Liquidity, or the ease with which users can trade assets on an exchange, correlates directly with the token volume locked in a liquidity pool on a decentralized exchange. Many DEXs allow market makers to create multiple liquidity pools with a variety of tokens.
As they are much smaller in scope, DeFi markets are less liquid than CeFi markets. The capital traded by users is often threatened by excessive volatility, impermanent loss, slippage, etc. To solve these issues, various developments have been launched and GMX’s unique liquidity pool (GLP) is one of them.
GMX is a decentralized exchange (DEX) that allows trading perpetual contracts. Unlike having separate liquidity pools for each trading pair, such as seen in Uniswap, GMX has only one liquidity pool, GLP, which contains all the assets its market offers. Half of the GLP liquidity is composed of stablecoins (USDT, USDC, DAI, FRAX), and the other half of high-cap crypto assets. These are BTC, WBTC, WETH, and AVAX on Avalanche, and BTC, ETH, LINK, and UNI on Arbitrum.
The Broader Integration of GMX’s Liquidity Pool (GMP)
Dolomite is a decentralized money market protocol and exchange whose virtual liquidity system offers token support and capital efficiency. It became a notable market player after it started supporting GLP collateral. It was the first DeFi platform to fully integrate GLP, supporting account transfers and letting users keep their multiplier points. Multiplier points increase a user’s yield or reward from participating in a DeFi lending protocol.
Users were able to continue earning rewards from vesting and staking when borrowing against GLP, which also made it possible to enhance GLP leverage and hedge GLP price volatility or maximize the annual percentage rate earned from holdings.
Dolomite’s main value proposition lies in the ability to use complex assets as loan collateral. Many of these assets aren’t available on other lending platforms. Dolomite offers them in ways farming protocols can’t match. For example, users retain full control of rewards, staking, vesting, and voting. The platform’s other financial instruments, such as over-collateralized loans, spot trading, and margin trading, also rank it among the few providers in this category.
Unlike perpetual trading, its spot-settled margin trading involves settling all trades on the market, where large trades can move the market price. While most perpetual exchanges offer only stablecoins as collateral for this trading type, Dolomite accepts a far wider range of collateral. Users can margin trade assets such as GMX, UNI, LINK, etc.
Users supply liquidity directly in exchange for rewards. Higher rewards incentivize them to provide liquidity through tokens that are in short supply in the liquidity pool. They also have an incentive to withdraw liquidity for surplus assets. When a provider deposits a certain volume of assets in the GLP, the equivalent in GLP tokens is minted, which they redeem later with the reward. They burn the minted tokens when they decide to withdraw an asset from GLP to obtain the reward.
Why Dominant Liquidity Providers are Theft
The above methods aim to overcome a known shortcoming of DeFi: sophisticated participants such as institutional investors dominate liquidity provision, outbalancing retail participants.
In approximately 50% of a sample of liquidity pools studied by the OECD in a report titled “Concentration of DeFi liquidity,” a single liquidity pool token holder controlled up to 90% of the pool’s liquidity in some cases. Their analysis of LPs with trading volume exceeding $100 million showed that most of the trading volume was concentrated in a limited number of pools.
The concentration was highest on Uniswap V3, where a fifth of the pools accounted for 92% of the trading volume. A tenth of the pools with trading volume exceeding $100 million comprised around 88% of the volume traded on Uniswap V3. The percentage for Uniswap V2 was 59%, and the fact that the number of Uniswap V2 pools is almost twice as high as V3 pools accounts for the difference. The OECD also examined Curve, where seven pools accounted for 59% of trading volume.
Advanced Liquidity Provision Strategies
Dolomite plans to integrate a DEX aggregator, which will allow users to exchange just about any asset through external liquidity, relegating slippage and limited markets to oblivion. Another strategy some DeFi platforms leverage is where the project team provides the initial liquidity to build a foundation for participation. They achieve this through auto-liquidity engines, which inject liquidity automatically. Pools containing assets like stablecoins are less vulnerable to impermanent loss due to price stability.
Sharing a portion of trading fees with providers incentivizes the latter. Liquidity providers can protect themselves from declining asset prices by buying put options. This helps maintain the value of assets in their pools in adverse conditions. Covered call strategies enable LPs to earn revenue by selling call options on any assets staked without losing ownership of the underlying tokens.
The use of machine learning and AI will optimize liquidity provisioning further, and enhanced user interfaces will ease access to liquidity management tools, encouraging more people to take part in liquidity provision. Staying informed about the latest strategies is crucial for navigating the markets as DeFi evolves and matures. Ultimately, the ability to adapt to changing market conditions will determine outcomes for liquidity providers.
