- Lack of liquidity and significant capital costs hamper the growth of Decentralized Finance (DeFi).
- One solution to that issue is arbitrage staking with AI protocols. These can detect slight price differences between exchanges, DeFi protocols, and reward stakers.
- Mosdex CEO Joseph Emmett says AI protocols could reach scale unseen in tradFi, and amplify the liquidity in DeFi.
Decentralized Finance (DeFi) promises a future where financial services won’t be in the hands of just a handful of big banks. In the future, users might not have to rely on financial institutions as middlemen.
Instead, they will have access to open protocols and smart contracts that would have replaced banks as efficient, cost-effective, and transparent alternatives. As the DeFi space evolves, it is becoming increasingly clear that Artificial intelligence (AI) will play a major role in it. AI is solving one of the biggest issues for DeFi – liquidity.
Liquidity Issues Plaguing DeFi
The decentralized finance (DeFi) space consists of various decentralized protocols offering financial services on blockchain platforms. Most of these DeFi protocols are on Ethereum, the largest smart contract blockchain network.
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Compared to traditional finance and even the rest of crypto, the DeFi space is still tiny. According to Messari, DeFi makes up just 0.2% of the global financial services market.
The relative size of DeFi means finding willing buyers or sellers at any moment can be difficult. This translates into liquidity issues for DeFi, and wild price swings during booms and busts.
For instance, 2022 saw most crypto and tech markets slump due to an unfavorable macroeconomic environment. This is because interest rate hikes hurt high-growth businesses the most.
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However, few industries were hit as hard as DeFi. By the end of 2022, the total value locked (TVL) in DeFi was $40 billion, or just 25% of what it was at the start of the year.
Due to its relative size to financial markets, analysts at firms like Messari still believe that DeFi will grow in 2023. However, a lack of liquidity will be a continuous roadblock to its growth.
To deal with the issue of low liquidity, DeFi space needs market markers or firms with enough capital to arbitrage. Few major financial players are willing to bet on this emerging space. However, DeFi companies are already finding alternative solutions to this problem.
How AI can Help Solve Liquidity Issues in DeFi
Instead of relying on giant financial firms to serve as market makers, DeFi players leverage staking rewards and AI to boost liquidity in the space.
One of the companies active in that field is Mosdex, an arbitrage staking and liquidity platform. Mosdex CEO Joseph Emmett believes that AI could significantly boost the potential of DeFi applications.
"Liquidity risks have been one of the major concerns for any company that's thinking of entering DeFi," Emmett said. "Solving this issue could be a major catalyst for DeFi growth."
Mosdex uses AI algorithms to find arbitrage opportunities between DeFi protocols and centralized exchanges. Because of low liquidity, crypto assets can have slightly different prices on different marketplaces. If these prices are different enough, an AI algorithm can perform arbitrage and make a small profit.
At the same time, the capital for these arbitrage trades comes from users that want to earn a yield on their crypto. Mosdex claims that this is a relatively low-risk strategy that can offer reliable returns to investors.
Mosdex is not the only industry player exploring synergies between DeFi and AI. Experts at the World Economic Forum have also pointed out how AI and blockchain tech can complement each other.
"It's no secret that tradFi has used AI tools for a long time. However, AI will be a true game-changer for DeFi,” Mosdex's CEO said. “Moreover, DeFi will truly unleash the power of AI in finance.”
On the Flipside
- Liquidity protocols (LP) are still an unregulated industry. Unlike in traditional finance, there is no insurance in case a DeFi protocol suffers a hack or goes under for any other reason. Potential investors should only invest with staking pools and liquidity protocols they trust.
Why You Should Care
DeFi is one of the stronger use cases for crypto. Its growth could boost the adoption of the entire blockchain ecosystem. Moreover, smart contract-enabled blockchains like Ethereum could benefit from the growth of DeFi.
