Decentralized Liquidity

Bringing liquidity into new marketplaces has historically been a massive challenge for decentralized exchanges. Hydro Protocol provides:

  • A framework which promotes highly liquid marketplaces
  • Tools to help bootstrap liquidity into Hydro Relayers

This section details several methods for channeling liquidity into your Hydro Relayer.

Liquidity Sharing Misconceptions

Liquidity sharing is a commonly misunderstood concept in decentralized ecosystems.

Modern Liquidity Sharing

Liquidity sharing is often referred to as "the abilty for anyone to fill an order from anywhere". For example: my order on exchange A could be filled on exchange B. This sounds great, but it leaves a bunch of unanswered questions:

  • Incentives: as exchange A, why would I want exchange B to be able to fill my orders?
  • Order collisions: how do you sync up the orderbooks properly to account for multiple places mirroring the same orderbook?
  • How would your exchange make profit in the long term if everyone shared the same orderbook?

This definition of liquidity sharing is too narrow for technology today, and has a huge amount of problems (front running, order collision, etc.). In practice, a more modern form of liquidity sharing happens every day without through cross-exchange order mirroring. Rather than directly allowing another platform to fill orders on exchanges, automated market making can effectively mirror orders on other platforms.

This is how centralized exchanges can create decentralized markets that roughly mirror their centralized processes.

On-chain vs Off-chain Liquidity

Not all liquidity is created equal. Examine the following marketplaces:

  • Centralized Exchanges (off-chain)
  • Hydro Relayers (off-chain)
  • Idex (off-chain)
  • Uniswap (on-chain)
  • Kyber (on-chain)
  • 0x Open Modal (on-chain)

Off-chain liquidity can be instantly taken - it does not suffer from the front running and order collision challenges associated with on-chain matching.

While the on-chain liquidity sources are more easily shared, the quality of the liquidity is often limited by the fact that it is on-chain.

What liquidity is worth sharing?

Initially, not all of these liquidity sources are actually valuable for all use cases. We have created some simple processes that focus on "sharing" liquidity from sources that provide it in a way that is easily transferred to Hydro Relayers. These sources are:

  • Centralized Exchanges (off-chain)
  • Uniswap (on-chain)
  • Kyber (on-chain)

Creating Liquid Markets

When creating liquid markets, digital assets can be broken down into two categories:

  • Has high liquidity on existing marketplaces
  • No liquidity on existing marketplaces (or very small)

If the asset is liquid somewhere else, you have the potential to funnel that liquidity into your Hydro Relayer through what we refer to as "liquidity bridges".

If the asset is newer, or is not liquid on any other marketplaces, then creating a liquid marketplace can be done through automated algorithmic market making.

Liquidity Bridges

If your market is already actively traded on another platform, you can use a liquidity bridge to channel that market into your Hydro Relayer. Our SDK will provide a few automated setups in time, but in the meantime tools like Hummingbot exist for this explicit purpose.

Hummingbot is a configurable automated trading bot that can be setup to do cross-exchange arbitrage. You can effectively mirror Binance's liquidity using hummingbot. The general concept is:

  • Pick a market that is already traded on binance
  • Use hummingbot to automatically mirror some of binance's orders on your Hydro Relayer (with a slight spread to account for trading fees)
  • Whenever a user makes a trade on your Hydro Relayer, you can make the respective trade instantly on Binance to keep your balances even
  • Periodically refresh balances to keep depth on each side of the market

This can also be used on other platforms. It can be done with on-chain liquidity as well, though typically with a larger spread to account for frontrunning/order collision problems.

Making A New Market

If your trading pair is not actively traded anywhere else, you can use our Hydro system to automatically create an algorithmic trading bot to create a liquid market within your Hydro Relayer. The basic structure is:

  • Deposit Tokens/Eth into a contract
  • Set the sensitivity parameters
  • Orderbook will now be automated!