https://itunes.apple.com/us/podcast/id1323372565
Episode 5 of the 'Flippening for Crypto Investors'
I recently listened to an insightful podcast episode by Clay Collins interviewing a 'liquidity provider' (link above) that explored their role in the crypto market space. So what is a liquidity provider?
Essentially, a liquidity provider is a 'market maker' that is required because there is rarely a natural buyer and seller for a given crypto asset or token. However, when you go on an exchange and trade a crypto asset for another asset, there is a spread of buyers or sellers for that given exchange of tokens. That spread is the 'liquidity' that enables these transactions to be seamless and fluid. Without this spread, transactions would not be as immediate.
Ben (the interviewee on this podcast) is a cofounder of CitizenHex, a liquidity provider for ERC20 tokens on the ethereum network. The decision to operate on the ethereum ecosystem was largely dependent on its underlying technology, that enables a large number of decentralised applications to be created with little upfront capital and relatively cheap running costs (i.e. gas and mining fees). It is anticipated that there will be an increase in order of magnitude of decentralised applications and this further drives the value of the ether commodity, the ERC20 token marketplace and the need for liquidity.
In the current marketplace, there are three parties taking a margin from transactions exchanging ether and ERC20 tokens; the exchange, the liquidity provider and the miner. The exchange takes a percentage fee per transaction for hosting the token and providing some form of initial balance. The liquidity provider profits from the median value of the asset and the bid-ask spread (the bid-ask spread is the difference between the highest price the buyer is willing to obtain the asset the lowest price the seller is willing to accept the asset) . And the miner's payment is the 'gas fee' that is required to run the ethereum network involving transmitting data and verifying blocks.
In the future, as exchanges move to the blockchain and become decentralised, existing centralised exchanges will become redundant as their fee per transaction will be a 'rent seeking' process. This implies the everyday users can exchange cryptoassets cheaper as there will only be two parties taking a margin from trading; the liquidity provider and the miner.
Ben supports the view that cryptocurrency will generally trend towards applications and protocols that seek the least rent and creates the most value for their users. If this is true, and I hope it is, we will see a rapid adoption of decentralised exchanges (like 0x, AirSwap and EtherDelta), the collapse of existing centralised exchanges and the emergence of a relatively unknown player, the liquidity provider.