Because there is an automated market maker based on tokens in the cryptocurrency market, (AMM), whose business operation model may create a liquidity “black hole”, this “black hole” can absorb assets from all sides, such as centralized exchanges, decentralized exchanges, cold repositories, and so on, eventually making AMM a lot of money. Next, let me talk to you about this issue.
First of all, we need to understand that there is a feedback loop on the liquidity of the cryptocurrency market, (feedback loops):.
Trading volume “market maker profit” is dedicated to market makers’ capital “liquidity” spread narrowing “repetition”
Note: spread is the difference between the buying price (Bid) and the selling price (Ask). The smaller the difference between the buying price and the selling price, the smaller the cost for investors.
From this feedback loop, we find that liquidity produces liquidity on its own. This feedback loop is the same for any market, including central limit order book (CLOB) transactions and collective liquidity models:
Feedback loop: more trading volume “market makers get more profits” provide more liquidity “spread narrowing” provide traders with better pricing “trading volume will become more.”
However, for those newly created cryptocurrency exchanges, they may have to face a “chicken and egg” problem because of the low trading volume and liquidity in the early days of the exchange. In the initial stage, many cryptocurrency exchanges have to face a difficult period of “feedback loop”. However, the liquidity mining (liquidity mining) proposes a novel mechanism to guide the network effect.
Simply put, liquidity mining stimulates the supply of liquidity through token incentives, which can promote liquidity to flourish and attract more trading volume. Here we give two examples of the successful implementation of liquidity mining, one is Synthetix, after the implementation of liquidity mining, the liquidity of sETH Pool has reached 1/3 of the total liquidity of Uniswap; the other is that one week after the implementation of liquidity mining, Balancer, has a total network lock-in value of US $30 million.
Now let’s take a look at the liquidity “black hole” model designed by automated market makers, that is, what happens if the central asset in the liquidity pool is a network native token?
For example, ETH is the central asset of all Uniswap markets. Imagine what would happen if Uniswap introduced its own online token and replaced ETH,.
In fact, Bancor and Thorchain have begun to adopt this mode of operation: the assets in each liquidity pool of Bancor, are ERC-20 tokens, but they need to own or mortgage the network native tokens BNT to obtain; the assets in each liquidity pool of Torchain, include Bitcoin (BTC), Ethernet Square (ETH), Ethernet Square classic (ETC), ERC-20 tokens, but also need to own or mortgage the network native tokens RUNE to obtain.
In this case, if we continue to apply the liquidity mining model, things could go crazy. Because if you implement a liquidity mining strategy for these liquidity pools, you must first own or mortgage network native tokens (such as RUNE or BNT),), which account for 50 per cent of the assets in each liquidity pool.
Once you buy tokens such as RUNE or BNT, the price will rise, which means that the pool of online capital will get deeper and deeper, which will naturally become more liquid and attract more traders.
The picture above shows a feedback loop using RUNE tokens as an example: the larger the liquidity pool, the lower the transaction costs (and the possibility of devaluation). The higher the trading volume, the higher the liquidity mining returns, the higher the RUNE price of the original online tokens, and the greater the liquidity pool value.
It is important to note that what I am describing is a liquidity feedback loop in extreme cases, so what else will liquidity mining bring as prices rise? The answer is: liquidity mining earnings.
When the benign feedback loop of rising prices, deeper liquidity pools and higher yields is formed, all encrypted assets fall into this “black hole”.
Now, if we consider the reflexive characteristics of the market, we will find that this “black hole effect” has a huge impact. Because as long as people want the liquidity of native tokens (such as BNT or RUNE) to be more profitable from mining, they will buy more native tokens, which in turn will push up the price of tokens, like creating a “self-fulfilling” prophecy. And that’s why the price of SNX tokens has risen 50-fold in just nine months.
What most people don’t realize is that most of the trading volume of Uniswap and Balancer comes from the carry trade, not the liquidity pool, but the carry trade does not benefit the liquidity pool, it only benefits the miners. Of course, due to the high cost, the continuous liquidity pool (CLP) will also make the liquidity pool gain more value from the carry trade.
Finally, the reflexivity of the market will reverse in the other direction, but the ultimate goal is to let the liquidity black hole create a pool and act as an impermeable moat of liquidity.