In this post, we will explore some next-generation DeFi projects that are changing the way liquidity is provided and used.
DeFi has changed the way liquidity is used on Ethereum the past couple of years with the rise of projects like Uniswap, Aave and Compound. Those projects have become part of the foundation of the way we interact with liquidity and earn yields. For an overview of how liquidity pools and AMM’s work, refer to our previous article “The Ultimate Guide to Liquidity Providing in Crypto Markets”.
Recently, there have been some exciting new projects trying to build on that foundation. One of the goals of this next generation of liquidity-focused projects is sustainable long-term liquidity achieved by moving away from short-term focused liquidity mining as it is widely used today. Rather than give project tokens away to liquidity providers that will instantly sell them on the market, there is a shift to new models like buying or renting more sustainable liquidity. There are also projects working to remove barriers that have slowed down some of the major players in the borrow & lend space. Uniswap V3 has also inspired projects to build technology to assist LP’s with the new challenge of concentrated, actively managed positions.
Some are calling this transition “DeFi 2.0”, but what does that mean? We will explore a few different approaches these next-generation projects are using to change the way the market for liquidity works.
Tokemak uses a new system of tokenized liquidity to help solve the problem of the short term incentives created by traditional liquidity mining. The platform acts as a decentralized market maker with the TOKE token being used to make decisions about where liquidity is directed to. Tokemak will help reduce risk by absorbing impermanent loss but will also collect the revenue from trading fees. Projects that use the platform can earn TOKE rewards by depositing their project tokens rather than spending them running a liquidity mining program.
From the perspective of a liquidity provider, Tokemak offers single asset deposits into any projects that have setup a “token reactor” where the LP can earn TOKE rewards. The assets then get deployed as liquidity to various exchanges to be used in market making.
Visor Finance allows DeFi participants to utilize NFT Smart Vaults for liquidity provisioning and active liquidity management on Uniswap v3. The Visor Finance protocol is made up of a few modular components which allow active management of assets within DeFi protocols, enabling its community to generate a high yield on liquidity pools, while minimizing costs and maintaining control of the funds. They allow for single asset deposits and work to take the complexity out of managing LP positions that have come with the move from passive to active LPing in the change from Uniswap V2 to V3.
They have created a smart contract Hypervisor layer to operate as a Uniswap v3 periphery contract that allows for placing assets into a position, creating limit orders, rebalancing of assets and re-investment of fees. They have also funded an organization called “Gamma” that works on developing active LP strategies and you can see the list of supported pairs currently available here. Another attractive feature Visor is offering is the ability to subscribe and unsubscribe to vaults by signing transactions rather than spending precious gas!
Gelato is focused on providing solutions for automating smart contract transactions. One of their interesting new products that deals with liquidity directly is G-UNI. G-UNI is tackling the same problem that Visor is taking on, the issue of how to make Uniswap V3 liquidity provisioning easier for LP’s.
G-UNI has some unique features that give benefits to LP’s. Uniswap V3 LP positions are non-fungible, but with G-UNI they are converted back to fungible so they can be used in composable “money lego” stacks. They also reinvest the earned fees (Uniswap V3 does not do this automatically) and manage the ranges at which liquidity is provided to ensure optimal returns. Because they are flexible, fungible ERC-20 positions – they can be used for liquidity mining programs much like Uniswap V2. They also have the capability to serve as passive or active liquidity management to give LP’s more choice in their level of risk.
Olympus aims to solve the problem of expensive liquidity mining programs by using a system called “bonding”. Instead of staking LP tokens to earn the protocol token as a reward, users can exchange LP tokens for governance tokens at a discounted rate and the LP tokens are then locked in within the treasury providing permanent liquidity to facilitate transactions. Several projects (Frax, Alchemix, Abracadabra, Float, Pendle, Stake DAO) have already started experimenting with this new way of protocols “owning” liquidity.
The drawbacks of liquidity mining in its current form center around misaligned incentives. Farmers create significant sell pressure to ensure returns and to avoid impermanent loss. Even farmers that wish to invest long term have to keep an eye on the LP rewards and exit the market during times of volatility.
Olympus Pro aims to address these issues by having the protocols own their liquidity. With their new bonding mechanism users are incentivized to help the project succeed due to the bonding vesting period. Having protocol owned liquidity locked in the treasury helps support price stability and protection from large liquidity exits while also offering new revenue streams by collecting trading fees. Olympus also supports their partner projects with exposure on their unified marketplace for bonds, Olympus X Pro.
While not directly taking on the problem of liquidity mining, Timeswap aims to remove the barriers of permission in place that are used by the current market leaders in the lending and borrowing space. A novel AMM design intends to get rid of the need for oracles and whitelisting of pools and assets. One goal they have is to improve on the liquidation process by allowing borrowers to pay back their debt anytime before maturity and in the event of borrowers defaulting, having their collateral distributed to the lenders of the pool. They also take a market-driven approach using changing supply to drive dynamic interest rates to improve capital efficiency and risk management.
Where do liquidity providers fit in? “Liquidity providers are the market makers of the pool. They add tokens into the pool and make both lending and borrowing transactions at the same time. They earn a spread between lenders and borrowers which is based on the number and size of transactions of the pools. They help add liquidity to facilitate transactions between lenders and borrowers.”
Fei x Ondo
Fei protocol recently partnered with Ondo Finance to offer cost effective and flexible term liquidity as a service using Fei’s proctol controlled value to back the positions with the FEI stablecoin as a base pair.
Projects can deposit their token into an Ondo liquidity vault with a flexible duration and Fei Protocol will match their deposit with FEI to form a liquidity pair that can be used on an AMM. This allows the project to increase liquidity with no upfront costs and at the end of the duration the FEI is returned and a small fee is paid. The participating projects are allowed to collect the trading fees but are also exposed to any impermanent loss incurred in the pool.
APY.Vision future support
As these projects continue to develop, APY.Vision is working to provide the historical analytics liquidity providers need to make intelligent decisions about where to deposit their funds. Visor Finance will be the first to be supported on the platform with more being added in the future.
Current supported Protocols at APY.Vision
Uniswap, Sushiswap, Curve, Balancer, 1inch, Kyber, DFYN, SpookySwap, SpiritSwap, Trader Joe, Pangolin, Ubeswap, Honeyswap, Cometh, Elk Finance, Wakaswap
Current supported Blockchains at APY.Vision
Ethereum, Polygon, Fantom, Avalanche, xDai, Celo, Binance Smart Chain (Harmony + Arbitrum coming soon)
Things have progressed rapidly in DeFi since awareness and user activity surged during “DeFi Summer” in 2020. Now that the financial primitives and base layers have been hardened and established themselves, this new breed of projects can build on top of the ideas that have been shown to work and make improvements along the way.