Chapter 1: The State of DeFi
mrgn labs is starting a substack. This is the first chapter.
We Live in a
DeFi currently exists in the first inning of its life. As much as I’d love to put the global financial system on the blockchain overnight, that’s not going to happen. In fact, it’s impossible as things stand, and it will stay impossible for a while. Adoption curves aside, there’s a lot that needs to be built to enable more liquidity to come on chain, from infrastructure to applications.
Trading, one of the primary drivers for crypto adoption, falls into the same bucket. There’s ecosystem-level blockers that need to be solved before any incremental trader-side tooling matters. At mrgn labs, we’re working top-down, starting with three primary blockers.
It may seem obvious, but defi is currently held back by:
There’s more to these than meets the eye. I’ll address each in order.
“Where’s the liquidity?” There’s a few things the defi ecosystem could benefit from here. First, we need trust in DEXs and their underlying cryptoeconomic & financial primitives to improve. This happens through transparency (e.g. open-source protocols) and expertise (e.g. user knowledge on how to securely interact with DEXs).
To an extent, we’ve reached that point with a niche group of retail & institutional players, but this isn’t nearly enough. In fact, what we currently have could form in to a dangerous, synthetic stasis (providing builders fail to scale defi to the masses). In that adverse scenario, defi will remain a space forever PvP, with new crypto entrants remaining on more accessible, friendlier venues (modeling CEXs).
There’s also a huge part to this I think the crypto industry often overlooks. Onboarding sucks. Off-boarding sucks just as bad… We know this (but don’t seem to be doing much about it). However, when you follow the capital flow from start to finish, I think you’ll discover a gaping hole.
To trade in defi, a user typically needs to transfer cash they’ve stored in their bank to a CEX, buy a token, send that token to their appropriate wallet on the appropriate blockchain. Then, they can access DEXs on that blockchain.
Each of these steps typically include fees and/or holding periods. Each step also comes with an accompanying user drop-off rate.
The banking industry has some unavoidable friction making it hard to improve the capital flow from bank account to CEX. However, very little has been done between the steps of CEX onboarding to DEX access. The permissioned layer, CEXs in particular, is where a ton of liquidity is gatekept from going on-chain. We’re not making it easy for that liquidity to come on-chain.
Let’s make this more clear with an example. What are we doing to enable traders to easily move between off-chain Binance perps and on-chain Zeta options? Why don’t traders have the ability to set up atomic positions between just those two venues, for example?
We don’t have this today, and traders are instead forced to constantly send capital back-and-forth, on-chain/off-chain, with resulting fees and holding periods in between. This causes most users to keep capital off-chain, never taking that next step, and liquidity is prevented from coming on-chain in the process.
DeFi gives anyone the ability to create their own DEX without a standardized set of rules or an established framework for how the exchange operates. That means whenever somebody accesses a new DEX, they essentially need to understand the codebase to translate what happens upon interacting with the exchange. There’s no mental shortcuts traders can take apart from how the underlying blockchain works.
This context makes it easy to see why the difficulty in monitoring positions across DEXs compounds with each additional venue a trader adds to their portfolio. Things like how much you’re making or losing, what the fees are, what the base currency is, what trades have been filled, which haven’t… Traders have to manage this across different products (e.g. options/spot), on different structures (e.g. AMM/order book), on different venues (e.g. Mango/01 Protocol). Now translate all of that into an acceptable accounting and risk-adjusted format.
It’s currently impossible to get a standardized snapshot of these variables as a trader moves across DEXs. Just as with the ecosystem-level blocker of liquidity, there’s a huge gap in the user experience.
That gap is an area marginfi is actively solving. We’re giving traders a single interface to trade across defi, not 10 or 20. In the process, we’re making it easier to interact with all underlying trading protocols (UTPs) through our cross-margining engine. Users can trade between DEXs with a step-function improvement in capital efficiency (something I’ll touch more on later).
Our team is working hard to standardize risk monitoring across any DEX we whitelist and integrate. This is a huge unlock for all traders running strategies across defi, especially in a more professional context (with need for proper accounting afterwards).
We’re not just standardizing the output of underlying risk, we’re also adding a SPAN-like risk layer to traders’ combined portfolio. This gives marginfi users greater control over the UTPs they’re trading across, and it also gives traders the ability to move quickly to new venues. By using a single interface to access venues where traders aren’t set up, or where they don’t have any capital, marginfi gives traders the speed they need to capture time-bound market opportunities in the most capital efficient way possible.
Defi right now consists of on-chain traders revolving around a few trusted venues to minimize the associated learning curves of experimenting with new DEXs. This is preventing liquidity from moving across the ecosystem, and it’s making the markets across defi less efficient. We’re solving this.
Liquidity Fragmentation ➔ Cross Margining
Liquidity fragmentation is everywhere in crypto. It’s across centralized exchanges, blockchains, DEXs, bridges, wallets, etc. This is destroying the user experience and pushing away sophisticated investors who can get better capital efficiency elsewhere.
In traditional finance, traders can use collateral in one place (like on a stock exchange) to set up positions in other places (like a futures market). There’s often a prime broker in the middle of this, connecting venues, providing risk management, and offering leverage.
marginfi is that for defi. Particularly in defi, traders need access to multiple DEXs to obtain exposure to different products, preferably on the most liquid venues. To do this now, traders must park capital at every venue they plan to use to be prepared for opportunities. This means traders start off already fragmented, with a handicapped ability to borrow against their smaller pools of capital as opposed to one unified pool.
Complicating this further is when traders construct trades across venues. Let’s say you’re constructing a delta-neutral trade across two perp venues. 01 Protocol doesn’t know your account positioning on Mango, and vice versa. That means a trader needs to park capital on each venue and use custom tooling to execute their trade atomically (minimizing risk during trade construction). Then, they need to manually monitor each position throughout the trade duration, constantly rebalancing between venues to avoid liquidation. Neither UTP knows the trader has a net-0 delta exposure, so whichever way the market moves, capital is at increased risk. If a trader wishes to borrow against this position to take advantage of an outside opportunity, they can’t. A borrow/lend protocol won’t recognize and lend against their position, even though they should be able to obtain significant leverage with neutralized delta exposure. Finally, when they’re ready to exit the trade, they also must do so atomically. Traders can then choose to either leave capital scattered across venues, or move it elsewhere.
Yes. What we have now is pathetic. This is liquidity fragmentation, this is inefficient capital, and this is where our cross-margining engine comes in.
marginfi fixes each problem I just mentioned in a trader’s journey to construct & maintain a delta-neutral position on-chain. Now, traders don’t have to park capital on a handful of venues. They can deposit once with marginfi — while keeping every UTP they access through marginfi as capital efficient as possible. Traders can also borrow against a unified capital base, as well as borrow against positions created through marginfi.
Traders no longer need to manually rebalance through separate accounts across different UTPs. marginfi will automatically rebalance trades based on the parameters traders specify (like a delta neutral trade between DEXs). Through one interface, traders can place combined, atomic trades across different DEXs, seamlessly. They can yield on un-deployed capital through our borrow/lend pool.
We’re unifying the liquidity fragmentation that has plagued defi, bringing the on-chain trading experience closer to the experience traders enjoy off-chain. This is an important catalyst in driving more liquidity into the space.
End of Chapter 1
This is a new series that centers on the state of defi, and how marginfi’s approach could shape the ecosystem. The defi landscape is currently held back by three primary blockers of Liquidity, Risk Monitoring, and Liquidity Fragmentation. By directly solving the latter two blockers, marginfi is also breaking down the first blocker, pushing defi into a new chapter of development by inviting in more efficient liquidity.
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