Elixir Protocol Explained: The Decentralized Market-Making
What is decentralized market-making and its challenges; how this is implemented in Elixir; the Elixir architecture.
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1. Introduction
2. Centralized And Decentralized Market-Making
3. Here comes the Elixir
4. Where the Liquidity Flows
5. Current State of Elixir
6. Conclusion
1. Introduction
In the evolving world of decentralized finance, a new player has emerged that seeks to reconfigure the role of market makers and streamline the process of liquidity provision. This transformative player is Elixir Protocol, a revolutionary system designed to democratize market-making, putting power in the hands of the community, while simultaneously streamlining liquidity provision across both decentralized (DEX) and centralized exchanges (CEX).
Elixir's aim is not just to disrupt, but to dispense with the traditional market maker paradigm, where a considerable portion of tokens are relinquished to these intermediaries for their services. The Protocol goes beyond the limitations of this established model, making market-making a more inclusive, efficient, and cost-effective process.
This introduction to Elixir Protocol opens the gateway to understanding a new age in the financial market, where democratization of services and decentralization of power promise to reconfigure the very fundamentals of market making and liquidity provision.
2. Centralized And Decentralized Market-Making
Market-making is a crucial activity in the financial world, one that helps ensure the smooth functioning of markets. A market-maker is a firm or individual who actively quotes two-sided markets in a security, providing bids (buy prices) and offers (sell prices) along with the market size of each. Their primary role is to provide liquidity to the market, essentially making it easier for buyers and sellers to trade by always standing ready to either buy or sell. They make money from the spread, which is the difference between the buying and selling price. Market making encourages market efficiency by facilitating trades and maintaining fair and orderly markets.
The concept of market making extends to the cryptocurrency world as well. Crypto market makers operate similarly to their traditional counterparts, by quoting buy and sell prices for a cryptocurrency on an exchange. This contributes to the liquidity of the cryptocurrency, which is essential for enabling easy trading without significant price impacts from individual trades. However, it's worth noting that the majority of crypto market making activities occur on centralized platforms.
In decentralized exchanges (DEXes), the role of market makers is assumed by liquidity pools. A liquidity pool is a reservoir of funds securely stored in a smart contract, with multiple participants committing their assets to this contract, thus adding liquidity to the market. When other users seek to make a trade, they interact directly with this pool, creating a system that guarantees the availability of a buyer and seller for each transaction.
Those participants who offer their assets to the liquidity pool are compensated with transaction fees generated from trading activities. As such, in contrast to centralized exchanges (CEXes) where a single, large entity typically acts as the market maker, on DEXes, numerous users become akin to smaller-scale market makers by contributing to liquidity pools.
3. Here comes the Elixir
Elixir Protocol introduces a fresh approach to liquidity provision and market making, contrasting with both centralized and decentralized market-making models. The protocol is designed to allow retail users to tap into the incentives and fees that exchanges and tokens typically pay out to centralized firms, disrupting the traditional market-making landscape and opening up the gates for an influx of liquidity to orderbook pairs across the space.
Elixir Protocol is a platform that allows the creation of trading pairs and stimulates liquidity on both Decentralized Exchanges (DEX) and Centralized Exchanges (CEX). This means projects can sidestep traditional market-making firms, which often demand a significant number of tokens for their services. Moreover, exchanges sometimes necessitate contracts with certain market makers, introducing additional cost risks.
Elixir's market making is entirely algorithmic, which is one of its key distinguishing features. With Elixir V1, users can place their capital in pools geared towards Central Limit Order Books (CLOBs) on exchanges like Injective, Vertex, RabbitX, dYdX, and others – via front-end integrations. This liquidity is algorithmically positioned to capture the majority of trading commissions and market-maker incentives, which flow directly to the individual liquidity providers.
Elixir boasts its unique network, with multiple roles playing crucial parts. To comprehend it, let's visualize it as a bustling city, with different entities working together to maintain security, regulate traffic, and maintain law and order:
Validators — Think of validators as the city's security officers. They secure the network through a system known as delegated Proof of Stake. To achieve consensus, 66% agreement is required among validators. The requirements to become a validator are relatively low and the processes are mostly automated.
Relay nodes — Relay nodes act as traffic controllers, handling trade keys for individual exchanges and collating order snapshots from validators. These are then passed onto auditors for validation, similar to how a traffic officer would report to their superiors.
Auditors — Auditors function as the city's detectives, scrutinizing the network for malicious activity. If they find evidence of wrongdoing, they're rewarded with funds from the guilty party's stake, much like a detective receiving a commendation for solving a case.
Controller — The controller can be compared to the city's mayor or governor, managing important aspects like staking, rewards, bond pools, and penalties via a smart contract.
Market makers, like city traders, have two major concerns:
Minimizing inventory risk
Finding the optimal bid-ask spread, analogous to maintaining an ideal inventory of goods and setting the best buying and selling prices.
