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 liquidity in major pools, including Uniswap v2, v3 and v4, as well as Curve, remains unused for most of the year. This means billions of dollars are being placed into smart contracts without incurring fees or generating significant returns.
In Uniswap v2 alone, only 0.5% of liquidity is typically within active trading price ranges, rendering nearly $1.8 billion ineffective according to the report.
This inefficiency hits retail players the hardest. Research cited in the report shows that 50% of liquidity providers (LPs) lose money when accounting for transient losses, with liquidity providers’ net deficit exceeding $60 million. In one notable example, a single Uniswap v3 pool experienced a profit loss of over $30 million due to just-in-time liquidity manipulation.
Part of the problem is the large number of fragmented basins, with more than seven million in the ecosystem. This complexity not only dilutes liquidity, but also makes it more difficult to route transactions efficiently, further reducing returns for liquidity providers.
“New approach”
For 1inch, the solution is its Aqua protocol, designed to allow DeFi applications to share the same capital base across multiple strategies without compromising user custody.
“We are solving 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 their assets in their 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 use this important liquidity. “Any DEX in existence today can be implemented under 10 lines of code,” Kunz added, noting that the goal is to provide “a foundation to build on” so that liquidity providers can “hold assets in the wallet” rather than locking them into complex protocol contracts.
