Can A “Consolidated Liquidity Vault” Model Open The Doors to Permissionless Market Listings?

Source: Midjourney

It hasn’t happened yet in the DeFi space, but it’s an enticing proposal:  What if, instead of looking for an exchange to list the pairing you want to trade, you can simply create the market yourself?  True, there are a number of different exchanges offering a wide variety of pairs to trade.  However, it’s important to realize just how dynamic the crypto market is, and just how quickly the market is moving at any given point.  The number of tokens launched consistently will likely only grow as new chains, new platforms, and new geographical markets open their doors to the crypto industry.  With all of this movement, there are many token pairs that can get left behind, or suffer from a stagnating delay in getting listed.  Even with niche markets, the Web3 ecosystem is growing larger and larger, and gaining enough traders to ensure that there will likely be enough trading available if the pairing is interesting enough.

So the question is, are market listings that can be user initiated a pipe dream?  Surprisingly, not for long, if dYdX is successful with its Unlimited suite of tools, set to release in the fall.  One such tool, the MegaVault, shows off the elements that would be needed for permissionless market listings.  It’s worth exploring their proposed take on this idea, but also worth looking at this model as a whole.  Will this idea catch on in the rest of the industry, and does it have a value that will benefit traders and liquidity providers alike?  Let’s find out.

A Long Tail of Pairing Slots

The dYdX version of the “Consolidated Liquidity Vault” solves two critical problems, which is good because the first problem actually creates the second problem.  The first problem, as mentioned above, is the series of gaps created for listing token pairs.  This gap is caused by the timing of releases, a lack of perceived interest (the exchange doesn’t create a market listing because it doesn’t see any demand), or it simply doesn’t track all new tokens.  Because the most popular token pairs are listed, the majority of trading continues, and there isn’t a major uproar.  However, if the rise of the internet has taught us anything, it is the power of the long tail—using the efficiency of digital technologies to serve smaller and smaller markets, including markets of a single customer.  All of those small markets can add up and become valuable when the cost of doing business is very low.  In this case, the cost of creating market listings is quite low.  It is just a matter of identifying even small amounts of demand that together build up enough overall activity to excite the community.  This buildup of activity can then create the fees, and therefore the rewards, for those who are contributing to make it possible.  If the process can become user-driver, especially as part of a permissionless process, this is even more efficient.  In that case, the authorization doesn’t have to involve any centralized body or, if none exists, a governance approval from a DAO.  

Having users identify and set up the long tail token pairs, and do so on a permissionless basis, creates a system that generates new ways for users to trade, while using almost zero resources to make it happen.  With decentralized organizations such as DeFi, this is an ideal way to find new products and services, where the market demand and product setup is completed by the users themselves.  dYdX roughly follows this process, and it seems like it would be a solid playbook for other exchanges looking to serve up the long tail marketplace for token listings.  This long tail, however, is what creates the second problem:  liquidity.

Liquidity on Demand

Having a long tail offering of niche products is well and good, but only when you do not have to use up any capital to offer them, at least until an order has been confirmed.  In a traditional model, you might look to assign a certain amount of liquidity to pairings depending on how much demand you anticipate.  This would likely work for the more popular pairings, but doesn’t create any sort of minimum liquidity needed to support a market for those niche pairings to trade.  In addition, because they are niche-driven pairings, any estimates you give are going to be rough guesses, meaning that the liquidity either won’t be enough and the market will be ineffective, or the liquidity is more than enough and it’s being wasted.  Either way it’s an ugly situation if you care at all about efficiency.  

The solution, which was spoiled by the title, is to consolidate the liquidity into a single vault that serves all pairings.  Named MegaVault by dYdX, the concept would look similar for any provider.  In dYdX, users deposit USDC into the vault, which begins to create yield immediately.  The consolidated liquidity runs the markets throughout, being used exactly where needed in order to service trades.  This in turn generates the revenue fees and other returns that are used to return yield to the liquidity providers.  The USDC can be retrieved at any time, keeping the vault a low risk capital hold for users.  Of course, other chains that choose to create their own consolidated liquidity vault could also offer a no penalty lock-up, or could create various lock-up options in order to provide better yield rates.