Key Takeaways:

Crypto market making is dominated by a handful of centralized entities that provide short-term services in exchange for discounted token rewards.
Elixir will offer an automated market making system that enables permissionless liquidity sourcing at competitive prices. This could challenge today’s centralized state of market making.
The protocol can offer both CEX and DEX market making services along with liquidity mining campaigns.
Elixir will utilize a PoS network and its own algorithm with introduced randomness to deploy liquidity, capture fees, and ultimately accrue value to its ELXR token if governance deems fit.

Crypto market making is a critical service for the industry that can help reduce token volatility and provide traders with optimal execution prices. Market making also represents a significant operating expense for many protocols, as liquidity is essential for most governance tokens. A market participant will have no desire to purchase a token if a $500 purchase moves the price 10%. When a protocol hires a market maker, the protocol usually pays a fee or even its own token to a market maker in exchange for services.

Elixir Protocol is an upcoming protocol that seeks to siphon market share from centralized market makers, such as Wintermute and GSR, via competitive pricing and incentive alignment. Instead of concentrating market making power in the hands of a small selection of centralized market makers, Elixir seeks to offer a transparent solution where protocols can hire market making services and distribute tokens into the hands of less predatory participants. Elixir would allow anybody, regardless of their ability to code algorithms and manage liquidity bands, to benefit from market making fees.

Market Making Today

As mentioned above, crypto market making can be expensive, and often results in a protocol funneling its own tokens at a discount to a centralized party who likely does not have the best interests of the protocol in mind. Market makers usually require a loan of native tokens so that they can both buy and sell an asset around its market price. This loan is then matched with stablecoins to begin market making operations. Market makers often have several KPIs to focus on and achieve these through setting bid-ask spreads, trade frequency, and order book depth. When market making, firms must identify the best bid-ask spread to preserve inventory, maximize profitability, and ideally remain market neutral.

Market making firms stand to profit from an order book spread, as well as arbitrage opportunities. For example, if the bid for a token is $50 and the ask price is $55, the market maker can pocket this spread of $5 upon completion of the trade. In exchange for services, market makers sometimes receive a call option to buy a significant portion of token supply at a set price upon conclusion of a market making engagement. This provides an incentive for the market maker to run the token price up to protect its interest in its call option, removing ideal market neutrality from market making. Stargate currently has a proposal on its forum that offers a great inside look into the world of crypto market making. Another example can be found on the Index Coop governance forum.

Remember that the very reason Uniswap marked such a significant leap forward for liquid token markets is that it enabled anybody to provide 50/50 buy/sell liquidity with the click of a button, removing the need for centralized market makers. Providing liquidity in a 50/50 weighting exposes users to undesirable impermanent loss, and LP token rewards often do not justify impermanent loss exposure. Further, a simple deposit into a x*y=k pool does not provide optimum capital efficiency, leaving both liquidity providers and protocols with subpar results. From a quick glance at how liquidity mining incentives worked out in the long run, go look at Ribbon Finance’s RBN token, which currently has $1M in its liquidity pool. Now look at its market cap of $160M. This ratio is not ideal. Both CEX and DEX market making liquidity incentives results in the same outcome: inflationary token emissions for unsustainable liquidity.

A huge barrier to entry for DeFi is liquidity. A DeFi protocol often struggles to gain adoption outside of the DeFi bubble because of low AUM, which cannot be gained without ample liquidity in both governance tokens (for protocol participation) and lending/trading markets. Even for TradFi institutions to enter the DeFi space with size, the current market making landscape needs to expand multiples larger. For trustless and decentralized solutions to succeed, they first need to become competitive with centralized market making solutions.

Despite the large expense, market making is an essential service for protocols. Through hiring market makers, a protocol stands to gain higher liquidity, higher trading volume, lower probability of price manipulation, less volatility, CEX listings, and ultimately higher interest in its native token. Potential issues arise in market making engagements due to misaligned incentives and a lack of transparency. How does a protocol monitor that a market maker is actually performing in the best interest of both parties, and further how does a protocol monitor the actual performance of market making activities?

Hello Elixir

While market making is a critical component of crypto markets, the issue remains that only centralized market makers stand to gain from this market for now. Elixir is building a product that seeks to challenge the status-quo via a decentralized protocol that aligns incentives for all participants, while opening the market to anybody with a basic understanding of DeFi. Further, enhanced transparency is essential for the post-FTX era of crypto. Too often have we seen centralized entities perform shady actions with tokens that blatantly go against what they claim they are doing.

Elixir aims to be a simplified venue where retail participants can deploy liquidity across both DEXs and CEXs. By permissionlessly sourcing liquidity from anyone and utilizing its own algorithms, Elixir provides more affordable market making services for protocols while distributing tokens to more strategically aligned market makers. Profits from market making activities are free to be distributed to all ELXR holders if governance participants vote accordingly. A major benefit of Elixir’s entrance to the market making space is the potential reduction of centralized entity monopolization seen today.

