Using Liquidity As An Indicator of Cryptocurrency Market Uncertainty
Blackswan $SWAN is an ERC-20 token that strives to allow investors to hedge downside risk in the cryptocurrency market. The token tracks liquidity (as a percentage of total supply) in order to determine market uncertainty. In this article we will explore the feasibility and reasoning of doing so.
Why do investors decide to exit a liquidity providing position?
Liquidity providers in the current AMM system are constantly exposed to impermanent loss. Especially during periods of high volatility that may increase the likely-hood of an asset, in an LP position, to move away from its original entry price.
This may render the benefits of providing liquidity virtually obsolete, causing the investor to decide to remove their liquidity.
Recent examples of uncertainty reflected in liquidity
Feb 22, 2021 cryptocurrency markets made one of the largest corrections in recent history, and we are able to see the direct result in the WETH/USDC liquidity pool on Uniswap.
As we can see from the graph above, this was not an isolated indecent and occurred generally across all Uniswap pools (although the representation in USD in not representative of actual liquidity outflows due to negative price action).
Where it gets more interesting is in stablecoin AMM protocols such as curve, where even in stable price action, liquidity providers still significantly drew down their positions as seen below within this Feb 22 period.
Why does this matter?
Liquidity incentive programs have clearly failed and will only exacerbate market draw downs. By providing passive incentives, liquidity will generally reach higher levels than before, however this is quickly reverts during periods of uncertainty creating a liquidity run.
When liquidity is needed most, liquidity providers clearly do not want to be in the market. This means that markets become illiquid and allow price action to be affected with much lower levels of volume.
How does Blackswan $SWAN differ?
Blackswan takes a different approach outside of passive incentives by providing liquidity incentives when they are needed most, during periods of uncertainty and low liquidity.
This creates a scenario where liquidity is able to reach artificially high levels during market growth as investors hope to capture liquidity incentives during uncertainty as a hedge. This is a best of both worlds solution that allows Blackswan liquidity to remain at high levels, even when other currencies experience liquidity runs.
