Recap from Liquidity Wars: Strategies for Building Thriving DeFi Ecosystems

Yesterday, we hosted Liquidity Wars in Singapore at TOKEN2049. The event was co-hosted with Valence and aimed to explore state-of-the-art strategies and tools to attract liquidity and build resilient DeFi ecosystems.

We hosted an all-star panel with:

• Felix Lutsch, Head of Ecosystem at Symbiotic
• Rushi Manche, CTO & Co-founder of Movement Labs
• Mitya Argunov, Co-founder of Drop
• Max Einhorn, Co-founder & CEO of Timewave, the team building Valence

This panel delved into the nuances of attracting new sources of yield, fragmentation, deploying protocol-owned liquidity, and ecosystem building. Here are the highlights from this fascinating conversation.

Liquidity is fragmented, and we should seek efficiency gains

Fragmentation exists at both the distribution and network levels. Mitya breaks it down.

• Service providers such as exchanges, wallets, custodians, and data APIs generate revenue from the most desired assets. For projects outside the top 50 assets by market cap, it's difficult to gain users and visibility.
• Network fragmentation creates challenges for DeFi to manage liquidity that sits across different chains. Cosmos chains suffer less from these technical challenges thanks to IBC and ICS. This infrastructure indeed creates better user experiences where assets seamlessly move and are utilized cross-chain. This problem is largely solved, at least in Cosmos.

The distribution problem remains an issue, and there are signs of worsening with consolidation around the best-performing assets, making it difficult for altcoins to gain interest.

Protocols need to rethink monetary policy

Crypto innovation is eclipsing traditional finance infrastructure. Though we've seen lots of innovation in DeFi primitives in the last years, protocol monetary policy remains undeveloped.

Max explains that most protocols have rather rigid monetary policies, effectively copying Bitcoin's lead. Inflation rates are set at genesis and rarely reviewed. In Cosmos, the inflation rate is often based on the staking rate but lacks other parameters that might benefit protocols. Ethereum implemented EIP-1559, which was a notable improvement but remains the exception rather than the rule.

Protocols need to be as efficient as possible when it comes to liquidity management through flexible monetary policy. For Felix, token allocations can be tricky for VC-backed projects with limited supply. Though a portion of tokens often gets allocated to ecosystem development, liquidity incentives can be overlooked.

We need better protocols for managing Protocol-Owned Liquidity

The Cosmos Hub has been at the forefront of complex POL deals and has strategically deployed liquidity in a variety of protocols (Neutron, Stride, Osmosis, etc.). These are positive-sum initiatives—for example, in lending where providing liquidity reduces interest rates and increases borrowing. Max argues that the cost to the protocol is low, except for the occasional event of impermanent loss.

Currently, POL deals are done manually. Governance passes a proposal approving lending of liquidity and the terms. Felix explains that typically, funds are moved to a multi-sig with community stakeholders as signers, who are tasked and trusted to execute the terms of the deal. This is inefficient, insecure, and lacks the ability for real-time response.

New protocols are enabling better efficiency for liquidity management. Valence addresses the inefficiencies of manual POL deals by allowing protocols to enter programmatic economic relationships. This creates a market for crypto institutional debt. Roiko creates a market for incentivized actions.

As protocols find more ways to monetize these liquidity deployments—by coupling them with security perhaps—this could be a great source of liquidity and greater efficiency.

Building strong communities remains core to a project's long-term health and success

A strong community remains the backbone of any successful project.

Rushi highlights the importance of bridging the gap between the West and developing regions like Africa, Southeast Asia, and Latin America. Movement has been proactive in organizing community meetups and hackathons, and hiring new team members in these regions.

Validators play a crucial role in building local communities and educating users. As Mitya points out, validators host local workshops and events, and produce non-English content, helping educate and spread knowledge in all regions of the world. Projects that incentivize validators correctly can unlock surprising avenues for community growth.

Community fragmentation can mirror liquidity fragmentation. Max cites Neutron and Osmosis as examples, two chains that shifted from competition to collaboration through shared liquidity deals. A positive-sum approach not only resolves conflict but strengthens overall competition.

Felix emphasizes the need to balance institutional and community participation. Fair launches and inclusive token distribution ensure that projects are accessible to all, not just institutions and VCs.

Crypto needs new liquidity and institutional capital

Attracting new liquidity, specifically in the form of institutional capital, will be important for the growth of the space.

Rushi discusses how Movement avoided short-term capital by securing long-term commitments from funds and other institutional liquidity providers. Deals with around 15 large LPs ensure Movement will have a stable liquidity base in ETH, BTC, USDC, and other assets on launch day.

Athena is cited as a textbook example of building long-term aligned liquidity. They secured commitments from about 20 institutional LPs from day one. As a result, it experienced slow and steady growth, evolving into a robust stablecoin with healthy TVL.

By contrast, points farming attracts fleeting capital that leaves as soon as incentives dry up. Rushi cites Blast as an example of a project that suffered from a TVL farming approach to capital formation. Initially, Blast had attracted $2 billion in TVL until token incentives could no longer sustain LPs' engagement.

Dormant assets and technological improvements could unlock billions in TVL

One fascinating insight to arise from the panel was the idea that billions in untapped TVL are sitting in dormant protocols.

Rushi is optimistic about these alternative assets, citing Cardano as one example. Despite being a top 20 crypto asset with a market cap of $12 billion, it's largely under-utilized in DeFi. Bridging wrapped versions of these assets into lending protocols presents an opportunity to build huge pools of TVL. This idea is echoed by Mitya, who notes that altcoins sitting idle could significantly expand the liquidity available in DeFi markets.

Other technical improvements, such as zero-knowledge proofs and threshold encryption, can help improve user experience. Felix notes that enhancing security and mitigating negative externalities like MEV are important to making DeFi more accessible and efficient for users.