❓The Problem

Liquidity problems arise at every stage of the lifecycle of a blockchain project and are often severe enough to kill whatever momentum they have built. The key liquidity problems faced by projects typically include:

1. Insufficient initial liquidity and trading volume: Many DeFi projects struggle to attract enough initial liquidity, meaning there aren't enough funds in the market to facilitate smooth trading. Without sufficient liquidity and trading volumes, the native token experiences high price volatility and struggles to attract investors who fear they will be unable to exit without causing major price depreciation of their asset. This can create a negative feedback loop, where low liquidity discourages participation, further reducing liquidity.

2. Inability to attract and retain investor interest: Even those projects that do secure initial liquidity often find that as time goes on and the initial burst of hype around the project dies down, they struggle to maintain the levels of liquidity required to attract and retain investor interest.

3. Market Manipulation Risks: The high volatility caused by shallow liquidity can make projects ripe for market manipulation tactics, such as pump-and-dump schemes, where prices are artificially inflated before being sold off. Such practices undermine market integrity and scare away potential investors, further decreasing liquidity.

4. Lack of market depth and liquidity distribution: Lack of liquidity also diminishes a token’s ability to absorb large orders without significant price changes. It can also mean that liquidity can become unevenly distributed across different trading pairs and platforms, making it difficult for traders to execute large orders efficiently. This can lead to slippage, where the executed price differs from the expected price, deterring trading activity.

5. Dependence on centralized exchanges for liquidity services: To address their liquidity issues, projects are often overly reliant on CEX listings. Top CEXs charge vast fees that can even number in the 7-figure range for the most highly-sought ones, incurring a massive cost-burden on projects that turn to them.

6. Stagnating volumes in older projects: Even for those projects that overcome the odds to secure deep initial liquidity and maintain it over time, many eventually hit a wall and face declining trading volumes during slower periods for their project or the market. This makes it harder for remaining investors to exit their positions and further diminishes market activity.

Meanwhile, turning to centralized market makers to solve these problems only creates new challenges, principally

1. High costs: Like CEXs, centralized market makers charge vast fees, diverting operational funds from core areas like development and marketing.

2. Dependence & loss of control: Dependence on centralized market makers means that the project loses direct control of their own liquidity management process, making it harder to ensure it aligns with their strategy on a day-by-day basis. Projects may also have less control over their market operations and strategic decisions due to the influence and requirements of centralized market makers.

These obstacles combine to make centralized market makers an sub-optimal solution for solving the liquidity management challenges described above.