The Role of Liquidity in Building More Predictable DeFi Markets
According to the efficient market hypothesis (EMH), asset prices reflect all available information. A direct implication of the EMH is that consistently beating the market is difficult. For example, stock prices rapidly incorporate data from earnings announcements, making it challenging to profit by trading on these events.
The idea of financial market returns being hard to predict is associated with Eugene Fama, the 2013 Nobel Prize winner in economics. Assuming the hypothesis is valid, of which there is proof, DeFi markets would be even harder to predict than their CeFi counterparts. They are younger, more volatile, and lack some of the regulations and mechanisms needed to help ensure stability. Efforts should be focused on improving DeFi market efficiency, as more efficient markets are also more predictable and stable.
The future of DeFi is modular and composable
As BNB Chains trading and business development hub, THENA is contributing to such efforts. It has released its V3,3 upgrade, which brings advanced liquidity, a modular architecture, and a reengineered governance model. According to THENA CEO and co-founder Theseus, the upgrade focuses on the steps that DeFi needs to take: composable, modular, and centered on capital efficiency. It sets the foundation for programmable liquidity by integrating Pluginscomposable smart contract modules that enable liquidity pools to operate dynamically. The modular approach does away with the need to redeploy pools, unlocking adaptability in AMM design on a new level.
THENA V3,3 pools will be available with a built-in Plugin suite, including a sliding fee scale, volatility-based fees, and an upcoming tool offering identity-based fee reductions. V3,3 also allows liquidity providers to provide manual liquidity within a custom price range. In exchange, they will receive an NFT representing that position. They can stake the NFT into a gauge to earn $THE tokens. This creates an efficient, performance-based reward system, putting manual and managed providers on equal footing.
Governance in V3,3 is automated and designed to be more accessible. Holders of veTHE can vote cross-chain without bridging. Chainlink Automation powers features such as auto-voting, auto-claiming rewards, and prolonging locks to minimize friction and encourage participation.
Higher returns, a competitive edge, and risk mitigation
Capital efficiency is a major factor driving the prosperity of the DeFi sector, ranking it among DeFi protocols key objectives. It maximizes returns by optimizing investments. Efficient protocols attract more liquidity and users and have an inherent advantage over competitors. Adequate liquidity with efficient use of capital will improve trading, reduce slippage, and attract interest to any DeFi platform.
DeFi organizations can also mitigate the risks associated with market fluctuations or potential protocol failures by spreading capital across platforms or assets. Such diversification protects user funds, limiting the impact of volatility or failure.
DeFi is moving in the direction of efficiency. In the past, users would have to choose between providing liquidity and lending or borrowing funds, or between lending platforms like Aave and AMM protocols like Uniswap. Now, hybrid solutions combine these approaches and enable optimized capital use. For instance, a user can deposit ether as collateral, borrow funds in stablecoins against the ether, and use them to provide liquidity. This gives them access to additional liquidity and allows them to earn trading fees at the same time.
The impact of transaction costs on market efficiency
Empirical studies have drawn attention to the impact of transaction costs on market efficiency. Evidence suggests that anomalies associated with market inefficiency are due to a cost-benefit analysis carried out by individuals willing to bear the cost of procuring valuable information in order to trade on it. Liquidity is crucial to detecting inadequacies in tests for abnormal returns. Any such test faces the following issue: testing for market efficiency requires a measure to compare abnormal returns, and if you dont know whether a given model accurately stipulates the required return rate, you dont know if the market is efficient. Either the market is inefficient or the asset pricing model is inaccurate, but you have no way of knowing which.
Arguments against the EMH
Famas Nobel Prize co-winner, economist Robert Shiller, argues that the EMH is a half-truth. He finds that capital markets can be efficient but also irrational, and they dont always reflect asset values accurately. Four key factors make public capital markets inefficient: lack of transparency, insider trading, irrational markets, and information speed. A market is irrational when there are differences in assumptions and asset pricing models. Investors can benefit or incur losses due to the speed at which they receive publicly available information.
If these factors are valid for CeFi, there is no reason they wouldnt apply to DeFi. The last factor has been overcome by networks of AI agents that react to the market and execute trades much faster than a human could. Agents are even capable of predicting the market.
Liquidity enhances market efficiency through arbitrage activity
Predictability of short-term returns diminishes with narrower bid-ask spreads. As the minimum tick size (the smallest possible price movement of a trading instrument) declines over time, so does predictability. According to variance ratio tests, prices are closer to random walk benchmarks, or reference models used to assess how well a forecasting model performs, in the more liquid decimal regime. This shows that liquidity stimulates arbitrage activity, which improves market efficiency.
THENAs V3,3 upgrade eliminates liquidity pool redeployment, enhancing market efficiency. It also overcomes issues like fragmentation and temporary drops in liquidity, loss of network effects and historical data, and other disadvantages of redeployment. Splitting liquidity across multiple pools or versions dilutes trading depth, leading to higher slippage for traders and a worse user experience. Fragmented TVL can also hurt the protocols reputation and perceived health.
During migration, liquidity may drop significantly, affecting both traders and provider rewards and potentially causing price volatility or arbitrage opportunities that hurt providers. The original pool may have organic volume, integrations, or aggregator routes, and redeploying it risks losing those routing optimizations until aggregators catch up. Redeploying can also cause on-chain analytics, historical volume, APR, and usage metrics to become scattered across pool versions. This makes it harder to track long-term performance and attract institutional liquidity.
While the degree to which markets are efficient and predictable remains a subject of dispute, one cannot claim that enhanced liquidity doesnt drive investor profit.
Disclaimer: This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.
Read more: https://cryptodaily.co.uk/2025/05/the-role-of-liquidity-in-building-more-predictable-defi-markets
Text source: Crypto Daily™
