Liquidity refers to the amount of an asset that is available for trading or to cash out. The more liquidity available, the lower the price impact your trades will have. Trading on a platform with too shallow liquidity can cause the price of the token crashing, leave you squeezed in a sandwich attack, or cause the trade to fail. 

Better liquidity in many cases means better prices, so let’s look at how Matcha handles DeFi liquidity to get you the best value!

Why you need deep liquidity

Liquidity keeps prices elastic when faced with sharp volatility caused by supply and demand. Available assets must be much greater than the size of the order being executed so as not to drain or inflate supplies, which could otherwise cause a sudden jump in price when you swap crypto.

Getting the deepest liquidity is a matter of choosing the right platform. Even the largest decentralized exchanges (DEXs) can’t manage liquidity across every token, and even on the trading pairs which they do support they are not always prepared for sudden change in demand. 

A DEX aggregator like Matcha taps into over a hundred exchanges - plus private liquidity sources -  to aggregate all available liquidity for any token you might want to trade. Access the best prices in DeFi, with coverage of up to 4 million tokens!

Price Execution

Getting the price you were quoted should not be taken for granted in a decentralized market! Many factors can affect the price the trade is executed at, such as block order, network latency and MEV, and crucially, liquidity.

Most exchanges are limited to executing orders from their own liquidity sources, which are not always aligned with market prices. Aggregated liquidity improves price execution by giving you the most competitive prices from across the market. Matcha will even execute across multiple sources if it results in better value for you.

Less slippage

Trading crypto on a platform with shallow liquidity will lead to higher price impact of any trade you make. If you only trade small volumes you may not notice any significant impact from this until you try to buy a token with barely any liquidity at all. 

As a trader, you want to be positioned where there’s deep liquidity across a broad range of opportunities. Not only will it reduce the impact of your trades, but also those of traders competing with you, giving you a better chance of your trade executing at a better price during high activity periods.

Where liquidity comes from

In DeFi, there are various types of liquidity sources, most of which fall under the category of automated market makers (AMMs) or private market makers (PMMs). Each has its pros and cons, so understanding them lets you leverage their unique advantages to improve your trading. 

Automated Market Makers (AMMs)

AMMs are a type of decentralized exchange (DEX) protocol that prices cryptocurrencies using a formula instead of typical market pricing through buyers and sellers. The AMM is funded by Liquidity Providers (LPs), wallets that deposit a pair of crypto assets, such as WETH and USDC, into smart contracts known as liquidity pools. 

An AMM will use LP liquidity to facilitate trades, deriving its initial asset pricing information from the ratio of assets in the pool. As you trade, the ratio of assets may become imbalanced, changing their pricing, which leads to larger trades having a higher price impact. AMMs attract new liquidity to balance their pools through fees and incentives, usually rewarding LPs with LP tokens.

On Matcha, we connect you to over 100 DEXs where trades are facilitated by AMMs to find you the best price among them. The AMM model is unique to DeFi, and it enables robust peer-to-peer trading around the clock. Liquidity is crucial in ensuring AMM pricing is competitive, which means larger players that attract more liquidity will often win on price. 

Impermanent loss for liquidity providers

Liquidity providers who deposit assets into a liquidity pool are susceptible to impermanent loss, which is where the price of an asset shifts significantly from the price set by the funding balance of assets in a pool, and you get stuck with your funds in a pool that has little or no value. In such a case, one of the assets could end up valued higher outside of the AMM structure, and the AMM will balance the pooled assets to reflect this, potentially leaving you missing out on price appreciation that you would have seen from simply holding on to the asset. 

Withdrawing pooled assets that have been rebalanced may leave you with more of the less valuable asset, and less of any asset that increased in price. This is where impermanent loss becomes permanent loss.

Private Market Makers (PMMs)

Funds or individuals managing large amounts of crypto assets can monetize their holdings by facilitating trades through traditional market making methods, within a decentralized context. 

Private market makers use automated systems to offer liquidity and price assets. A PMM will constantly submit buy and sell orders, providing quotes to other market participants which can then be fulfilled over private channels, bypassing public mempools.

Request-for-Quote (RFQ) orders fetch quotes created by PMMs and chooses the best value among them. Advantages of this include experiencing less slippage on your trades and cost savings through MEV protection. 

On Matcha, when you see 0x RFQ in the Route field, your trade is being executed by finding the best price across many PMMs. 

PMMs: RFQ vs OTC

Trading using RFQ orders on a platform like Matcha is different from over-the-counter (OTC) orders, though a PMM liquidity source may offer both services. 

OTC trades generally involve larger value transactions that are arranged directly between buyer and seller and settled in private, with prices agreed upon by involved parties, minimizing immediate market impact. 

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RFQ orders can be smaller in value and are accessible to anyone using the platform. While orders are more private than regular AMM swaps and can therefore prevent sandwich attacks, they will still impact the price as they are immediately identifiable onchain once the exchange is made.

Measuring liquidity with Total Value Locked (TVL)

Total Value Locked (TVL) is a pivotal metric used to understand liquidity, representing the aggregate value of all assets deposited in various protocols. TVL evolves over time to reflect the changing dynamics of market participation, risk assessment, and capital allocation within DeFi. 

Changes in TVL can signal changes in broader market sentiment and the health of individual liquidity sources. While rising asset values can inflate TVL naturally, bear market conditions  require more capital efficiency and favor platforms with concentrated liquidity. In this context, aggregators help find an optimal source of liquidity, either from the source with the most value locked, or from multiple sources combined.

Unified liquidity for better crypto trading

Managing liquidity across the diverse crypto landscape is a massive undertaking. No single market maker can cover liquidity needs of all the tokens out there, or ensure there’s enough liquidity for sudden increase in demand. Aggregators like Matcha exist to unify this liquidity in one place, so you can search and trade millions of tokens, without worrying about draining the supply, or wondering if you’d get a better deal elsewhere. Get the deepest liquidity across the broadest range of tokens - try Matcha today!