The first time I heard of "concentrated liquidity" and its functions in DeFi smart investments protocols, I thought, what a cool way to leave an asset owner in control of his assets even whilst locked up in a smart contract and making him money.
The idea of concentrated liquidity is quite simple, whether or not this is actually being leveraged in real time is what I cannot tell, but if it should exist anywhere, it should be on Uniswap.
So in theory, an individual provides his assets to a liquidity pool, to earn rewards and enable the decentralized exchange to facilitate trades or the DeFi smart investments protocol deploy loans for yields. But unlike traditional methods of doing this, the individual is given more influence over his asset in the pool, so he can decide on what "price" he agrees for his assets to be sold.
The smart contracts withholds these assets regardless of swap initiations until the specified price is reached.
The reason I'm talking about this is that concentrated liquidity is kind of a pre-version of timelocks because waiting on the specified price leaves the assets locked through time.
The difference? The asset owner does not actually specify the time, thus doesn't control when assets will be traded although he can always remove his liquidity when needed, something that would be slightly different with timelocks.
Defining volatility, it's causes and effects
Volatility, in the context of finance and investments, refers to the degree of variation in the price of a financial instrument (such as a stock, bond, or cryptocurrency) over time. It is a measure of how much the price of an asset tends to fluctuate.
High volatility means that the price can change significantly in a short period, while low volatility implies more stable and predictable price movements. Volatility can be caused by various factors, including market sentiment, economic events, and news. Traders and investors often use volatility as a key factor in their decision-making processes when buying or selling assets.
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To explain further, the rapid rise and fall of asset prices is volatility and this is very common amongst crypto assets. It is a known fact that crypto is the most volatile asset class in the world and there's a few reasons for that.
The cryptocurrency and asset industry is a sovereign ecosystem that governs itself as opposed to traditional finance structures that are regulated by the state governments. So where there's the absence of trade regulations, what happens?
A 24/7 market madness I'd say.
The cryptocurrency markets never sleep, both bots and humans roam the markets searching for value and profits. This consistent search creates rapid price shifts or fluctuations, resulting in an uncontrollably volatile asset market.
The effects?
Losing money, people consistently lose money due to crypto volatility and its rather a weird relationship because the loss is a product of the activities carried out by the same people, well, not exactly the same but looking at the larger spectrum, using the phrase "the same people" really fits perfectly.
Timelocks and Concentrated Liquidity as a theorized solution
The crypto ecosystem is built on "incentive", decentralization and sustainability is attained through strategic incentivization of the community, this is what maintains ethical operations within the space.
As such, it is only understandable that it will be the same route to take in attaining reduced market volatility.
When it comes to decentralized exchanges, we understand one thing and that is that the size of the liquidity pool will determine the rate of volatility between trades.
So if there's a consistent buying or selling pressure, there's bound to be a lean too great towards one side of the pool's token balance, resulting in high volatility.
So what if? We can use concentrated liquidity to define prices accepted by individuals to trade a specific asset and timelocks to define the specific times allowed for trades to occur with even some tweaks in between to boost incentives and engagement.
Here are some rough examples:
Example 1: an individual defines a value of $1,000 to be the accepted value to trade his Hive token but only after a year of pooling his assets.
Example 2: an individual defines a value of $1,200 to be the accepted value to trade his Hive token with a 2 years timelock before trade can be initiated but at the same time, offers an instant trade if the buyer can offer $1,350 for each Hive token.
Example 3: the individual offers up his Hive asset for a price of $900 each but is willing to take any amount after a year's timelock.
Testing out these examples with more can help us figure out some potential "network-side" incentives and charges that can be applied to these trades to ensure that it is not exploited and also that it brings value to the larger network.
How would this curb volatility? Well, if there are rules set on trades and long-term incentives to leverage this system, trades could potentially take slower patterns, however, there's still the risk that without enough participants, this could at the same time cause even higher volatility.
The idea of leveraging timelocks and concentrated liquidity in decentralized markets is that it would reduce easily available for trade assets which is scarcity in a sense and that increases an assets' value overtime and this also promotes the need and use of P2P trading to buy and sell crypto assets, which also reduces volatility.