How Liquidity Aggregation Solves The Liquidity Issue For Institutional Investors.
One of the significant advantages of cryptocurrency is the ability for users to manage their funds with self-custody and complete sovereignty.
For everyday investors, this has worked fantastically. Cryptocurrency has already prevented thousands of issues that could have arisen had people’s funds been held by a bank or central entity.
Until recently, many large institutional investors did not need or see self-custody’s value. Furthermore, the decentralised finance industry could not provide the liquidity necessary to facilitate institutional transactions without high price impact, but the past 12 months have rocked the industry and following the Luna Terra collapse, countless massive cryptocurrency companies fell. Mostly, this was due to a domino effect caused by over-leveraged and under-collateralized practices.
These collapses included Three Arrows Capital and FTX. The bulk of funds managed or held on these platforms was institutional investment aimed at exposure to one of the world’s fastest-growing asset classes.
But why trust SBF in the first place? Let’s explain.
Why Take The Risk With Centralised Organisations?
When crypto-enthusiasts hear of centralised organisation collapses, like FTX or 3AC, they often question why people would take that risk when safer, non-custodial alternatives exist.
For many users, including institutions, it comes down to user experience or ease of access. Institutions prefer a product which they understand and they are bureaucratic, so it is easier to agree to hand over $100 million to a “genius” billionaire like Sam Bankman-Fried, the owner of FTX, than take the risk of learning and using DeFi.
Overall, institutions are so used to TradFi practices that they do not see centralisation as a risk, but with the recent collapses, this may be about to change.
But secondly, and most importantly, many institutions opted for the centralised route due to DeFi’s relatively low liquidity.
You only need to Google “liquidity exploits” to see the endless number of attacks on AMMs liquidity pools. Currently, many DeFi solutions are not robust enough to deal with orders of size.
The lower available DeFi liquidity would lead to large price impact for institutions. Let’s use an example to explain this better.
Until its collapse in September, FTX’s total trading volume for 2022 was $3.1 trillion. Whereas for the Entire year of 2022, Uniswap’s volume was $620 billion.
Bear in mind, Uniswap is by far the biggest DEX, but FTX is one of many CEXs used for institutional investment.
With all this in mind, you can see why institutions have gone the centralised route in the past.
But look how that turned out!
The Next Steps
Considering institutions had multiple reasons to use CEXs over DEXs, there needed to be an earth-shaking event to change things. But, the collapse of numerous institutional platforms has delivered the event.
To retain institutional funds, the cryptocurrency industry needs a solution to the liquidity problem.
Introducing Aggregated liquidity.
Simply put, a liquidity aggregator is a group of smart contracts which find the best price of an asset from a range of exchanges. While this may not immediately stand out as a solution to our DeFi liquidity issue, let’s break it down.
There are various forms of liquidity aggregators, but to solve our issue, we will look at how Magpie Protocol works.
A decentralised cross-chain liquidity aggregator. Why bridge when you can fly?
Here is how:
- Interoperability from a single dashboard
Magpie is a chain-agnostic decentralised application (dApp). So it pulls price data for assets on multiple blockchains into one app.
- Price data
If the interoperable dashboard is its top layer, the next layer is its price data. The blockchain displays the best price across multiple AMMs using an API endpoint.
- Trade execution
Once the user has identified the asset they want to buy, the protocol begins its execution and a relayer node executes the transaction, sending funds to the user’s wallet.
Magpie Protocol also offers cross-chain swaps, where this process differs slightly, but this is how it works for liquidity efficiency on a single chain.
How Does Magpie Protocol Solve The Issue?
You can better understand how aggregation solves liquidity issues for institutions when you break it down a little further.
First, with aggregation, traders will always take the best price, regardless of the platform.
When trading through an AMM, traders only use liquidity from that single platform. So if a high volume of orders comes in, the price can be artificially pumped up, causing slippage. To better explain this, let’s use an example.
Imagine we have multiple institutions that want to buy the Aave token on Uniswap. After each institution places a trade, the price pumps. This would result in an artificially high price for the Aave token on Uniswap compared to other platforms.
*Arbitrage bots will help regulate the price in the first scenario, but there will still be a time when slippage is high.*
In comparison, let’s say they were to use a liquidity aggregator, such as Magpie Protocol.
Instead, each order would be split to achieve the best price. So imagine order A was for $2 million, the first $1.5 million might be used on Uniswap, while the remainder is used on SushiSwap. Order B would then follow from this, which could also be split to attain the best price.
Always providing the cheapest available rates minimises the price impact caused by significant trades and it makes liquidity from multiple platforms available to users from a single dashboard.
In conclusion, liquidity aggregation can fix institutional investors’ DeFi liquidity problem in a non-custodial and secure way. Therefore massively reducing the risks faced in comparison to centralised platforms.
Using Magpie Protocol, investors can take advantage of the technology from a seamless, user-friendly dashboard. Many aggregators have struggled to implement this, but Magpie Protocol has executed it perfectly. Check us out today and get involved with the Beta.
