Intent-Based Active Liquidity Management — a glimpse into Clip Finance v2

The better way for market making is on decentralized exchanges.

Introduction

Market makers are entities who stand ready to buy and sell a particular asset — in this case, cryptocurrencies — at all times, providing much-needed liquidity to the markets. Their constant presence ensures that there is always a price set for an asset, whether for buying or selling, contributing to smoother and more efficient market operations.

Centralized cryptocurrency exchanges like KuCoin, Binance, and OKEx often have prerequisites for tokens to be listed, one of which is the presence of a dedicated market maker. This requirement underscores the importance of consistent liquidity and stable market conditions for newly listed tokens. These market-making firms typically pitch their services with the promise of leveraging their established relationships with exchanges to help navigate the often complex listing process. In exchange for these services, they charge the token projects a monthly fee. This fee covers the operational costs of market making, such as maintaining trading bots, managing orders across various exchanges, and monitoring market conditions to optimize the token’s market presence.

CEX vs DEX

Navigating from centralized exchanges (CEXs) to decentralized exchanges (DEXs) represents a significant shift in the landscape of market making. While CEXs rely heavily on traditional market-making firms and their established strategies, DEXs introduce innovative models that redefine liquidity provision and price determination.

Automated market-making (AMM) platforms like Uniswap, Curve, and Balancer have revolutionized liquidity provision in the DeFi space with two predominant models. The first model, often associated with earlier iterations like ‘V2’, operates on a simple principle where liquidity providers (LPs) contribute equal values of two different assets to a pool, creating a market for those assets. The ratio of these assets within the pool determines the price, adhering to a constant product formula. This model, while straightforward, can expose LPs to impermanent loss, especially in volatile market conditions.

The second model, known as ‘concentrated liquidity’, offers a more granular and flexible approach to liquidity provision. In this model, LPs can allocate their capital to specific price ranges within a pool, rather than across the entire price spectrum. This approach gives more control over the price dynamics, as liquidity is concentrated where it is most likely to be utilized, based on the LP’s assessment of likely price movements. The concentrated liquidity model can be likened to a traditional order book system, where LPs essentially set ‘limit orders’ to provide liquidity at predetermined price points. This model leads LP providers to higher fee earnings when their price predictions align with market movements and the funds are concentrated at a tighter price range.

How do market makers operate?

Market makers operate across centralized and decentralized exchanges with distinct operational strategies. In centralized exchanges (CEXs), their approach typically includes the use of trading bots and algorithms for real-time order management and strategy adjustments. Conversely, in decentralized exchanges (DEXs), the absence of traditional order books shifts their role towards liquidity provision, adapting to either centralized or decentralized mechanisms.

For blue-chip tokens, market makers often implement delta-neutral strategies to hedge risks of impermanent loss. This involves balancing their holdings by opening short positions in correlated assets or derivatives, aiming to maintain a neutral position despite market fluctuations.

In contrast, with project tokens, market makers frequently opt for loan agreements or options agreements. These agreements enable them to secure tokens at future-determined prices, mitigating the risks tied to price volatility.

Risks involved

The traditional market-making paradigm, especially in centralized exchanges, presents a significant risk factor for token projects. When projects lend their tokens to market makers, transparency and accountability often take a backseat. Projects have limited visibility into how their tokens are being utilized, leading to a lack of control over market-making activities. Moreover, the risk is asymmetrically distributed, as market makers, operating with borrowed assets, carry less financial risk. This dynamic can lead to situations where projects are exposed to the potential malpractice of market makers, including the dreaded scenario of a ‘rug pull’.

This risk is further exacerbated by the reliance on the solvency of centralized exchanges. The recent collapse of FTX, one of the largest exchanges, is a stark reminder of the vulnerabilities inherent in centralized systems. The insolvency of such a major player not only disrupts market operations but also impacts numerous projects and liquidity providers who have funds locked in the exchange.

Transition to Decentralized Market Makers

In contrast, decentralized market makers offer solutions that align better with the ethos of DeFi. These platforms typically manage liquidity for blue-chip tokens on decentralized exchanges (DEXs), facilitating transactions while minimizing the costs associated with gas fees. Their approach typically involves creating various deposit pools with different range options — wide or narrow — catering to different market strategies and risk appetites.

Decentralized market-making solutions stand out for their transparency and non-custodial nature. Unlike centralized counterparts, they offer clear visibility into how assets are managed and ensure that control remains with the token holders. However, the current models often limit liquidity providers to one or two predetermined price ranges, which can be restrictive and may not always align with the dynamic nature of the crypto markets.

Introducing a More Holistic Solution: Clip Finance V2

Clip Finance emerges as a more comprehensive solution, addressing the limitations of both centralized and current decentralized market-making models. Our approach involves the creation of multiple liquidity ranges and shapes, tailored to the specific price dynamics a project desires. This flexibility allows for more effective market-making strategies, adapting to changing market conditions.

What are the intents?

Definition: In the Web3 and blockchain context, an “intent” refers to a declared purpose or plan to execute a specific operation or set of operations. It essentially signals a desired action within a blockchain network or a decentralized application (dApp).

Functionality: Intents are used to indicate a user’s or a system’s planned actions within the blockchain or dApp environment. They represent a preliminary step, outlining the intended actions before actual execution on the blockchain. This could range from initiating a transaction, updating a smart contract, or executing a complex series of operations.

Use Cases: In decentralized finance (DeFi), intents are crucial for structuring complex financial actions like token swaps, liquidity provisions, or a series of automated trades. They ensure actions are organized, transparent, and predictable, facilitating smoother and more efficient blockchain operations.

Features of Clip Finance’s Model

• Adaptive Liquidity Provision: Beyond the conventional narrow or wide-range approach, Clip Finance introduces dynamic liquidity ranges. These adapt to market conditions like volatility and predicted price trends, informed by backtested data. This flexibility offers a more nuanced, reactive, and effective liquidity management than the static models used elsewhere.
• Customizable Shapes: Our platform enables the creation of unique liquidity ‘shapes’ within pools. These shapes are strategic distributions of funds across different price points, tailored to market predictions and desired behavior.
• Re-allocation of Idle Assets: In low-volatility markets, idle assets can be strategically moved across different yield-bearing pools. For instance, token projects that are paired with a stablecoin like USDC can generate additional returns on USDC single asset pools while awaiting market activity.
• Intents: At the core of Clip Finance’s innovative approach are our intents. This feature allows for the creation of highly customizable and secure transactions, even of a complex nature. By leveraging our intent infrastructure, we can stack transactions prepared by our decentralized nodes, utilizing different interfaces of protocols. This results in a system capable of executing intricate strategies while maintaining a high level of security and transparency.
• Secured by Decentralized Node System: The entire operation is underpinned by a decentralized node system, which secures and validates all activities on the platform. This system guarantees the integrity and security of the strategies executed, reinforcing trust and reliability.

Summary

In essence, Clip Finance’s model represents a significant advancement in the realm of DeFi market-making. By offering a solution that combines the benefits of decentralized operations with enhanced flexibility and strategic depth, we are setting a new standard in liquidity management for the DeFi space.