The rise of decentralized currency and the competition to preserve it’s P2P model gave birth to the decentralized exchanges concept. It rests heavily on the principles of open, trust-minimized, and non-custodial exchange of cryptocurrency tokens. The development of privacy-centric coins like Monero and ZCash, and the highest volume of trading reported on Bisq (decentralized exchange) for Monero proves that the sentiment is inclined towards decentralization and privacy.
Decentralized exchanges, with on-chain settlement through smart contracts, have expanded via a requirement to fight against serious weaknesses in centralized exchange. Let’s take a look at the major challenge poised by centralized exchanges.
The liquidity deficit
In common terms, liquidity signifies the ability of an asset to be purchased or sold in the market. In the crypto sphere, liquidity refers to the ease one could convert a coin into cash or other cryptocurrency. The problem arises when the required amount of coins is not available in the exchange, and thus increases the operational cost of bringing in additional coins to the platform and to the buyer. Less liquidity means big players could cash in by the increasing demand in the illiquid market. Here are some factors that affect liquidity:
Trading Volume: The volume indicates the market activity of a given coin. Higher volume reflects that more people are purchasing and selling coins and these are signs of a liquid market.
Crypto Exchange: More the number of exchanges, more availability of coins for trading. It gives more platforms to traders to do business. This leads to increase in frequency and volume thus creating a liquid market.
Network Effects: The success of a coin depends on the acceptance of a coin and its ability to build a community.
Government Laws: The ban of cryptocurrency trading in certain countries as a result of government regulations could hamper the liquidity in that specific region.
Why liquidity is important?
Liquidity is a significant component for any global market. Lack of fund generates an imbalanced situation that gives rise to operational costs and unnecessary price rise.
On the other hand, the fluctuations generated by the normal trading in exchanges gives a legitimate upsurge to the prices that is healthy and provides a better ROI for individual investments. A higher liquidity is important for the market, as it has several advantages associated to it, including:
Fair Pricing: Owing to a large number of buyers and sellers, a liquid market offers fairer pricing. Sellers get satisfactory rates and buyers get coins at a rate that is close to their estimate.
Market Stability: High liquidity ensures genuine buyers and sellers and leaves no scope for larger sharks to manipulate the pricing. This is because the asset is easily available to be traded.
Faster Transaction: Due to the on-going demand and supply in the liquid market, you will be able to make quicker transactions.
How to enhance liquidity in decentralized exchanges?
Cultivating the liquidity factor in decentralized exchanges is one way to inspire mass adoption. Obviously, plenty of factors support the asset liquidity.
But if traders know that they could trade cryptocurrencies in a non-custodial and secure means of digital tokens, that is powered by decentralization and privacy, they will definitely want to give it a shot.
There’s a slight uncertainty that trading crypto coins will carry on to take place on multiple trading platforms without a single, more stable asset evolving to keep their value in check. Means solving market fragmentation as well as liquidity issues need an exceptional solution.
One tactic to overcome the challenges is to decrease the price of the switch for coin traders. If an on-chain exchange can fit for different assets, and lower the hurdles to switching from one to another by functioning with different wallet providers. Then users can log-in to their wallets and perform a token conversion without leaving the wallets. This enables receipts to access payments from different token supported by a decentralized platform.
Token-to-token conversion is not the only method to overcome the liquidity. There are plenty other unique concepts on how to assist users to execute cross-network transactions easily and at sensible charges. Decentralized exchanges solutions are introducing new ways for the public to take part in the crypto ecosystem.
Pooling liquidity for a better market
You will need to attract more users to your platform. Investors need safe, liquid markets where they can trade at reasonable prices as well as leave swiftly. If your platform’s trading volume is low,
- Traders will become competitors with better charges.
- Lose the profits regarding your USP.
- Use of centralized exchange that keeps the funds at risk.
Second, sharing liquidity means you can focus on the development of your exchange in the way your customers want. A customer experience, from the development of a user-friendly UI to 24/7 technical support. You might also need to support additional tokens, or build new dApps. If you think you have suitable users to make things work, you can focus to build what is missing in the market.
If we share liquidity, trading volume as well as frequency will upsurge. It makes digital assets more liquid and results in a more attractive investment.
Liquidity is not the only thing in the implementation of the technology, but it is a critical element in how the market develops. Endorsing liquidity in the crypto ecosystem, and especially in decentralized exchange platforms, will be significant to enhance the general public’s awareness of digital coins as a valued tactic to trade coins securely.
Max Hunt is a very early Bitcoin adopter and knows the who’s who of the Crypto world. He’s been in the Bitcoin fraternity for a long time, and explores various nuances of cryptocurrency exchange software development.