Liquidity Auctions: Can They Solve The Liquidity Problem for DeFi Startups?

The current time in the cryptocurrency space feels like a more mature version of 2017. Bitcoin is once again on a bull run, and it is about to once again reach the all-time high of $20,000 set three years ago. Two of the major differences between the crypto bull run of 2017 and 2020 is the involvement of institutional investors and the absence of initial coin offers, or ICOs.

The latter was a noble method of fundraising for crypto projects. But ICOs became the de facto means of defrauding crypto investors. After causing damage worth hundreds of millions of dollars, ICOs are now gone for good, leaving behind a void in the crypto market nonetheless.

Despite that, more and better innovation has found its way into the cryptocurrency industry. In 2020, the crypto industry found its new big thing — decentralized finance, or DeFi. The DeFi market has grown by over 2,000%, reaching a market capitalization of almost $14 billion, in the last 10 months. Decentralized lending and borrowing protocols by Uniswap, Aave, and Compound have been the frontrunner in this space.

With the rapid growth in demand for decentralized finance, there is both a huge opportunity and room for more crypto projects. The major problems with these projects are early-stage capitals and token liquidity.

Challenges Faced by Early-stage Crypto Projects

Theoretically, ICOs were an effective means of fundraising without the need for an authorized body or exchange intermediating the process. They also provided the much-needed liquidity for the trading and exchange of a crypto token. Now that ICOs are a thing of the past, crypto projects struggle to find new methods to raise funds and bootstrap liquidity for their tokens.

The DeFi revolution has made it all the more crucial for cryptocurrency tokens to have high liquidity to trade on decentralized exchanges (DEXs) and Automated Market Makers (AMM). Without token liquidity in the liquidity pools, the tokens may not fully leverage the potential of DeFi. They can fail to attract many crypto traders, which may considerably affect the token’s price.

On that note, there is a rising demand for decentralized ways to raise funds for new projects and add liquidity to the tokens. This is a major reason why projects have started turning to Initial DeFi Offerings, or IDOs, and Initial Liquidity Offerings, or ILOs.

The DeFi popularity is also pushing pre-listing auctions as a potential means to raise funds and liquidity. Let’s see how they solve the challenges of liquidity and early-stage capital.

Liquidity Auctions in a Decentralized Ecosystem

In the DeFi space, automated market makers have become an effective means of exchanging cryptocurrencies within a decentralized ecosystem. The AMMs have liquidity pools where liquidity providers add their tokens and allow other users to borrow those tokens from the smart contract. This disintermediates the process of transacting cryptocurrencies.

Using a similar concept of liquidity pools in AMMs, it is also possible for early-stage startups to create liquidity pools of their new tokens and conduct liquidity auctions.

DeFi projects like Bounce.Finance, Polkastarter, and Poolz are building platforms that bridge the gap between project owners and early-stage investors and liquidity providers using a decentralized infrastructure. All three projects have a cross-chain swapping protocol that enables the exchange of crypto tokens across different blockchain networks.

Bounce.Finance already has a live product and it claims that its users have so far created 7,321 pools on the platform.

Guy Oren, the Founder and CEO of Poolz, explains that by enabling cross-chain swaps and liquidity auctions, they will not only help new startups raise funds and bootstrap liquidity, but also make crypto tokens interoperable. He explains:

“Cross-chain swapping protocols will make crypto fundraising blockchain agnostic. Projects building a product on any blockchain network will be able to conduct a liquidity auction using a swapping protocol that is originally based on a different blockchain.”

“For example, let’s consider a cross-chain swapping protocol is based on the Ethereum network but can interoperate with the Binance chain. Then, a project that has its token based on Binance chain can still conduct a liquidity auction on that Ethereum-based swapping protocol.”

Bounce.Finance, Polkastarter, and Poolz support the auctions of both fungible and non-fungible tokens. Bounce.Finance and Polkastarter categorise its pools as sealed-bid and dutch auction pools. Poolz, on the other hand, has direct sales pools and time-locked pools, where tokens have a lock-in period before the investors can redeem them.

Blockchain agnostic swapping protocols mean that every project, irrespective of what blockchain they’re based on, will have more exposure for their tokens. It will be easier for them to attract more investors, raise funds and bootstrap liquidity for their tokens.

Are Decentralized Liquidity Auctions the Future?

After the ICO craze went bust, DeFi is making the headlines everywhere with new projects rolling in as fast as they could. With this, there’s a need for a convenient yet decentralized way to raise funds and add token liquidity. Cross-chain swapping protocols for liquidity auctions may potentially fill a major void that has existed in the crypto industry for long.