Romain FIGUEREO - Liquidity in crypto: a new flow of value creation

Transcript

thank you for uh staying for this last Talk of the day so I'm not sure why the presentation was supposed to be in Orange it's in blue oh no it's in Orange now good uh so maybe uh today we're going to talk about liquidity it's interesting because it's linked to the past two talks and it's kind of going to make the links with some of the arguments that the previous speakers have made in general the idea is to understand how crypto is actually going to create value in the ecosystem a lot of people keep saying that crypto does not create value that's wrong it's been wrong since the start it's just that uh there's a very different definition of what value is and my point here is to explain that liquidity is kind of an oracle to understand this value creation so first we've heard liquidity a lot

over the past few talks you hear it always in crypto you're going to hear a lot about it in finance in general so I just wanted to start by quickly uh talking a bit about what is liquidity my personal definition and it doesn't come from me I didn't invent it it comes from a a fintech blogger that's called fintech ration uh it's that it's the efficiency at which an asset can be converted into cash and the opposite vice versa right what does this mean that's actually really interesting if you stop on this because it means that uh in a sense liquidity is a pricing mechanism if you have liquidity you're able to understand the value of a project and I think that's really important because in the end if you think about it it means that liquidity is the underlying Oracle of a of a PR of

an asset the more liquidity you have the harder the actual pricing of something is the less liquidity you have the less reliable the actual pricing is so um in finance in general it's important to understand that uh this concept is basically the underlying of any value that you're going to have uh something uh maybe that I should add is that value is very subjective a family herem might be super valuable for you but the market will probably Mark Mark it down to zero right so here when I mean pricing liquidity I mean how other people are actually pricing and that's important because in traditional Finance liquidity is basically just supply and demand right people want to buy something other

people want to sell it so the way it has been built is that it we have created giant order books this is what traditional uh exchanges look like simply because what we do is we aggregate all of the people who want to buy all of the people who want to sell and it should be super efficient right has anyone here traded on centralized exchange or any stock exchanges in general I see one person does no one try two three but what's important about this is if you look at it there's going to be a spread basically there's a split between what's the price people want to buy at and what's the price people want to sell at and the convergence is more than likely often made by market makers so there are

huge inefficiencies in this market and the other thing that I want to talk about is the real problem in this system oh that's better uh in a sense there's something that I call evaporation which is when there's no demand or when there's no Supply one of the two sides of what you're seeing here there's basically no liquidity right does it mean that if there's one of the sites that's missing the asset has suddenly no value that's a good question if suddenly no one is ready to buy or no one is ready to sell has an asset no value that's actually not true because let's say something is really rare if you think about Gram's law right if an asset becomes really rare and suddenly everyone thinks there's a lot of value

let's say an exotic car for example no one wants to sell it does the car have no value no it has it's just the market is not able to define the value and that's where amm as we're going to see come in and become create something very interesting because when there's no liquidity uh everything stops working in term of pricing mechanism so when everything goes wrong let's say there's a a crisis for on any type of commodity uh what what could happen is the liquidity entirely dries out that doesn't always happen but it can happen for example if you look during the the Russian invasion every single Russian stock basically went to zero but the the companies were not worth zero so that's why uh crypto

is Reinventing the flow of value creation because with amm we're totally Reinventing the way we can understand and price liquidity so that's just the part for TR five that's why I wanted to introduce amm I'm not going to go into the hyper comp complex stuff the idea is just to understand that the basic invariant formula is a logarithmic curve which enables people to deposit two pairs of tokens and they can be used to trade people basically trade over it and it enables you to Value the price without one of the part of the Lego piece I just said so you can actually trade and have a pricing mechanism that's updated without one part of the two markets so why is this

important because resilience what it means is that once you have liquidity on an amm instead of an order book you basically have liquidity that does not need human interaction to function and that's really important because it means that if you're in a place that's censorable if uh you're uh in a high frequency environment if you're in a using a very Niche asset you do not need to constantly interact with humans it also means that you can have much more compossibility in what you're doing so at some point the value of an amm versus uh traditional liquidity in an order book is simply the fact that it's permissionless and it's immutable and nothing's going to happen to it

