Liquidity 101 and Solving Liquidity Risks in DeFi with DAM Finance

What is Liquidity?

As per Adam Hayes et al, the term "liquidity" is the simplicity with which an asset can be exchanged at current market prices. Cash is usually regarded as the most liquid asset.

Real estate, works of art, and collections fall within the category of illiquid tangible assets. Other financial assets, from shares to partnership units, lie at different points in the liquidity spectral range.

The offer price and the stock price for securities on an exchange where buying and selling are somewhat balanced will be close to one another if the trading volume is significantly large.

A more liquid market is achieved when the difference between the bid and ask prices is small; an illiquid market is said to exist when the spread widens.

Comparatively speaking, real estate markets tend to be less liquid than stock markets. The extent to which markets for derivatives, contracts, currencies, and commodities are liquid is generally correlated with the number and volume-depth of exchanges where such needs are transacted.

What is Liquidity Risk?

As per Risk.net, “liquidity risk” is the danger of not being able to make large purchases or sales of an asset in a particular time frame without causing the asset's price to fluctuate significantly. If, for instance, a significantly large deal is made in a short time in a market with little liquidity, the risk will be substantial.

After the global financial crisis, several market players stated that liquidity risk had increased owing to banks’ capital limits, resulting in greater costs for dealers to retain inventories of securities and storage risk.

In times of stress, investors' tendency to group for similar transactions raises the prospect that the market may become oversaturated with buyers and undersupplied with sellers, reducing liquidity and putting extra downward pressure on asset prices.

As per Risk.net, liquidity risk in financing is the risk that an organization won't have enough cash to pay off its debts (in time) when they come due. Liquidity imbalances between banks' assets and liabilities have been a focus of post-crisis regulation. Under Basel III regulations, financial institutions must maintain sufficient high-quality liquid assets to meet their liability needs even during extreme market volatility.

By enacting rules and providing guidance to reduce the potential for disparities between the liquidity of fund investments and the redemption terms offered, regulatory agencies like the US Securities and Exchange Commission and the International Organization of Securities Commissions have attempted to reduce liquidity risk in investment funds.

Solving the Liquidity Concerns for DeFi

Every blockchain in the market has different features, consensus algorithms, hashing algorithms, and other things that make it hard for them to talk to each other. DApps (decentralized applications) can only make transactions using tokens native to their underlying blockchains.

This means that applications can't access most of the liquidity in the crypto space, which is accessible on other blockchains. Any trading activity depends on liquidity, the ease with which an item may be purchased or sold at a stable price in a particular market.

DAM Finance, also known as DAM, has taken a new step toward introducing and testing a decentralized omni-chain stablecoin solution to securely address the liquidity issues confronting the broader decentralized finance (DeFi) industry. The DAM Finance team has rolled out the Moonwalkers v1 testnet as part of ongoing initiatives to solve liquidity issues in DeFi.

Harrison Comfort, CO-fonder of DAM, stated that the company wants to promote innovation by making it simpler to securely direct stablecoin liquidity away from Ethereum and toward newer networks without the ongoing risks posed by bridges.

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Image credits: Shubham Dhage and Shubham's Web3.