A Paradigm Shift in DeFi Liquidity: minimizing liquidity fragmentation through more efficient TVL

Crane
9 min readJun 9, 2023

Abstract
In this comprehensive exploration of next-generation decentralized finance (DeFi), we delve into HydraDX’s innovative liquidity protocol, the Omnipool, which seeks to redefine efficiency in the DeFi landscape. We introduce two newly coined terms, effective Total Value Locked (eTVL) and effective Liquidity (eLiquidity), to encapsulate the unprecedented potential of this unique protocol. As we traverse the realms of traditional decentralized exchanges (DEXs), liquidity fragmentation, and liquidity provision, we contrast Omnipool’s groundbreaking approach with the conventional models, shedding light on how it minimizes risk and maximizes profitability for liquidity providers. Through this analysis, we will explore the future of DeFi, demarcated by innovative concepts and significant advancements in efficiency and liquidity.

Introduction

In the landscape of DeFi, liquidity plays an integral role. However, conventional liquidity models, with their fragmented approach, often impose limitations on the efficiency and effectiveness of DEXs. HydraDX, a next-gen DeFi project, is challenging the status quo by introducing the Omnipool protocol and ushering in the innovative concept of eTVL and eLiquidity right alongside with it. These groundbreaking principles seek to maximize the efficiency of liquidity provision and utilization, introducing a new era in DeFi.

Traditional DEXs and the Issue of Liquidity Fragmentation

DEXs, epitomized by platforms such as Uniswap V2, rely heavily on a dual-token liquidity provision model. In this model, liquidity providers must deposit an equivalent amount of two different tokens to create a trading pair. The liquidity provided can then only be used for trades involving that specific pair.

While this dual-token model has been instrumental in the rapid growth of DeFi, it brings about inherent limitations and inefficiencies. Primarily, it results in the fragmentation of liquidity. Given the wide variety of tokens available in the market, liquidity gets distributed across countless pools, each catering to a different token pair. This fragmented structure results in reduced trading opportunities and increased slippage due to shallow liquidity in many pairs. This is a challenge that has also been encountered in the Polkadot ecosystem.

Moreover, this model imposes a significant burden on liquidity providers, requiring them to manage their portfolio in a way that matches the pairs they wish to provide liquidity for. This burden further inhibits the overall efficiency and effectiveness of DEXs, which inherently creates a need for a more streamlined and efficient system.

The inherent constraints of the dual-token model become progressively conspicuous as the DeFi ecosystem matures and expands. The burgeoning array of tokens and the escalating intricacy of the trading environment accentuate the disadvantages of fragmented liquidity. Consequently, there is an escalating demand for a groundbreaking perspective on liquidity provision and administration — one that is equipped to accommodate the multifaceted and evolving requirements of the DeFi landscape.

The Revolutionary eTVL: A New Lens to View Liquidity

Taking a monumental leap away from the dual-token model, HydraDX’s Omnipool implements an innovative system that permits single-sided liquidity provision. This pioneering mechanism ensures that any token deposited into the Omnipool functions as a liquidity source for every conceivable pair incorporating that asset.. This groundbreaking method offers a fresh perspective on Total Value Locked TVL, giving birth to the concept of eTVL.

The eTVL concept captures the remarkable efficiency that the Omnipool brings to the DeFi landscape by eliminating the dual-token liquidity requirement. Let’s delve deeper into the astonishing potential of this exponential efficiency, especially regarding its implications for the total value locked in a protocol.

The efficiency from the Omnipool comes through the fact that each token which gets added to the Omnipool will automatically be paired with all other tokens. This means that the 41st token added to the Omnipool will automatically have 40 fully hydrated liquidity pairs. This concept lets the Omnipool grow exponentially each time a new token is added.

Take a situation where five different tokens are added to the Omnipool. Compared to a conventional DEX, the efficiency factor in this scenario would be four times, not merely because of the increased number of tokens but due to the enhanced interoperability among them.