there's always going to be liquidity it's just going to be very down and amm the theoretically in the basic configuration cannot go to zero but it can go the closest to zero without being zero so it means almost no value so I like resilience I think that's the whole point of crypto uh and I think that's has a lot of value as I mentioned just before why and who provides liquidity I want to go a bit into details into why this is actually useful and then explain what are the risk to understand where we're going with this in liquidity as you've seen what we showed just before this kind of formula that was 2018 right we've evolved a lot you have curve you have un3 you have balcer a lot of other much more complex models but this base are

resilient liquidity is uh what actually enables to create value because uh when you talk about m coins you can think they have no value but that's not true as long as there's a liquidity pair and there's actually a pricing Market you can actually sell into to and create value so when you find a uh create uh an item the value is going to come from who is going to buy it here in crypto and to amm it's going to depend into the depth of your liquidity pool that's why we talked about Oracle before right oops sorry going back I'm going to stop hovering between slides it's going to become a bit more confusing if I do uh but there's three type of people who are actually providing liquidity in Defi and this is basically the the very basic

uh type of people who are actually participating in crypto you have the projects the people who are actually creating the the assets who are creating products the funds so very large investors and then retail users who are basically all of us why would these projects create liquidity and provide it well because uh they can benefit from the actual volume the actual trading activity of their assets it also means that uh once they have this liquidity they can actually basically start the composability machine machine almost nothing is doable without liquidity if you have an asset but you do not have liquidity you don't have an oracle you can't do Integrations you probably are not going to get into lending protocols etc etc liquidity is basically the base building block that enables projects to

do so and of course you enable people who have your asset to do correct trading experience the second one are going to be funds so funds probably investors but not just are people who think they can profit from providing liquidity they can hedge as an investment for example if you put a significant uh bill into a an asset and you're pretty convinced it's going to be resilient you can create liquidity pair and basically it means that you're Pro progressively selling the asset into uh basically harder assets and the last is that it basically enables a better valuation of their investment as I mentioned before the more liquidity you have the more more robust uh pricing environment you have for the assets

lastly retail users so let's be honest retail users when they deposit liquidity most of the time they get screwed the reason why they get screwed is simply that they don't have as much knowledge as funds or projects may be internal or external and uh unless they go for Edge opportunities they get diluted very quickly because they simply don't have the size necessary to basically uh do this at scale that's very quickly for the people who are providing liquidity we're basically in the third column most of us and we're getting wrecked uh because there's all of these risks that are happening I'm not going to go into in depth all of what these risk mean and do but the idea is to understand that you have technical risk you have economical risk and then you have human

risk in a sense and what happens is that liquidity providing is simply not just depositing funds and getting them out there's actually value that's being transferred in and out uh at every trade and um that's why we're building new versions of amm constantly because we realize a sign significant amount of value leakage right so if there's value leakage why would people actually provide liquidity especially the retail part because there's actually money to be made there is a TRNA of this money to be made first is the swap fee that's the classic one right it's basically just people to be able uh trading and paying for the to for the ability to trade but that doesn't bring in enough fees to basically really attract unless you have huge amounts of levels of U of sorry of

volume that's actually Happ inside uh that's actually the biggest problem because I as I mentioned before a lot of assets that starts that are basically created we start by amm liquidity and the problem is that they don't have volume at the beginning so if they don't have volume there's no swap fees so what's the incentive of depositing unless you're the actual project and for a project to deposit they need significant funds in harder assets in order to pair them and to RIS them once you start having volume on the other side you can have rebalancing rewards but they're not very significant uh outside of basically rewarding newer people and taking more risk uh to rebalance the polls so the first Solutions is basically additional incentives you're going to pay for liquidity and that's a very important

point because it's a comparison that hasn't been made a lot but basically um it means that you can actually compare the price of paying for liquidity on chain today in amm to how much certain companies are paying to have market makers because the way it happens is that the more your asset is liquid if you're go Google or Facebook you don't pay for market makers people pay to work with you because you're making so much volume that uh it's a business to actually work with you but the less volume you have the more you have to struggle to have people to find people one very interesting thing is uh I don't know how many of you know or use Euro next which is the European Stock Exchange but if you look at the Paris office there's 871 stocks that are

