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Liquidity Aggregation in Web3: Why it Matters, Challenges, and How We're Making it Happen

by Yellow NetworkMarch 26th, 2022

Too Long; Didn't Read

The latest developments in Web3 finance aim to solve the problem of crypto market fragmentation. For that, two tasks need to be solved simultaneously: crypto liquidity aggregation and cross-chain interoperability. Once this is done, we will get what is called Web3 Liquidity Aggregation.

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To The Attention Of Everyone Who Wants To Make Money With Crypto

Whatever anyone would say, crypto is not for everyone yet. Despite that initially, crypto was intended to be accessible for everyone freely, and without any prequalification requirements, most people still see it as full of barriers.

The most common complaint about crypto: it’s toooo complicated!

It’s not!

Indeed, crypto doesn’t require anyone to be a genius to use it. It just seems complicated because the whole crypto industry infrastructure is exceptionally inconvenient and cumbersome. It reminds more of a chaotic set of disconnected fragments, rather than a holistic symbiotic system.

Too many stand-alone blockchains, wallets, exchanges (centralized, decentralized, and hybrid), OTCs, dark pools, etc. They all have different rules, fees, interfaces, deposit requirements, trading pairs, and APIs. How not to go crazy here?!

Breathe out. Web3 technology will save you from madness. The latest developments in Web3 finance aim to unify all these isolated scattered fragments and make them interconnected. To achieve these, two tasks need to be solved simultaneously: crypto liquidity aggregation and cross-chain interoperability.

Once this is done, we will get what is called Web3 Liquidity Aggregation.

Understanding this concept is crucial not only for sophisticated traders or institutions but for everyone who wants to succeed with crypto. Once you decide to start playing with crypto, you will already know what essential factors should be considered for your crypto investment strategy to make it more profitable and less risky.

As we all know, knowledge is power.

So let’s dive in. I promise to keep things simple.

What is liquidity?

Liquidity refers to the ease with which an asset (a real estate, currency, security, or crypto) can be bought or sold without affecting its market price.

So, let’s say you need cash fast and wish to exchange for that your asset. If the market is liquid, you can do it smoothly and joyfully.

Simply put, good liquidity exists where the market can meet your buy/sell whims quickly and at the best price.

In terms of crypto, liquidity is the ability of a digital asset to be easily converted into cash or another crypto. Exactly the same meaning as on the traditional market.

Why does liquidity matter in crypto?

Because digital assets’ prices are vulnerable to liquidity deviations. In other words, liquidity changes move in tandem with the volatility of price changes.

Low liquidity levels mean that market volatility is present, causing spikes in cryptocurrency prices. High liquidity, on the other hand, means there is a stable market, with few fluctuations in price.

For any asset holder, poor liquidity creates multiple risks.

One of them is the inability to exit a position quickly or at its market price. Your asset might probably have value, but buyers for it have temporarily evaporated. Or there are just a few buyers so that you can only sell your asset imminently at a fire sale price.

In the described case that the market for the asset is deemed thin. Among other risks that it can lead to are:

Price swings. In thin markets, they tend to be larger than normal.
Slippage — occurs when a trader places a market order for an asset at one price, but the order executes at another. All too often, this price difference is not in the trader’s favor.
Market manipulation. Suppose a particular asset suffers from low liquidity. In that case, it makes it easier for a large trader to manipulate the market for that asset by placing a significant buy or sell order. If there aren’t many orders taking place, a large buy order could cause outsized gains in a digital currency, for example. Likewise, a substantial sell order could provoke significant declines in the price of a cryptocurrency.
Impermanent loss. This can occur in providing liquidity to dual-asset pools in Defi protocols. It is the difference in value between depositing two cryptocurrency assets within an Automated Market Maker-based liquidity pool or simply holding them in a cryptocurrency wallet.

So as we see here, liquidity is a very important concept to understand in order to avoid or at least mitigate the risks related to it.

What’s going on with crypto liquidity?

As was mentioned earlier, the crypto space is terribly fragmented. So is the liquidity.

The fragmentation of the whole industry is rooted right in blockchain technology development: so many different blockchain protocols appear every day (ok, not every day, but often), and most of them are heterogeneous. That means they have nothing in common in their design and can not seamlessly communicate with each other.

Then we have a plethora of stand-alone apps and projects hosted on different blockchain protocols or networks. They are not interoperable as well.

On the top layer of this cake are multiple trading venues: CEXs, DEXs, hybrid exchanges, semi exchanges (those that aggregate liquidity but do not execute orders on their sides). All living according to their unique rules and acting like independent sovereign states.

