the platform by depositing a certain amount of USDC into the MegaVault in order to provide liquidity.  Because the listings are completely community driven, they have a proven demand, but will also vary quite a bit in popularity.  However, each will help to provide additional liquidity to the MegaVault as a whole, which collectively provides liquidity as the various markets need it.  It also uses various incentives to encourage and reward additional depositing, staking, etc.

Provide liquidity, earn yield 🤝

Say hello to MegaVault, coming soon on dYdX Chain.

Find out more ⤵️https://t.co/nTaPAEWQtT

— dYdX (@dYdX) August 6, 2024

Near Future Trends

Given the industry’s continued growth, it’s likely that new participants in the Web3 community can help provide more liquidity if they become active in Web3 trading, but at the same time, there continues to be a growth of new Web3 platforms looking for liquidity.  Platforms across the industry must work harder in general, but smarter in particular.  Finding the right mix of incentives without losing too much as a result is important.  However, ensuring that operations are smooth, fast, and minimize negative effects will continue to be a high priority.  Innovations like the permissionless market and the MegaVault concept from dYdX provide a lot to consider in terms of how to maximize whatever liquidity you have to work with.  Being able to intelligently leverage liquidity to its max, and to use whatever other best practices that might give the platform’s liquidity a boost; this activity will see a growing amount of attention in the next 1-2 years.  Liquidity has always been a key focus area in Web3, but we can expect that focus to become an obsession between now and a much greater level of Web3 adoption worldwide.