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The Need for Liquidity Aggregation & Regulatory Controls In DeFi Has Never Been Greater: A letter from Ahmed Ismail, President & CEO, FLUID

Over the past 48 hours, the FLUID team has been closely monitoring the current climate and the impact FLUID can play in helping to reduce huge volatility in the face of black swan events such as the UST downfall.

A black swan event is unpredictable beyond what is normally expected of a situation, obvious in hindsight, and has potentially severe consequences. Examples include the subprime crisis and subsequent meltdown of the banking sector in 2008, the market capitulation that happened as a result of COVID-19 and its inherent global shutdown. In the financial markets or any industry for that matter, black swan events are mostly known as negative. Still, history shows that these events are also a pivotal point of positive systemic change. FLUID believes that the same process will apply to this event. 

As FLUID, we officially state, the biggest mistake in this event was the lack of regulation of stablecoins, and from day one, FLUID welcomes regulation to enter the industry and elevate standards to safeguard all stakeholders across the board. 

The downfall of UST as an algorithmic stablecoin is a black swan event and should never have happened – a project worth over $18bn, it was too big to fail, and regulatory controls around the project’s automated trading system could have mitigated this situation a long time ago. Its death spiral brought BTC down by over $10,000 in a matter of hours and has caused widespread damage to our peers, exchanges and investors. It’s evident that the industry, and in this case automated DeFi trading systems that grow to this size financially, need to be better regulated in order to safeguard all stakeholders.

As a company, FLUID gathered in the past 48 hours to discuss the current climate and came up with some important observations as a team: 

1. Risks Associated With Algorithmic Stablecoins

What has come to fruition are the risks associated with algorithmic stablecoins. We want to explain FLUID’s point of view as simply as possible, and the key message here is that computer code cannot replace asset-backed collateral.

An algorithmic stablecoin isn’t backed by assets; instead, it’s stabilized by computer code with an advanced algorithm to hedge the peg against its reserves. It is now proven that algorithmic stablecoins have loopholes in their architecture. Unfortunately, this crack in the architecture has managed to bring a project worth $18bn to almost zero within a few days as it tried to defend its UST/USD peg position by selling large amounts of BTC in the market. This event has managed to cause systemic risk in DeFi, even affecting BTC to touch $24K at the time of writing.

That said, it seems as though asset-backed stablecoins such as USDT, USDC and BUSD have more or less weathered the storm and investor sentiment remains intact here – a silver lining. USDT still traded nearly 5% wide of USD peg over the last few hours showing how extreme volatility managed to affect the price of stablecoins that are meant to be 100% asset-backed.

This event has highlighted key lessons to be learned by the DeFi industry, and certainly that algorithmic stablecoins do not work and need much more R&D and controls before they can be allowed to get so big.

2. When Black Swan Events Happen, Crypto Market Participants Need to Be Able To Handle Extreme Volatility

This isn’t the first black swan event, nor will it be the last. They will happen again in the future – That’s just our industry growing and learning.

HOWEVER, the BIG question is, why was there so much systemic fallout that affected other assets in the market?

The answer boils down to liquidity, volatility and how markets react in the face of black swan events. Crypto markets are illiquid and thinly traded. Liquidity is siloed, and crypto markets are extremely inefficient. They become especially vulnerable, and even the most stable cryptos such as BTC and ETH become fragile and are in the spotlight when liquidity cannot move.

‘Crypto markets need liquidity aggregators’ more than ever before in order to help investors weather dark storms caused by black swan events.

When volatile conditions occur, market participants need access to liquidity quickly and at the best possible price in order to maintain equilibriums.

FLUID is working to create a risk mitigation controls-focused high throughput and ultra-low latency liquidity aggregator by using AI quant-based methodologies to increase market efficiency and help crypto trading venues and overall market participants reduce volatility in the face of adverse events.

Even though FLUID is not regulated, we embrace exacting industry-wide regulations in DeFi to help the industry evolve and will be ready when the time comes.