Fixing Liquidity Fragmentation, One Of The Biggest Headaches In DeFi

Decentralized finance has created a new paradigm in the world of money, with its ability to facilitate lending, borrowing and other financial services without any centralized gatekeepers.

The benefits of not having any gatekeepers are numerous, with one of the most important being the low barrier to entry. Whereas banks require KYC/AML, credit score assessment and risk profiles, DeFi only requires that users understand how the protocol works. In addition, DeFi gives users complete control over their finances, with users fully responsible for managing the private keys to their assets. That means no censorship and no risk of having your assets frozen or limits being imposed.

DeFi also enables a superior way of transacting, with peer-to-peer asset transfers that are low cost, private and free from cross-border barriers. It also paves the way for users to obtain incentives, by providing liquidity for others to trade, the chance to earn interest when lending their capital to others, and rewards for their participation in governance, transactional validation, protocol development and evangelism.

DeFi Lives In Siloes

DeFi is a shining example of the potential of decentralization, yet it faces a number of challenges. One of the major ones is the lack of interoperability between the thousands of different DeFi protocols in the world. This is due to the siloed nature of the blockchains they run on. These decentralized networks are essentially incompatible with one another. As a result, the total liquidity locked within them is locked in countless silos.

Because there are so many blockchains, including Layer-1 and Layer-2 networks, crypto assets and liquidity have become fragmented across multiple platforms. For example, it’s impossible for someone holding ETH tokens to trade directly with someone who owns BTC, due to those assets living on different networks.

Centralized exchanges have arisen as a solution to this problem, enabling assets that live across different chains to be traded with one another. However, these CEXs are silos themselves, trapping liquidity within them. Each CEX has its own list of markets, and unlike in traditional finance, none of them are aggregated or global.

It's ironic that CEXs have come to dominate crypto trading, an industry that prides itself on decentralization. Decentralized exchanges have emerged as an alternative, but because they’re reliant on their users to provide liquidity, they have not been able to scale to the same heights as CEXs. The issue is that DEX liquidity providers tend to factor in the volatility of crypto and its security issues, and so they’re only willing to deploy a limited amount of capital. With so many DEXs competing for market share, many of these platforms struggle to retain the liquidity they need to operate.

Fixing DeFi Fragmentation

The innovative nature of DeFi may yet come up with a solution to its liquidity fragmentation problem. Yellow Network is a Layer-3 protocol that envisions businesses working together with a shared architecture that pools DeFi’s available liquidity into one enormous reservoir. It can be thought of as a single gateway trading environment that interconnects hundreds of standalone blockchains and DEX platforms into a single, non-custodial and automated trading hub. It aggregates liquidity into a single price feed to enable high-speed trading across chains with minimal fees.

Yellow Network connects multiple exchanges, market makers and brokers via a blockchain-agnostic mesh network made up of connected nodes that aggregate liquidity across chain to increase trading efficiency. The system is based on a Layer-3 state channel infrastructure, which enables participants to communicate and trade with one another in a fully decentralized way.

The key to this is Yellow’s state channel-based smart clearing protocol, which is completely decentralized. Users are required to lock collateral in a state channel that’s controlled by a smart contract, which in turn, is governed by the parties that opened the channel. In this way, Yellow Network never controls any of the funds traded on its network, making the system non-custodial.

Yellow Network is not built atop of any single blockchain platform. Rather, it’s a network of intermediate nodes powered by Yellow’s code and run by the interconnected exchanges and brokers. It paves the way for network participants to engage in high-frequency off-chain trading, with the smart clearing protocol pooling on-chain collateral to minimize counterparty risk and guarantee broker-to-broker liabilities.

Pooling Global Liquidity

By providing a fully decentralized clearing and settlement network for trading liabilities, frequently updating state channels and facilitating any challenges, Yellow Network can fulfill a unique role in the DeFi industry. It combines the capabilities of the SWIFT messaging protocol and ECN order matching protocol found in traditional finance. Just as SWIFT and ECN connect each broker’s assets to the global financial system in traditional markets, Yellow performs the same role for DeFi. It aggregates the total liquidity of DeFi into a single, global pool and facilitates access to every participant, regardless of the underlying blockchain.

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