A new report from decentralized exchange aggregator 1inch has shown a growing crisis in decentralized finance (DeFi): the vast majority of capital deployed in large DeFi liquidity pools is not being used effectively.
According to data presented at Devconnect Buenos Aires, between 83% and 95% of liquidity in top pools, including Uniswap v2, v3 and v4, as well as Curve, remain inactive for most of the year. This means billions of dollars are sitting in smart contracts without earning fees or generating meaningful returns.
In Uniswap v2 alone, only 0.5% of liquidity typically falls within active trading price ranges, making nearly $1.8 billion ineffective, according to the report.
This inefficiency hits retail participants the hardest. Research cited in the report shows that 50% of liquidity providers (LPs) lose money when permanent losses are taken into account, with net liquidity provider losses exceeding $60 million. In one notable example, a single Uniswap v3 pool saw over $30 million in lost profits due to Just-in-Time liquidity manipulation.
Part of the problem stems from the large number of fragmented pools, with more than seven million across the ecosystem. This complexity not only dilutes liquidity, but also makes it more difficult to route trades efficiently, further reducing returns for liquidity providers.
‘New approach’
For 1inch, the solution is its Aqua protocol, which is designed to let DeFi applications share the same capital base across multiple strategies without compromising user custody.
“We solve 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 just keep assets in the wallet and we allow people 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 looking to tap into this deep liquidity. “Any existing DEX right now can be implemented under 10 lines of code,” Kunz added, noting that the goal is to create “a foundation to build on top of” so that liquidity providers can “keep assets in the wallet” instead of locking them up in complex protocol contracts.