Elixir V1

For the first iteration of Elixir, protocols will be able to “buy liquidity” via customizable token bonds. Users will deposit a 50/50 weighting of the token XYZ and a stablecoin, then swap the LP receipt token for a 100% position in token XYZ with an additional premium to be determined by the protocol. This enables the protocol to own its liquidity instead of renting it.

Elixir will also enable protocols to offer liquidity mining campaigns for CEX trading pairs. Users will be able to connect to Elixir’s website and exchange accounts via an API connection to view different liquidity mining programs and deposit/withdraw funds on demand.

After a user deposits liquidity, Elixir can utilize it in both CEX and DEX algorithmic market making strategies. Elixir has access to institutional market making accounts on CEXs and allows protocols to access near zero fees. Elixir can also integrate with DeFi CLOBs and concentrated liquidity AMMs. While concentrated liquidity AMMs offer great flexibility and granularity for liquidity providers, it can be difficult for the average trader to optimize positions. Elixir will automatically manage deposited liquidity on concentrated liquidity AMMs to maximize returns and capital efficiency for both traders and liquidity providers.

Elixir V1 will enable protocols to access market making services for substantially lower costs than traditional market making firms. Elixir can also significantly simplify the market making process for liquidity providers, align token holder incentives, and distribute revenue to multiple stakeholders. While the benefits and PMF exist, the tech stack to power such a feat must be strong.

The Elixir Recipe

Elixir utilizes a hybrid tech stack of on-chain and off-chain infrastructure to run its network.

Elixir’s on-chain infrastructure consists of auditor nodes, Provable.xyz, and a controller smart contract. The off-chain infrastructure relies on Intel SGX and operates very similarly to Arbitrum’s security model.

The data aggregator, an integral part of the system, connects to exchanges and oracles to get real-time data on trades, positions, and order books to keep the network in sync with CEXs. This data is synchronized with validator orders for market making processes. Elixir introduces randomness to its market making strategies to circumvent toxic flow and attempts of third parties to game the system.

Validators require two-thirds consensus, which is enforced at the relay node level. ELXR holders can delegate to validators and receive a share of ELXR rewards. Validators propose orders with deposited liquidity and send them to Relay nodes. Relay nodes hold trading keys for exchanges and count validators’ order proposals before relaying them to an auditor node to confirm correctness. An auditor node monitors orderflow and Elixir’s aggregated data feed before relaying transactions to the controller.

Elixir utilizes a controller smart contract to manage staking, slashing, bonds, and disputes. Upon receipt of a valid proposed order, the controller calls on Provable.xyz to execute and publish the transaction. Provable.xyz is an on-chain infrastructure provider that enables clear audit trails and attestation for data validation. Overall the actions of the auditor nodes, controller, and Provable.xyz maintain verifiable execution of market making activities and enable the Elixir system to function.

ELXR

Elixir relies on its native ELXR governance token to create a functional system. All validators and nodes must stake ELXR to maintain infrastructure, which aligns incentives and secures the network. With an economic stake in the network, infrastructure providers have it in their best interest to be honest. To create a permissionless and decentralized economy, ELXR holders will govern the protocol, which can include parameter modifications, incentive alignment, fee directing, etc. Elixir’s initial value capture model discusses a “buy-and-make” model, where earned fees would be directed to ELXR’s trading pairs and used to market make the pairs. This would create a liquidity flywheel and continuous buy pressure. One exciting aspect of Elixir is that its actual customers could participate in the Elixir system to own a stake in the market making infrastructure that they are actually using.

Final Thoughts

Elixir has the potential to be a major disruptive force in the crypto industry. By aligning incentives among stakeholders and offering more affordable market making options, the protocol could break up the currently centralized market making structure seen across crypto protocols today. This could lead to more sustainable liquidity practices for tokens, as well as a wealth effect for all ELXR holders. Elixir testnet is currently live, and anybody can navigate to the docs and attempt to run a validator.

While the intricate system design shows great promise, latency and security will be crucial to the success of the protocol. Exchange feed and oracle data infrastructure downtime could render the system useless, so continual iteration on failsafe practices will be paramount to Elixir’s success. Further, throughput and latency must be lightning fast to keep up with orders both on-chain and off-chain. This is a major concern, and current blockchain infrastructure may not be robust enough to support necessary speed.

Elixir’s modified Avellaneda & Stoikov algorithm for liquidity deployment has been sufficiently back tested and proven functional, but the introduced randomness to prevent gamification will very much be something tested in production. However, after thorough audits and endless testing and refinement, Elixir stands to flip the market making industry on its head while distributing incentives to ELXR holders and ironing out critical bottlenecks in the entire crypto economy.

Elixir: A Decentralized Liquidity Engine

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