Liquidity Utilization

In an ideal world, a project would aim to use all of its liquidity to increase returns. However, this isn’t possible as it would mean there is no spare liquidity available for anything else. So there needs to be consideration of what proportion is allocated to liquidity and what proportion can be used to improve performance.

There is also another consideration: how much of your capital can be used, and how much of it remains idle. Let’s take a look at an example:

Let's assume that the markets, in combination with our strategies, can handle around 100 million in total position sizing, and on average, there is a daily liquidity demand of approximately 25%.

In this example, we would allocate 25 million as liquidity on demand on a daily basis, with the remaining 75 million being efficiently utilized within our position size threshold. This threshold is essential to minimize slippage during position exits.

If we increased our TVL to 200 million, we would still need to maintain 25% of assets as liquidity on demand (50 million), leaving us with 150 million in assets. However, only 100 million would be efficiently utilized on a daily basis, as the market is constrained at $100 million*. (this is an assumption for the purposes of explaining our thinking)

This would mean that a 100 million TVL would have approximately 75% utilization, while a 200 million TVL would have around 50% utilization. If the total TVL were to reach 1 billion, it would result in 250 million as liquidity with only 10% of assets being effectively utilized, rendering the majority of assets idle and inefficient.

We prefer maximum utilization where possible while remaining nimble enough to utilize smaller time-frames when it comes to investing.

In summary, there is a sweet spot to utilization. If our TVL becomes too big, it causes

  • Lower performance due to slippage.

  • Lower amount of strategies due to time exposure.

  • Lower utilization as we'd still need more liquidity on demand as time exposure increases.

In the next section, we dive more deeply into this idea.

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