A new report from decentralized exchange aggregator 1inch has shown a growing crisis in decentralized finance (DeFi): the vast majority of capital deployed in major DeFi liquidity pools is not being used effectively.
According to data presented at Devconnect Buenos Aires, between 83% and 95% of the liquidity of the main pools, including Uniswap v2, v3 and v4, as well as Curve, remains idle for most of the year. That means billions of dollars are sitting in smart contracts without earning fees or generating significant returns.
In Uniswap v2 alone, only 0.5% of liquidity typically falls within active trading price ranges, rendering nearly $1.8 billion ineffective, according to the report.
This inefficiency affects retail participants the most. Research cited in the report shows that 50% of liquidity providers (LPs) are losing money when accounting for non-permanent losses, with net liquidity provider shortfalls exceeding $60 million. In one notable example, a single Uniswap v3 pool suffered over $30 million in lost profits due to Just-in-Time liquidity manipulation.
Part of the problem arises from the large number of fragmented pools, with more than seven million in the entire ecosystem. This complexity not only dilutes liquidity, but also makes it difficult to route trades efficiently, further reducing returns for liquidity providers.
‘New approach’
For 1inch, the solution is its Aqua protocol, which is designed to allow DeFi applications to share the same capital base across multiple strategies without compromising user custody.
“We addressed this problem by introducing a new approach,” 1inch co-founder Segej Kunz told CoinDesk in an interview at Devconnect Buenos Aires. “We allow people to simply hold assets in the wallet and we allow them to create virtual trading positions.”
For Kunz, the current situation constitutes a “DeFi liquidity crisis.”
The protocol also aims to lower the barrier to entry for developers who want to utilize this deep liquidity. “Any DEX existing right now can be implemented under 10 lines of code,” Kunz added, noting that the goal is to provide “a foundation to build upon” so that liquidity providers can “keep assets in the wallet” rather than locking them inside complex protocol contracts.