Let’s say I have a wild dream to start trading seriously and earn a pile of cash monthly. I strongly believe in the potential of one “fly me to the moon” coin and am interested in playing with it. The problem here is that my coin circulates on different independent exchanges with different volumes and at different prices. By the way, I’m actually not even sure whether these volumes are true and not washed…🤔

My next steps?

Oh, I’ll start my exchanges research, checking trading pairs, volumes, order books, fees, prices, and APIs of each. Then I will pick up a few of them, open up several accounts, each depositing with money at my own risk and accepting their terms and conditions, each stating, “Go to hell with all your future claims. We owe you nothing!”.

No prob, I’ll accept this painful reality and proceed.

Then I need to keep in mind how to manage all these accounts, remember exchanges’ fee structures to build on them my trading strategies, understand the depth of their order books, follow the updates, chat with the support in case I accidentally forgot to turn off my VPN and exchange blocks me because I look suspicious…

At the same time, I just keep successfully accumulating multiple risks arising out of simultaneous trading on several exchanges, burn my nerves and spend a tremendous amount of time handling all this stuff.

Can anyone advise me a good therapist not to go crazy with all this??? Ahhh, I have no time for therapy. I’m too busy orchestrating billions of different elements of my digital investor’s life.

That could be really embarrassing, even for those who meditate all day long.

This is exactly why many people perceive crypto as something complicated and opt to stay just observing and missing out on its shiny opportunities.

So what will save us from madness here?🤔

A solution that will properly pull together all stand-alone pieces of the crypto industry and make them interoperable.

Nope, it’s not Trello.

I’m talking here about a solution that would aggregate for me all the crypto liquidity from multiple desynchronized sources in one place, show the best prices and enable cross-chain transaction execution securely, seamlessly, and at low fees.

Is there any out there?

Crypto Liquidity Aggregation: challenges and Web3 solutions

To aggregate liquidity on the crypto market is way more challenging than on the traditional one. Why so?

Because of the same damn fragmentation problem.

For the execution of an order using the liquidity from multiple different sources, the last must have some connectivity and be interoperable.

When we talk about effective crypto liquidity aggregation, we imply not only gathering buy/sell orders for digital assets but also solving a bigger and more complicated problem — the problem of cross-chain interoperability.

At the same time, we should not lose here on the fundamental benefits of crypto: decentralization, peer-to-peer interactions, and security. These are all tasks of Web3 liquidity aggregation.

Now let’s look at the existing technology that can help facilitate it.

Web3 Interoperability Solutions

Here is a smart definition of interoperability offered by the National Institute of Standards and Technology (NIST):

“blockchain interoperability is a composition of distinguishable blockchain systems, each representing a unique distributed data ledger, where atomic transaction execution may span multiple heterogeneous blockchain systems, and where data recorded in one blockchain are reachable, verifiable, and referable by another possibly foreign transaction in a semantically compatible manner”.

If that sounds heavy, think of interoperability as a possibility to transfer value from one blockchain to another without losing on security and data reliability.

To achieve such interoperability is not an easy task. The cross-chain transfer involves multiple questions to consider:

how to issue tokens on the blockchains, ways to disable tokens when they are leaving the blockchain
rebalancing of tokens across blockchain to maintain liquidity
which blockchain features are required for cross-chain transfer
which blockchain is suitable for cross-blockchain transfer
realization of cross-chain transfer despite lack of Turing-complete smart contracts, etc.

Currently, there is no standard way that different blockchain systems talk with each other.

Below I’d just list some of the existing blockchain interoperability solutions that are widely applied at present.

