GIBRALTAR – July 8, 2020 – Vega, a blockchain project that is building a decentralized protocol to run infrastructure for programmable financial markets, today released its research Market-Based Mechanisms for Incentivising Exchange Liquidity Provision. Low liquidity is a major known problem for decentralized exchanges (DEXs). In its paper, Vega introduces an improved solution using a mechanism for sustainable and highly scalable liquidity markets that optimises for liquidity and low cost of trading.
At present, the trade volume of the largest DEX, Uniswap, stands at about $18 million, a far cry from the $1.3 billion in trade activity on the popular centralized exchange Binance. Despite recent surges in decentralized exchange activity, DEXs still only account for less than 1% of all crypto trading. There is a glaring gap in performance between centralized and decentralized exchanges, and liquidity is a significant part of the problem.
A recent survey from Encrybit asked more than 1,000 traders, “What are the biggest problems that you see in currently available exchanges?” Thirty-six percent identified “lack of liquidity” as the most significant issue.
Below is an excerpt from Vega’s latest research:
“A key problem for exchanges is how to attract liquidity providers and retain their support in all market conditions. This is commonly approached through individual business agreements with market makers whereby a bespoke contract is negotiated for specific obligations and rewards. Such approaches require a central intermediary that profits from liquidity provision to administer, and typically fails to align the incentives of exchanges and liquidity providers as markets grow. This is costly, slow, and scalability is limited by the exchange’s resources, contacts, and expertise.”
Many DeFi projects have socialized yield farming and liquidity mining as a popular way to bootstrap early liquidity. However, these solutions only offer a short term fix. In the case of DeFi markets, rewards rely on allocation of some scarce asset, which ultimately makes yield farming a diminishing incentive for early enthusiasts to keep supplying liquidity.
“Right now, we are seeing an explosion of interest in DeFi and liquidity incentivisation, however much of the current activity is fuelled by unsustainable handouts rather than fundamental advances,” said Barney Mannerings, Vega Co-founder. “It’s too early to tell which approaches will succeed and which will fail, but there’s precious little rigorous research into the measurement and pricing of liquidity and the resulting mechanism design. This paper is our contribution to the conversation, and takes us one step closer to sustainable decentralised markets. ”
Vega proposes a novel way to structure liquidity commitments and a mechanism based on a financial bond with penalties for under-provision to maximise market makers’ adherence to their obligations.
The paper explains, “The goal is to set up a market mechanism that optimises the amount of liquidity provision such that liquidity incentives increase when liquidity is under-supplied, and decrease when there is sufficient liquidity in the market. Markets are assumed to potentially have multiple market makers, each of whom can decide which market to supply liquidity to.”
Liquidity incentives are at the core of the Vega protocol. In this paper the Vega research team has explored several approaches to decentralising this critical aspect of exchange system design. They use agent based modelling to demonstrate how these approaches result in liquid markets and optimal price setting for fees.
According to Token Insight’s 2019 DeFi Industry Annual Research Report,
“With the integration of liquidity aggregator and market making bot, DEXs will grow [at] a much faster pace in 2020, however centralised exchanges will still dominate the market.”
For DeFi to scale and be competitive with traditional markets, liquidity incentives need to be automated at the protocol layer. To date, DEXs have not demonstrated sustainable and scalable liquidity solutions and have either ignored the problem and suffered from a “graveyard” of illiquid markets, or attempted solutions that don’t scale or adapt to the market demand for liquidity. Vega’s “liquidity markets” designs a new approach to matching liquidity providers with trading demand in a scalable and sustainable way.
Vega recently launched their Markets and Liquidity Programme with 7 founding members to explore these concepts further and develop community led proposals for the first liquid markets on their Mainnet Alpha release, expected later this year.
Those who have questions or who would like to further discuss Vega’s research can contact the team via email: email@example.com.
Vega is building tools that guarantee the freedom to trade and make capital markets available to everyone. This vision will be realized through a protocol for creating and trading derivatives on a fully decentralized network. Traders can use Vega Protocol pseudonymously and be rewarded by other participants for creating new products and providing liquidity.
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