Liquidity in DeFi
Liquidity is a relative measure of how quick it is to trade one asset for another. The most liquid asset we know today is cash, while assets like real estate are relatively liquid, and you may have to reduce the price to find someone willing to buy your property. By drawing insights from industry situations, this W3G Capital report explores the origin and significance of liquidity in the crypto space. Liquidity varies with markets as the stock market, for example, is more liquid than the real estate market. Assets of the same kind have different liquidity, as you may have noticed in the crypto space, where you can easily buy a coin like Bitcoin with less price impact. In comparison, altcoins are less liquid, with fewer transactions leading to a bigger price impact.
Why Does Liquidity Matter?
Liquidity matters because markets with better liquidity allow their participants to enter and exit an investment position faster and at a fair price. If you are not in haste to sell your car, you can set a fair price and wait until a buyer comes to take your order at that price. If you are in a hurry to sell the car, however, you may have to sell it at a lower price. Reports at W3G Capital gathered that liquid markets attract more participants due to the ease of entering and exiting positions. In the cryptocurrency market, the rise of both centralized and decentralized exchanges led to a growth in the liquidity level of the market, and the cryptocurrency market depends on the activities of these market participants to thrive. Market makers are crucial in crypto because they ensure the continuity of transactions by holding perpetually opposite positions to trades executed by market participants.
Where Token Liquidity Comes From
Whether on centralized or decentralized exchanges, liquidity comes from individuals and institutions. Individuals taking both sides of the trade can help make the market liquid, but it is hardly sustainable to rely on individuals to make the market. Most individual traders do so occasionally and are not available to use their funds to execute trades. Hence, centralized exchanges often rely on institutional market makers or act as institutional market makers under a different name.
If a trader wants to sell one Bitcoin for $16,000 without delay, someone must be willing to buy at that price; otherwise, the trader will have to wait forever. The entities buying to resell with some margin of profit are institutional market makers. Since institutional market makers execute trades with millions, sometimes billions of dollars, they can help retail traders fill their orders with little price slippage and profit from the little price difference when it is eventually added up. Institutional market makers can charge $2 for each trade but considering the millions of settled orders daily, this amount could become huge. W3G Capital’s research into market-making on centralized exchanges reveals institutional players are some of the biggest market makers and are important to build a reasonably stable market and catalyzing growth in the space.
Liquidity on DeFi Protocols
After checking through the background and mode of operation of most DeFi protocols, these protocols use variations of the market maker function X*Y=K. Most of these projects started with individual liquidity providers. Still, the incentives received for providing liquidity made these market actors ready to leave their funds and use them to facilitate exchange on the protocol. Uniswap, for example, charges transaction fees and pays a part of this money out to liquidity providers on its exchange. All transactions, including the liquidity provider rewards, which are paid out in the platform’s native token, the UNI, are settled automatically since DeFi protocols are decentralized. Over time, institutional market makers have started staking like individuals to facilitate transactions on these exchanges. In return, they receive liquidity rewards like individual market makers or liquidity providers. Anyone can provide liquidity on decentralized exchanges and receive liquidity mining rewards. The only caveats to providing liquidity are that the token price is often volatile, and there could be discrepancies in the price on centralized exchanges compared to the price of the same token on a DEX. Such price differences are an impermanent loss since arbitrageurs will eventually resolve the differences and bring the price back to normal.
Who provides liquidity?
Any market player can provide liquidity for crypto assets, but most of the liquidity is provided by market makers and Web3 funds. We compiled this list based on the popularity and size of their operations in no particular order:
B2C2 is a digital asset pioneer and forging the growth of the future of finance. The institutional market maker has unlocked institutional access to crypto by providing trusted liquidity across market conditions for some of the biggest crypto brands. The platform’s success is built on blockchain technology and continuous innovation.
W3G Capital is a safe investment fund for the Web3 ecosystem that lets you raise capital interest rates and minimum value per annum on your project. The fund offers equity investment for developing and growing deserving Web3 projects, providing liquidity to facilitate trade, and offering infrastructural support.
Wintermute is a global algorithmic market maker offering liquid and efficient markets for centralized and decentralized exchanges. The platform also offers OTC, API integration, and voice trading services.
GSR is a crypto trading firm, ecosystem builder, and market maker. They partner with exchanges to provide deep liquidity in all market conditions and execute orders with strong ethics and precision. They also manage risk and help growing crypto projects build to scale and contribute positively to the space.
Keyrock is building scalable and self-adaptive technologies to power an efficient market. The platform supports the growth and wide adoption of innovative technologies in the digital asset space, intending to create a fairer and more efficient capital market. Using a highly scalable market-making technology, they execute trades, provide liquidity, and collaborate for growth in crypto.
Companies like W3G Capital prioritize market-making and liquidity solutions for Web3 projects to increase growth, access, and wider adoption of cryptocurrencies. Liquidity is critical to the growth of crypto and the adoption of digital assets. Without liquidity providers, the market will disappear as there will be no one to sell or buy an asset. Even though trading of digital assets started as one-sided bids where a seller had to wait for a buyer willing to accept their asset in exchange for what the seller needed, the current massive growth in the crypto space was only possible through the activities of crucial actors like market makers. With market makers in the space, trades can be executed in a wink, and such flexibility will bring more buyers and sellers into the market. As the crypto market evolves into the future stock and financial market, market makers will have a bigger role in the space.