Liquidity aggregation has been mentioned a lot around here but hasn’t been properly explained in detail and today is the day for some details on what exactly it means. In fact, Smartdex 2.1 utilizes liquidity aggregation in order to get traders or investors the best possible prices on each of its supported chains. First it’s necessary to explain, in an easy to understand way, what liquidity is, and then what it means to be aggregated.
What is liquidity?
In DeFi, think of liquidity like it is a swimming pool of tokens/funds, usually in a pair (ETH/USDT), that is necessary to allow traders to swap one side of the token for the other. Without these pools a user would need to find someone to trade with or go to a CEX (centralized exchange). If you have $5000 in USDT and want to buy some ETH, the pool facilitates this by allowing you to deposit $5000 USDT into it and receive roughly $5000 worth of ETH out. The reason the word roughly is there is the issue at hand, price impact of a trade on the liquidity pool. If there is not a lot of liquidity (tokens/funds) in the pool, trading can cause a large price impact, meaning the user is trading so much value that it causes the price to go up (if buying) or down (if selling) for the token, resulting in the trader receiving less value as the pools goal is to keep the same amount of each token in it. Ex. If buying $5000 USDT of a token with a small liquidity pool it could impact the price by around 10% and result in you receiving only around $4500 worth of the other token as the value of the tokens in the pool needs to remain about the same after the transaction is completed. The goal for both CEXs (centralized exchanges) and DEXs is to have deep liquidity. For CEXs this means have as many buy and sell orders as possible on the orderbook at various similar prices to the current price and for DEXs it means have a deep pool of tokens/funds to draw upon (the more money deposited the better).
What is liquidity aggregation?
Liquidity aggregation is the process of taking multiples of these separated (fragmented) pools of liquidity and effectively but not literally combining them into one larger pool to draw upon when buying or selling a token. How is this done? To keep it short and simple, a liquidity aggregation protocol with a programming interface is utilized by almost all of the most popular and trafficked DEXs allows for those who utilize the protocol to call upon it with trade orders that can be filled by any of the DEXs within the network of aggregated pools on said DEXs. On Smartdex 2.1, this is currently done by using the 0x protocol, but the team has a surprise for later this year that could be a game changer in this regard, which uses an order relayer that is implemented by many different DEXs across Ethereum, Polygon, BSC, and more to find the best price across over 50 exchanges.
This process results in less price impact on token buys and sells, meaning that you receive the most tokens you can for the price you are paying. The more pools that are aggregated together, the better it is for price impact and for crypto as it simplifies the process of finding the best price on a token across all connected for a trade for traders and investors, thus promoting efficient trades across the DeFi crypto market, which in turn works to help stabilize crypto prices and get the traders or investors the best prices.
Liquidity aggregation helps both big, experienced investors and those brand new to crypto alike. Each not needing to spend hours searching exchange after exchange to find a good price on a token they want, having to search for an exchange that has the token they want, or accidentally spending too much on a token because the exchange had low liquidity.