Liquidity mirroring can help solve the liquidity fragmentation problem in the DeFi industry

Decentralized finance seeks to democratize access to finance by replacing traditional or centralized entities with smart contract protocols. What this means is that it takes the monopoly power of bigger financial entities run by a few and transfers the keys to financial platforms to all (at least those who care to participate in financial governance).

But beyond the increased activities in what we see in DeFi today whether, in lending protocols, AMM decentralized exchanges (DEX) like Uniswap, Balancer etc., aggregators, DeFi is not without its difficulties. For instance, now and then, we hear of slippage costs DEX users face because of other issues such as underlying gas costs and low liquidity in pools.

There have been several attempts at addressing these issues. First, we have slippage tolerance warped into the interface of most DEXs as adopted by Uniswap to help traders set beforehand the amount of slippage they can allow. Another is trading on L2 as we have on QuickSwap or PlasmSwap. Even Uniswap and SushiSwap have all deployed on L2 like Polygon, Optimism and Arbitrum. But as you know, no one can just wish away slippage because it arises from the fundamental design of blockchain, especially if decentralization is not to be done away with.

Even lending applications have had to deploy on Layer 2 to alleviate the pains of their users and have seen considerable improvements. But still, the problem is more of a fundamental one as slippage is the price difference between when you submit a transaction and when the transaction is confirmed on the blockchain. Ethereum, which is home to most of the DeFi primitives, is slow, and Eth 2.0 will only happen in 2022 (that is if it’s not postponed again). Hence, users of beast DEXs like Uniswap and SushiSwap suffer from slippage whenever the network is congested. And yes, the network is far too susceptible to congestion.

But newer chains like Solana, Algorand, Avalanche etc., are all racing to woo as many dapp developers away from Ethereum to their chains. Binance Smart Chain at the beginning of the year looked like it almost stole the show from Ethereum until incessant hacks and flash loan attacks became the norm in the BSC ecosystem. The ensuing effect of these ship jumping by projects is the liquidity fragmentation on pools in Ethereum dapps and challenger chains. And the higher the liquidity discrepancy in pools, the higher the slippage ratio DEX users suffer.

Liquidity fragmentation becomes even more evident with some dapps on their respective blockchains amassing massive liquidity in their pools like we see in Uniswap, Sushiswap, Pancakeswap and a few others while most other DEXs suffer from insignificant traction. Even with liquidity mining, not much of liquidity is attracted even after jumping ship to move onto newer and faster chains like Solana, Algorand etc.

Meanwhile, one way to solve the liquidity fragmentation will be through liquidity mirroring across different chains and their respective liquidity pools. Instead of the usual Plasma POS for bridging assets by liquidity providers or even Polygon, which takes at least 8 minutes and far more during withdrawal, LPs can simply add liquidity on Pontoon’s relayer network, allowing for cross-chain transfers in an instant. Anyone can then swap their assets in these pools without any care for the usual mad slippage while enjoying gasless transfers. On the other hand, LPs are incentivized with network fees and TOON tokens for their risk-taking ventures of supplying liquidity in the cross-chain pools. Read about how LPs and regular DEX users can bridge their assets using Pontoon’s relayer network.

Proof of Stake secured Pontoon’s relayer chain allows anyone to join the series of validators running their relayer nodes on the Pontoon network. Liquidity mirroring is still a new concept in the broader DeFi ecosystem but offers a huge upside to both LPs and regular DEX users in the DeFi industry. Slippage costs DEX users dearly every time it swings against them. Any scientific solution to reduce its effect will help sustain DEX growth which has been the gateway to decentralized finance.

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Cross-Chain liquidity mirror protocol