Chapter 1 - Efficient Capital Allocation

The Multi-Chain Transition​

Blockchains and DeFi apps require deep liquidity to succeed. Conversely, insufficient liquidity leads to a downward spiral and an untimely death. After securing the initial liquidity, sustaining substantial liquidity through organic yield or real use cases is vital for a protocol’s survival.

The importance of deep liquidity creates a competitive environment where protocols constantly fight for liquidity and Liquidity Providers (LPs) struggle to keep up. Although competition is inherent in the DeFi landscape, the multi-chain transition intensifies it.

For LPs, the multi-chain transition has created an overload of choices for asset allocation. The increase in opportunities makes it harder for protocols to attract LPs. As a result, protocols offer increasingly enticing rewards for the initial liquidity. This makes maintaining liquidity challenging, as LPs are incentivized to move their assets as soon as they find more rewarding opportunities.

Increased Dependence on Institutional Liquidity​

Protocols often turn to the private market to secure initial liquidity. Institutions offer greater stability for a larger volume of liquidity through legal contracts. In the current status quo, their liquidity plays a crucial role in the blockchain landscape, buying time for protocol builders until their products attract organic liquidity.

Excessive reliance on institutional liquidity might not always be healthy for the market. Centralization risk arises when a single stakeholder can decide on the maintenance of a significant proportion of liquidity. Additionally, if the rewards for liquidity are in governance tokens, a few entities can dominate the governance decisions or sway the token price.