Comparison TVL to eTVL at 4Tokens in the Omnipool Listed

Now imagine adding 21 different tokens to the Omnipool. This would result in a colossal twenty-fold increase in efficiency compared to traditional models, demonstrating the true potential of eTVL.

Comparison TVL to eTVL at 21 Tokens in the Omnipool Listed

Let’s extend this thought experiment even further. Consider a scenario where 51 different tokens are added to the Omnipool. In a traditional DEX, the liquidity provision would have been scattered across 1275 different potential pools, each dedicated to a specific trading pair. However, with Omnipool, the sheer efficiency of the single-sided liquidity model results in a staggering fifty-fold increase in efficiency.

TVL vs eTVL at 51 tokens listed in the omnipool
Comparison TVL to eTVL at 51 Tokens in the Omnipool Listed

This exponential growth of eTVL, therefore, goes beyond merely adding more tokens. It reshapes the fundamental dynamics of liquidity provision, transforming the very definition of value in DeFi. This is an unprecedented level of efficiency and a revolutionary advancement in the DeFi landscape.

When trying to demonstrate the scalable efficiency of the Omnipool model I often have to resort to using example numbers to make it clear — these concepts of effective TVL & liquidity really help to drive home how the benefits scale as Omnipool grows. LPs are providing liquidity to all possible “pairs” and so benefit from all trading activity — likewise you don’t need the same crazy high TVL values to achieve low slippage, direct trades. “Multi-hop” trades that users are familiar with add additional costs compared with simple asset A to asset B swaps — these are completely redundant in the Omnipool.
Ben McMahon — HydraDX Ecosystem Lead

Effective Liquidity: Unleashing the Full Potential of Liquidity Provision

Delving deeper into eLiquidity, this concept redefines how we view the role and rewards of liquidity providers in the DeFi ecosystem. In traditional DEX models, liquidity providers only earn fees from the specific pair they provide liquidity for. For instance, if they provided liquidity to an ETH-DAI pair, they only earn a portion of the trading fees from the trades occurring in that particular pair. This can limit the potential earnings and overall returns for liquidity providers, particularly when the trade volume is lower for their specific pair.

In stark contrast, the Omnipool’s single-sided liquidity model disrupts this convention. Reflecting on eLiquidity, it’s crucial to note that its symbiotic effects parallel those of eTVL. Just as eTVL multiplies the efficiency of trades with each additional token, eLiquidity does the same for the potential fees liquidity providers can accrue. This harmonious relationship promotes and amplifies the growth of the entire ecosystem.

The nature of eLiquidity within the Omnipool is such that when a liquidity provider deposits a token into the pool, they’re not just providing liquidity for a single pair — they’re supplying liquidity for all potential pairs that involve their token. This revolutionary concept thus significantly expands the number of transactions that can yield fees for them.

Moreover, with each additional token added to the Omnipool, a new myriad of trading pairs is created. These added pairs, in turn, further increase the range of trades where the liquidity provider’s token participates, thereby expanding their fee-earning potential. This directly leads to an exponential increase in earning possibilities, and hence in effective liquidity. For example, if 11 tokens are in the pool, the provider’s token can be involved in trades with 10 different pairs, potentially creating a ten-fold increase in fee-earning opportunities. If 51 tokens are in the pool, this potential increase expands to fifty-fold.

The beauty of this system is its passive nature. Once a token is added to the Omnipool, the liquidity provider doesn’t need to actively manage or adjust their provision — they simply benefit from the expanded fee generation due to the increased number of tradable pairs.

The exponential growth effect of eLiquidity ensures liquidity providers in the Omnipool stand to gain more — significantly more — than their counterparts in traditional DEXs. By radically multiplying earning opportunities with every new token, it truly maximizes the benefits of liquidity provision. This fundamentally enhances the value proposition for liquidity providers, ultimately contributing to a more vibrant, prosperous, and efficient real yield DeFi landscape.

