We’re pleased to announce that Hack VC has led the Series A financing round for the Elixir Protocol. Elixir is a decentralized Proof-of-Stake network purpose-built to power liquidity across central limit orderbooks. Through Elixir, LPs can provide capital directly to the orderbooks for specific pairs – creating a backbone of liquidity for both centralized and decentralized exchanges.
To appreciate Elixir, let’s first get up to speed on how liquidity works for tokens today. When a protocol first launches its token, that token is often “thinly traded” on exchanges. You can’t buy or sell those tokens without experiencing high price slippage, because there isn’t a mature market yet. This is problematic for investors and it’s also problematic for the protocol to gain traction. If the token has utility, the applicable network often can’t function since users can’t effectively acquire their tokens on exchanges to use the protocol.
Anecdotally, the same month we performed due diligence on Elixir, two of our portfolio companies approached us for help finding solutions for creating a liquid market for their protocol tokens – highlighting just how in-demand solutions truly are.
How Liquidity Works Traditionally
Historically, protocols would tap into centralized trading firms to help solve liquidity problems by being the “middlemen” on each trade on an exchange. They create a liquid market for each token pair, and they make a profit on the spread.
This is a lucrative service that can be highly profitable and is currently underserved in crypto. Examples include Wintermute, GSR, and Dexterity Capital. This service is lucrative because of the trading spreads combined with the terms trading firms charge protocol foundations for the service. In a typical deal structure, a protocol’s foundation will “lend” a basket of their tokens to a trading firm for 18 months. At the end of the negotiated period, the trading firm has an option to purchase those tokens at that day’s price. You can think of these trading firms as effectively “VCs in disguise,” without taking the level of investment risk that VC investors take.
Another reason these deals may become lucrative is that there is little competition among these trading firms due to some recent failures in the space (e.g., Alameda Research). Only a handful of firms can execute this service today and most protocols struggle to find a trading firm willing to partner with them. Those that do exist have a near-monopolistic control of the market, sometimes charging extremely expensive rates. Thus, this is a supply-constrained (not demand-constrained) market, which is a positive indicator for potential growth prospects of new entrants into this sector.
Liquidity of tokens is not only useful for newer protocols whose tokens are thinly traded – it also can be a valuable service for mature protocols. As the USD-denominated value of a protocol’s token grows, it needs to hire more trading firms. Perhaps in the early days, $1m of daily trading volume was sufficient, but as a token becomes more valuable, the protocol requires more trading firms to serve $10m or $100m in daily volume. Many top exchanges also require a minimum of liquidity at all times, forcing projects to choose between being delisted or hiring a trading firm. This is an important phenomenon. It indicates that customers of trading firms do not outgrow their need for liquidity, leading to this being a potential expansion revenue opportunity for any given account.
On the DeFi front, orderbook-based DEXes (and even concentrated liquidity AMMs) face the same issue, courting the same few large players for liquidity on their books. That is, until Elixir.
What is Elixir?
Elixir is a DPoS network that takes a novel approach to liquidity. Via Elixir, LPs trustlessly provide capital directly to orderbook pairs, with the off-chain protocol algorithmically building up the books, updating once a second. This is very different from traditional trading firms, who provide their own dedicated capital, or who source capital from uncollateralized loans.
Elixir is also differentiated in its approach. One challenge with liquidity is that a protocol’s DAO typically needs to “vote” to give the basket of tokens to the trading firm. These DAO votes can often be contentious since the DAO doesn’t want to “give away” large amounts of tokens to benefit third parties.
Elixir solves this political challenge by allowing for the DAO members themselves to directly supply liquidity to the token pair, typically in exchange for subsidized yield. Elixir is naturally aligned with the interests of the DAO and there’s a much higher probability of a “yes” vote, since the DAO members are individually profiting off supplying liquidity. This, combined with the complete decentralization and transparency of the protocol, creates a win-win for everyone.
Additionally, Elixir is a more efficient system than traditional trading firms taking loans. The Elixir Protocol’s off-chain network “is” effectively serving as the trading firm (with individual users being the ones supplying the capital). This removes the need for lending middlemen and makes fees massively more efficient, since there are fewer hands in the “proverbial cookie-jar” to extract profits.
Elixir’s launch partners include dYdX, Injective, Vertex Protocol, Bluefin, Satori, WooFi and RabbitX. Of note, LPs who participate in Elixir’s launch on Vertex Protocol will also benefit from Arbitrum grant tokens, boosting expected yields materially. Elixir is well positioned to power a meaningful swath of the total liquidity across the crypto landscape.
We’re grateful to be partnering with Elixir. Please join us and celebrate the future of orderbook liquidity together at https://elixir.finance.
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