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Saturday, December 3, 2022

Resolving the Problem of Leaking Cross-Chain Liquidity

Cross-chain liquidity

Cross-chain liquidity

Despite the soaring popularity of decentralized finance (DeFi), the crypto ecosystem is frequently criticized for its recurring liquidity shortfalls. Several competing realities underpin thin liquidity across the crypto universe.

First, liquid assets are those assets that can be traded easily for cash. This means that there must be enough buyers in any market willing to put up cash for the assets. Herein lies the conundrum of the crypto market.

Unlike their traditional counterparts (stocks, bonds, futures, and commodities), the marketability of digital assets doesn’t command wide acceptance – meaning only a limited number of people are investing in them. Contrast this with stocks, which represent productive assets or raw materials in the form of commodities vital for industrial inputs, and it’s easy to see why crypto doesn’t command the same liquidity.

Moreover, crypto trading volumes, except among a handful of exchanges (mostly CEXs), are low relative to traditional financial markets, notwithstanding the crypto market’s persistent volatility, which can make investing an unsettling experience at times. Many investors rush to dump holdings amid wild price swings, usually selling at significant discounts and sending prices to extreme lows. As demand drops, the market becomes less liquid, making price discovery a messier process.

On top of that, cryptocurrency investors are spread thinly across a broad market. Most blockchain networks, by design, operate individually. They aren’t interoperable despite ongoing efforts to improve cross-chain compatibility. While there are currently over 6,000 different cryptocurrencies across the broader market, most of them are confined to their own ecosystems and generally operate in standalone environments.

As a result, the cryptocurrencies and the DeFi primitives launched on these networks often subsist in siloed environments, catering only to a handful of investors and users. This, in turn, leads to fragmentation of the available liquidity. Although it might feel like liquidity increased during DeFi’s rapid rise, this was mainly a function of the rehypothecation of assets, which quickly drained out of the ecosystem during its latest decline.

Besides the lack of interoperability and less mainstream acceptance, the available liquidity of the crypto market hasn’t increased much in recent years due to the uncertainty of regulations. In the absence of more stringent regulation, investors often visualize major price discrepancies between the value of the same asset across different exchanges simultaneously.

The regulatory absence has also paved the way for unchecked market manipulation. All of these have forced interested institutional investors onto the sidelines until greater clarity and guidelines are issued. Despite their commitment to cryptocurrencies, retail investors can only add a limited amount of liquidity compared to their institutional counterparts and hedge funds.

Automated market makers (AMM) and liquidity aggregators have addressed the crypto market’s liquidity hurdles to an extent. However, they come with their own set of problems. Most of these solutions are deployed on an individual chain, forming their own heterogeneous silos.

For instance, a liquidity aggregator deployed on Ethereum will only aggregate liquidity from exchanges and DeFi projects operating on the Ethereum network. It won’t aggregate liquidity for assets available on the Bitcoin blockchain. Accordingly, existing solutions aggregating the available liquidity from projects operating on the same chain only solve half of the problem.

Answering The Dilemma Via A Proprietary Hedging Pool

To successfully attract institutional capital and other highly capitalized vehicles to the market, the crypto ecosystem needs a definitive way to aggregate liquidity while addressing other concerns such as regulation, throughput, and fees, among others.

This is where FLUID comes into the picture. FLUID’s AI-based smart order routing protocol and cross-chain liquidity aggregator, enabled via its proprietary hedging pool, delivers high throughput at low costs and low latency with zero counterparty risk.

The platform not only aggregates liquidity across both CEXs (centralized exchanges) and DEXs (decentralized exchanges), but it also adheres to regulatory requirements and maintains liquidity without any custodial requirements over transferred funds or synthetically wrapped assets.

The FLUID LP (Liquidity Pool) facilitates synth-free, cross-chain stablecoin transfers. Most existing solutions rely on issuing synthetic versions of stablecoins to enable cross-chain transfers. On the contrary, FLUID LP uses the already existing assets. So, instead of wrapping Binance Chain’s stablecoin BUSD into its platform-native fBUSD synthetic asset, it uses the BUSD reserves on Binance Chain and Ethereum directly.

Simply put, the FLUID team focuses on securing deep liquidity by concentrating pooled assets in the most viable and high-volume trading directions. As a result, anyone (retail investors, institutional investors, CEXs, even DEXs) can easily pool their stable reserves as part of FLUID’s cross-chain solution and generate revenue (yield). On top of that, the FLUID LP order book is connected with staking, which means that investors can stake their assets in the platform’s vaults to generate additional returns.

With this additional liquidity from the FLUID LP, the platform can seamlessly facilitate large volume trades without delays or errors. Additionally, the liquidity pools responsible for processing cross-chain transfers are managed by FLUID itself, ensuring that investors won’t face sudden withdrawals of liquidity.

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