Omnipool: The Natural Evolution for Token Trading

The structure of the Omnipool provides another considerable benefit: the capability for direct swaps, a distinct advantage over traditional DEXs. In a typical DEX, executing a trade from one token to a less common or obscure token often necessitates multi-hop trades. This is due to the frequent absence of a direct trading pair between the tokens one wishes to swap, thereby necessitating the routing of the trade through one or more intermediary tokens. Such a process increases the complexity of trading and imposes multiple fees, while also amplifying price impacts.

In stark contrast, the Omnipool eliminates the need for multi-hop trades by enabling direct swaps between any two tokens within the pool. This system inherently reduces fees incurred during trading, as traders are required to pay for a single swap, as opposed to several. The single-transaction nature of the swap minimizes the transaction fees imposed by the underlying protocol, thus making trades more cost-effective. Furthermore, the slippage, or price impact, experienced during trading is significantly reduced due to the elimination of the need to traverse multiple trading pairs, each with their respective liquidity depths and price volatilities.

Comparison Direct trade to multiple hops

Uniswap V3 vs Omnipool: Balancing Efficiency and Liquidity Risk

Uniswap v3 and Omnipool both offer unique strategies for liquidity providers (LPs), but they approach efficiency and risk differently. Uniswap v3’s main feature, concentrated liquidity, allows LPs to specify price ranges where their assets will be used for trading, potentially achieving up to 15x more capital efficiency. However, it also requires active management and involves significant risk. If the price moves outside the chosen range, LPs stop earning fees and face exposure to one of the pool’s assets. Many LPs reportedly operate at a loss due to these complexities and market volatility.

Comparison Fees vs IL in Uniswap v3 Protocol Source: https://hackernoon.com/half-of-uniswap-v3-users-lose-money-heres-why

On the other hand, Omnipool provides a single pool allowing each token to be directly traded with any other. This model increases efficiency for less popular token pairs, which often require multiple hops in Uniswap v3, resulting in higher fees and slippage. LPs in Omnipool are only exposed to the assets they provide and the LRNA token, minimizing the risk of price volatility across a wide array of tokens.

Uniswap v3 may offer higher capital efficiency for popular pairs and savvy LPs who actively manage their positions, but it comes with increased risk and complexity. Omnipool, meanwhile, offers a more straightforward approach with increased efficiency for less popular token pairs and potentially lower risk for LPs.

Ultimately, Omnipool aspires to match the efficiency of Uniswap V3 even for popular pairs. The lack of liquidity fragmentation in Omnipool’s model will ensure an abundant provision of liquidity for every pair, contributing to its overall efficiency.

In Conclusion: The Evolution of Decentralized Exchanges

The introduction of eTVL and eLiquidity epitomizes a transformative shift in the DeFi landscape, challenging traditional norms and unlocking vast potential for enhanced efficiency, profitability, and user experience. These revolutionary concepts represent a proactive response to the limitations of conventional DEXs, facilitating a more efficient and effective decentralized trading experience. With the addition of more tokens to the Omnipool, the symbiotic increase in eTVL and eLiquidity efficiency serves as a testament to the power and promise of this innovative approach.

Transitioning to a single-sided liquidity model and implementing a unified liquidity pool, the DeFi trading landscape is poised for clear evolution. The elimination of multi-hop trades and reduction of multiple fees are game-changers for user experience, offering a more transparent and straightforward trading environment. This transformation, coupled with the potential for manifold increase in rewards for liquidity providers, promises a more sustainable and appealing DeFi ecosystem. By striking a better balance between risk and reward, and the prospect of augmented earning possibilities, liquidity provision is set to become a more appealing activity, inviting broader participation, and fortifying the overall stability and resilience of the DeFi space.

At the forefront of this revolution is HydraDX’s Omnipool, embodying the potential of radical ideas and audacious innovation to stimulate profound changes in the DeFi landscape. As we stride into an era defined by relentless innovation, the future of DeFi is being reimagined and reshaped, promising a more efficient, inclusive, and profitable experience for all stakeholders. With the introduction of eTVL and eLiquidity, HydraDX’s Omnipool is leading the way, painting a future of DeFi that is bursting with unprecedented possibilities for liquidity providers, traders, and the entire DeFi ecosystem.

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