basically public there and out of these 25% have not been traded for the past 48 hours so basically a quarter of old EUR next is not liquid that means that the order book system does not work for them now what happened if most of these companies who are actually making a profit instead have an A had an amlp right people would be able to trade against it and it's not just about trading to be honest because if you don't have a robust price fed you can do lending which means it's going to be much harder to basically find longterm agreements it's going to be all of this is going to get more complicated so there's an incentive in saying that LPS in general are solutions for a low volume project the question is if you're low volume is it more interesting to pay

for a market maker who's going to spread who's going to be paid on the spread and who you're going to have to pay or is it more interesting to do direct liquidity incentives in crypto we basically mostly do direct liquidity incentives but what we do at Palin that's why we you see all of these little orange guys that's us uh well uh we basically try to understand how much uh you can get paid uh you can pay for these market makers how how much you can pay for liquidity incentives and we try to find the we're progressively trying to find the right way to allocate these so liquidity mining is what sparked the bull Mark in 2021 right it's basically just deposit tokens hopefully they have a liquid value right a market value sorry and uh

basically you just directly pay people to provide liquidity that's a very brick and mortar approach then came vote incentives that were pared by curve jda is that the protocol natively does liquidity Mining and you can basically pay in order to direct this the good thing is that because the asset is massively used for this strategy it's much more liquid has a much more robust market value it's more efficient usually you have a multiplier on the efficiency but it's more time consuming because there's complexity added and the last one which is the flavor of the month its points I'm not a huge fan uh simply because it's liquid so there's a huge a symmetry of information between the people who are taking the BET of basically saying points are going to be valuable and uh the actual teams who are organizing this and who get to choose

the value of these points now it's very much aot a lottery but for people who have played around with spendal for example if you had Insider info and you were able to actually gauge the value of a point could just buy the yield out of people who didn't know and you could make 10 20 50 times the actual value that was expected by the people who sold so there's a huge problem of as symmetry of information on points but in general that's the three options we have to incentivize of course against in traditional compan basically just paying for a market maker that's kind of the comparison so we talked about who are the LPS we talk about uh how do we track them now why do you want liquidity we talked about the fact that it was interesting to create as a pricing strategy but basically it's

a bit more granular than that and what we do a lot at Palin is just trying to understand what are the strategy of this project in order to basically get more liquidity do you want to create demand which basically means you want to reach a threshold where you have so much volume that you basically don't need LPS anymore and you just can go more into an order book style so to understand only the biggest Assets in crypto are able to do that something like uni a ldo and things like assets like St if now have enough volume as Adrian just mentioned in the previous talk have enough volume to be able to have an order book style but almost all of the assets after that they don't have enough volume to do that they're way too small they're ultra low ultra low cap in a public uh type of

environment so they have two choices if they can pass the to create demand threshold either they can find LPS so they can find Partners who are going to provide liquidity on the long term these guys usually either are paid as market makers or so they can be paid through liquidity mining by the way or uh you find people who find a profitable way to do strategy and the last one is if none of these fit you can actually build your own liquidity and I think that's the most interesting one uh that's the one we have built internally also because it means that as a project today you can ignore the fact that you need one part supply or demand of your project for it to be functional in the sense that you can simply just own your own liquidity profit from the speculation that's

happening around it and be resilient on that front because uh once you become a public company once you have a a token as a crypto project which are two very different things never confuse them or you're going to get C by The Regulators uh what's going to happen simply is that uh you can stop caring about this and you can focus on the actual important things which is building your product building your company okay so now that we've talked about liquidity in general uh the final thing is to understand where liquidity is going today as I mentioned liquidity is much more complex than simple invariant constant that we talked about from un from that was actually coined by vitalic uh but today we're seeing a

convergence towards traditional markets and a Divergence which means we're building more and more complex products that are looking like order books and probably with the idea if you look at univ V4 for example univ V3 then univ V4 to rebuild an order book on top of uh resilient liquidity so it's basically Reinventing the will which is the specialty apparently in crypto and then the other part which is the Divergence going fully resilient s very simple LPS and acknowledging that these are two very different products the fact that order books are made for high volume and high in demand assets and that LPS in general amm are made for liquidity that's most likely going to be much rarer but it's

going to be liquidity that's always going to be there so when your company crashes down when there's a huge problem when the market goes to literally your LP will still be there that's it I don't know if you have any questions but now's the time