Oracles — third-party services that provide an interface between smart contracts that live on the blockchain and any external (off-chain) data they need access to. Examples of blockchain oracle projects are Chainlink and Augur.
Cross-chain and cross-blockchain protocols. Here is the difference: cross-chain protocols provide communication between homogenous (having similar components) blockchains (like Polygon and Avalanche), whereas cross-blockchain interoperability protocols facilitate communication between heterogeneous blockchains (having a radically different design, like Bitcoin and Ethereum).
Sidechains and bridges — allow users to move their coins from one blockchain to themselves on another blockchain and back. Sidechains and bridges are often components of cross-blockchain interoperability protocols’ architecture. Some studies name them as synonyms. However, they are different in the designs and ways of their implementation.
Atomic swaps enable the exchange of digital assets between two users in a decentralized way. Assets could be on the same blockchain (e.g. two Ethereum ERC-20 tokens) or different blockchains (e.g. Bitcoin and Litecoin). The advantages of such atomic swaps are peer-to-peer transfer, a low cost of exchange, decentralization, increased security compared to other solutions, and ease of implementation. Atomic swaps can be performed on-chain or off-chain. Recently, atomic swaps have become the most important functionality in the De-Fi sector.
Hashed Time Locks. In a two-party transaction, the parties publish a contract in which they take ownership of the other party’s assets. An example of this is Lightning network/ state channels, allowing the transaction to be performed off-chain. The HTL mechanism is widely applied in Layer-2 scalability solutions and in atomic swaps to automate the exchange of tokens.
Blockchain routers facilitate inter-blockchain communication between different blockchain networks. In a nutshell, a router’s architecture implies a network of subchains (i.e., independent blockchains like Ethereum and Bitcoin) that do not communicate directly but do it through a router following a particular cross-chain communication protocol. An example of a blockchain router is the Anlink blockchain network.

If you want to get nerdier on blockchain interoperability solutions, check out this in-depth study “Blockchain Interoperability: Towards a Sustainable Payment System.”

Getting back to Web3 liquidity aggregation, its underlying architecture should be the best-balanced combination of interoperability principles and techniques. Such architecture should enable a user for seamless, high-speed, and low-cost exchange of any digital assets regardless if they are running on different protocols or circulating in various trading venues.

Web3 Example of Liquidity Aggregation

The unlimited access to all digital assets in one place and the possibility of their seamless cross-chain exchange are just parts of the task to make a user’s experience in crypto hassle-free.

There must be a single gateway trading environment, also offering a great crypto trading UI/UX, ease of connectivity, transparent fee structure, high transaction latency, effective settlement and clearing solutions, trade messengers, algorithmic trading capabilities, etc.

At the same time, it shall preserve all the perks that crypto stands for: security, decentralization, and p2p permissionless transactions at a low cost.

Having vast experience in FinTech and a deep understanding of retail and institutional traders’ needs, Yellow Network’s team is tasked to provide users with this kind of one-shop stop cross-chain trading environment.

Particularly, Yellow offers to interconnect multiple stand-alone exchanges in one automated non-custodial trading hub, providing a user with the aggregated liquidity and price feed and seamless high-speed cross-chain transactions at minimal fees.

On the level of technology, Yellow offers a 3-Layers model.

On Layer-1 of Yellow Network are multiple blockchain protocols (ETH, BTC, Solana, etc.) that validate transactions.

These protocols are paired up with a Layer-2 scaling solution called “state channels,” allowing users to transact with one another with high speed and at low cost.

And the Layer-3 is Yellow Network, offering a P2P cross-chain overlay mesh network built on top of OpenDAX v4 technologies. The network’s Finex nodes and protocol allow connecting multiple exchange platforms in a broad trading environment, launching new DEXs and easily integrating them.

The network will reach Layer-1 blockchains through Layer-2 state channels and procure low-cost, high-speed cross-chain transactions suitable, even for high-frequency trading(HFT). It will also share the liquidity and price feed aggregated from all the exchanges integrated with the network.

Also, Yellow Network facilitates non-custodial trading, which means that users will be able to deposit and withdraw funds using their addresses on a specific blockchain. So trading on Yellow Network, users do not face counterparty risk, as they remain in complete control over their private keys and digital assets.

Another attractive technological component of the Network is the sharded order book.

Yellow uses sharding as a method for distributing its aggregated order book across the Network nodes. The sharded order book has unlimited capacity for the Network’s participants’ requests and at the same time is resistant against any work interruptions, as it has no one point of failure.

If any network node goes down, it would in no way affect the global order book’s accessibility by traders.

Wrapping it up, here are the main benefits that an end-user will get from Yellow Network, whether they are a retail trader or institutional one:

secure P2P cross-chain in the absence of the counterparty risk
deep assets liquidity, which means no risk of slippage and market manipulations by large-size traders,
high-speed transactions, enabling even HFT trading,
best assets prices, low cost of transactions, and
user-friendly interface, providing, at least, the same features as traditional stock markets.

Sounds like something that will skyrocket mass adoption of crypto, doesn’t it?

Key Takeaway

With developments of new Web3 finance solutions, like Yellow Network, offering cross-chain crypto liquidity aggregation together with a convenient and full-stack trading experience, the crypto industry will no longer seem so complicated and inaccessible for users. What is more, it would reach the same level of professionalism and maturity as traditional financing markets while surpassing it in choice for instruments and higher profits.