Two economists, Avellaneda and Stoikov, devised a model, much like a blueprint, to handle these issues. They proposed a formula for an ideal reserve price and an optimal bid-ask spread, much like how city planners determine optimal resource allocation and price regulation.
For creating an optimal bid-ask spread, Avellaneda & Stoikov developed a formula that determines the order book's density to set a benchmark price where the bid and ask order spread will be set from.
In the given formula, “κ” signifies the orderbook liquidity parameter. A larger κ indicates higher book liquidity, influencing the strategy's spread size: thicker order books warrant tighter spreads, thinner ones need larger spreads. The strategy executes several steps to deploy orderbook liquidity: first, it calculates an ideal market price based on the user's inventory target using the reserve price formula. Then, it determines the optimal bid-ask spread according to the book's depth and starts placing bids and asks based on this spread.
4. Where the Liquidity Flows
Liquidity lies at the heart of the Elixir Protocol, serving as the critical engine that drives its operations. By employing innovative strategies for liquidity provision, Elixir ensures smoother transactions, better price stability, and overall enhanced market efficiency. As a platform that strives for democratized and transparent market-making, the role of liquidity in Elixir Protocol cannot be overstated, making it a cornerstone for the system's success.
DeFi protocols building CLOB infrastructure on-chain can natively integrate Elixir into their backend to unlock their retail liquidity for making markets on their exchange, creating an entirely better user experience, with user-added liquidity reducing slippage, tightening bid-ask spreads, and reducing volatility.
Elixir can also plug directly into most on-chain CLOBs without the need for a native integration simply via API endpoints, allowing users to make markets on orderbooks that have previously been dominated by centralized financial firms who capture the bulk of the MM incentives and yield that exist on these platforms. Via Elixir, retail DeFi users have an entirely new source of yield.
With its decentralized setup, Elixir reduces reliance on centralized computations, providing inherent transparency and security. Projects targeting increased liquidity for Decentralized Exchange (DEX) pairs find Elixir a critical asset, as it helps incentivize their pools for efficient capital deployment. Importantly, profits go to community members, not big Market Making (MM) firms, promoting a democratic and decentralized finance ecosystem.
Elixir has 20+ native integrations into the core infrastructure of leading DeFi DEXs (both CLOB and AMM exchanges, including dYdX, Injective, Vertex, Osmosis, etc), and boasts 60+ protocols that have committed to using Elixir for market making on CEXs.
5. Current State of Elixir
As of now, Elixir has become a prominent entity in the realm of liquidity protocols, showcasing its prowess through a multitude of integrations and partnerships. With over 20 strategic collaborations, including Layer Zero, Perpetual Protocol, Olympus, Avalanche, dYdX, Sei, and Sudoswap, Elixir has carved out a niche for itself. It is not just these integrations that display the reach of Elixir; it's also the more than 50 decentralized applications (dApps) that have chosen to leverage Elixir for Market Making, amplifying their liquidity and trading efficiency.
The faith in Elixir's innovative approach to liquidity is mirrored in its impressive lineup of backers. Elixir enjoys support from investors such as Dewhales, Commonwealth, Hack VC, ChapterOne, Arthur Hayes, FalconX, Ava Labs, and KuCoin, among others. This strong backing underscores the confidence that these esteemed entities have in Elixir’s potential to redefine the liquidity landscape.
In terms of supported assets, Elixir has left no stone unturned, currently supporting over 50 different cryptocurrencies. This diverse range of supported assets increases the accessibility and appeal of Elixir, ensuring it caters to a wide array of user preferences.
During their testnet phase, Elixir demonstrated its immense potential. It recorded a staggering trading volume of over $300 million, a testament to the robust and efficient infrastructure that Elixir brings to the table. The testnet phase also saw participation from over 2000 validators, highlighting the interest and faith the community has in Elixir's mission.
6. Conclusion
In conclusion, Elixir Protocol emerges as a revolutionary force in the liquidity landscape, transforming the dynamics of both centralized and decentralized exchanges. By innovatively harnessing the principles of active, algorithmic market-making, Elixir efficiently manages liquidity, creating an environment that benefits individual contributors, projects, and the entire DeFi ecosystem.
Elixir's remarkable array of integrations and partnerships, its strong support from industry-leading investors, the extensive range of cryptocurrencies it supports, and its impressive testnet performance underscore its potential to be a game-changer in the field. Furthermore, Elixir's commitment to decentralization and community involvement is forging a path towards a more democratic and equitable financial ecosystem.
As Elixir continues to build on its current success, it is poised to not only shape the future of liquidity management but also redefine the contours of the DeFi space. By focusing on efficient capital deployment, reducing reliance on centralized entities, and incentivizing community participation, Elixir stands as a beacon of innovation in the DeFi landscape. It’s not just a protocol; it’s a promise for a more efficient, secure, and democratic financial future.
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