Good UX, good tokenomics, and good tech are all important. But these properties are worthless if there isn’t an even more precious attribute powering it all – liquidity. Exchanges, networks, and dapps live or die by liquidity. It is to traders what water is to humans. When liquidity runs dry, ecosystems start to wilt. No wonder that crypto builders devote so much resources to deepening liquidity.
Whether it’s aping the latest memecoin on your favorite DEX or trading perps on a centralized orderbook, there needs to be sufficient liquidity to enter and exit positions at the desired price. Otherwise, you’re throwing money away with every trade you place.
Of course, it’s one thing to appreciate the value of liquidity as the foundation for everything crypto is built on. It’s quite another to attain and maintain it, particularly on decentralized networks. Thanks to recent innovations, however, onchain liquidity has improved significantly, driven by hybrid solutions that combine CeFi and DeFi.
The Constant Quest for Deeper Liquidity
Optimizing liquidity isn’t just about reducing slippage, important as this is. Liquidity also contributes to price stability since in highly liquid markets assets will be less volatile because large trades can occur without drastically affecting the price. In illiquid markets, such as new tokens launched on DEXs, the price can yo-yo, with even moderate sized orders making an impact.
This impacts everyone from the next trader waiting in line, whose order may be executed at a different price to that quoted a moment earlier, to liquidity providers who can be affected by impermanent loss. On centralized exchanges, such stability is also desirable for attracting institutional investors and building trust in the market, as professional trading firms are only drawn to liquid assets.
CEXs typically use an order book system, with the exchange matching buy and sell orders to facilitate trades. Liquidity on centralized platforms is often managed by market makers who continuously offer to buy and sell assets at different prices. These market makers profit from the spread between buy and sell orders and play a vital role in ensuring there is always liquidity available.
Market makers are also utilized in DeFi, but the majority of liquidity comes from retail users, especially whales (HNWIs). In return for pooling liquidity, users earn a portion of the trading fees generated by the platform, incentivizing a liquid market. Effective as this model is, the proliferation of DEXs, AMMs, L1s, and L2s has caused liquidity fragmentation. There might be billions of dollars in DeFi liquidity, but it’s scattered everywhere. To solve this problem, DeFi developers have had to get creative.
Liquidity Layers and Hybrid Solutions
DeFi devs have tried a number of approaches to solving the liquidity challenge, leveraging variants of the following solutions:
Liquidity aggregators: Services that combine liquidity from multiple DEXs, allowing traders on a particular network to obtain the best possible price. Aggregators are limited by available onchain liquidity however.
Liquidity layers: These seek to draw liquidity from multiple chains and protocols and can be thought of as an enhanced DEX aggregator that can access more sources.
Hybrid solutions: Can derive liquidity from both centralized and decentralized sources, allowing a greater spectrum of crypto liquidity to be provisioned onchain.
To visualize how this works in practice, let’s consider a couple of working solutions.
One of the best known liquidity protocols is Orbs, whose L3 aggregates liquidity and is capable of merging CeFi and DeFi sources. This allows DEXs to offer liquidity that can match that available on centralized order books. As a result, traders can enjoy the non-custodial benefits of an onchain environment coupled with the liquidity synonymous with a CEX.
Orbs’ Liquidity Hub forms the optimization layer that allows DEXs to access external sources such as CEXs, and is complemented by a similar solution, known as Perpetual Hub, for onchain futures trading. Orbs has also developed dTWAP and dLIMIT, two protocols that bring CEX-style limit and DCA orders to DEXs, with the likes of SushiSwap and PancakeSwap having integrated this technology.
Then we have Orderly Network which takes a slightly different approach to provisioning onchain liquidity. Like Orbs, it’s developed a liquidity layer but it’s intended for spot and futures orderbooks operating onchain. It provides CEX-like infrastructure that DEXs can use to create their own white-label onchain exchanges that are fully decentralized.
Using Orderly’s tech, DEXs can introduce services such as spot aggregators that source the best rates when trading major assets, and perps aggregators that draw upon the full spectrum of liquidity Orderly’s perps ecosystem contains. Because Orderly procures liquidity from multiple chains, DEXs aren’t constrained by the chain they’re operating on. While Orderly has deep ties to NEAR, its roots extend much further, making it a true multi-chain solution.
The Unification of Onchain Liquidity
There is sufficient onchain liquidity to handle the largest swaps and perps trades. The trick is in aggregating it so that it will support rapid and seamless order execution. Achieving this calls for innovation not just in terms of infrastructure design, but in interface design too. The emergence of cross-chain liquidity aggregators has significantly enhanced onchain liquidity, while the introduction of CEX sources has further enhanced this.
While the tech is now in place to deliver CEX-quality trading on decentralized networks, there’s still work to be done in widening adoption of these services. As more DEXs and networks connect to liquidity layers and cross-chain orderbooks, user experience will improve. We’re not there yet, but one day traders should be able to place a trade on any DEX in the knowledge that they will receive the token they want at the quoted price. No slippage, no latency, and no custodial risk. When that happens, the onchain liquidity problem will have been well and truly solved.