On-demand Liquidity could improve market stability and encourage retail investment

You know the popular sentiment most people have concernig the rich on why they ought to pay more taxes?

While I'm not entirely in support of that, I do however believe that if what the rich do at any given point causes direct or indirect negative impact on the little guys, then they should pay an incentive to be able to proceed.

In the case of a market order, this is a sort of cost offsetting payment and it's not really a tax but a way to ensure that neither the rich or the poor are brutally hurt in the process of settling an order.

Everyone knows that volatility of crypto isn't because of a couple $100 to $1,000 trades, even $10,000 may fail to make the cut depending on the specific asset pair. So if this is the case, it's unfair to pass on the cost of larger trades on the little guys.

What is On-demand Liquidity(ODL)?

I quickly ran this through Chat to see what it has to say and the response is related to a cross-border payment system offered by Ripple and to clarify, what's being discussed here has nothing to do with shady XRP business.

I call this solution on-demand liquidity because it would generally be designed like an off-market system to handle large trades when the demand is there.

To put it simply, On-demand liquidity is a decentralized trading solution that allows large-scale traders access immediate liquidity to exit market positions without causing a significant price impact.

Improving market stability: the how

Generally, I view the act of entering into any traditional liquidity position(LP) as a process of shorting the USD to make more USD because the reverse involves you losing money.

It doesn't matter if it's a BTC-paired or ETH-paired pool, impermanent loss makes taking LP positions an act of shorting USD otherwise you'd just be buying into assets that further declines and that isn't the wish of anyone.

I'm pointing this out because people could be tempted to ask why “on-demand liquidity” can't be used to enable large-scale traders buy into an asset and not just for exiting.

The reason is because ODL is the opposite of traditional LP.

With ODL, you'd be shorting the USD, gaining multiple-layers of incentives both on the short term and in the long term. The reason it is considered “shorting the USD” is because you're facilitating a direct P2P trade and will rely on the asset you bought growing(essentially outperforming) in USD value, to recover your capital.

Let's assume that a trader wants to sell off $100 million in ETH, and it is determined that an order that large could cause 2-5% price crash, the smart contract would autonomously reroute the trade through an ODL provider, enabling a sort of OTC sell off where the ODL earns a premium fee for the trouble.

By reason of fairness, the system could be designed to force traders to pay as much as they would have cost the market. That is, if the trade would have caused the ETH market valuation to drop by 5%, the fee should be exactly 5% of the trade value.

A $100 million trade, yields $5 million. So the ODL provider immediately makes $5 million to settle a $95 million trade.

Quick exits must have consequences otherwise we leave our economies exposed to great damage. If a large-scale trader doesn't want to pay the fee, they are simply left to sought out more market-friendly ways to exit their positions, ensuring stability in the process.

Why it could work

Firstly, it is important to note that these trades being settled peer-to-peer means that they will generally not reflect on direct market volumes, almost like it never happened, and that's encoded stability, in practice.

Why it would work is that ODL saves time and lowers overall cost both for the market and the trader. If the market impact of a $100 million trade is 5% then $5 million is a small fee to take on a $95 million risk position.

Also, considering ETH’s current marketcap, $5 million saves the market $15 - $20 billion. By matching large trades with willing large on-demand liquidity providers, we incentivize institutions to stabilize the market and charge to reckless traders the cost of finalising those large trades.

Now, a common misconception that could arise about this approach could be that it creates an environment for “numbers up only” for asset pairs enbaling ODL but that's not entirely true.

ODL only restricts a downward trend in an asset’s price, if the organic liquidity of said asset doesn't grow, in which case they would be at risk of losing a lot, considering that they take on huge risks settling these trades.

ODL is primarily meant to stabilize the market so it can grow more effectively. As organic liquidity grows, certain trade scales up to be low impact and can be settled traditionally.

The built-in long-term incentive is that ODL sets the stage for the general market to perceive these asset pairs as stable.

The effect of this perception is expectedly, a growth in retail market makers, creating room for ODL providers to sell off the ETH bought and recover its $95 million. The short term incentive is the $5 million charged, whilst the long term incentive is they could potentially recover more than $95 million by selling off slowly as retail liquidity grows, overtime, again, just shorting USD in the process.

That said, to further expose how ODL doesn't force the market to move in one direction, traditional LPs can always choose rotate into ODL, forcing the reordering of traditional order books as organic liquidity grows thin. One can only imagine that this move would also trigger some changes to where incentives are higher, automously causing a rebalancing.

ODL is meant to take the burden of large trades off the market, not limit organic market making as that is actually encouraged in the process.

This is because ODL enables retail benefit from more stability in their pooled assets and a more predictable yield because institutions are too busy settling large trades than trying to manipulate the order book to fuck over leverage traders.

Certainly, they could be some flaws I'm yet to figure out, as there are really various layers of incentives and risks that could make this all turn into a sustainable and self-maintained market liquidity solution or a total shitshow.

Posted Using INLEO