Utility is the Mother of Liquidity

Good Afternoon Masterminds,

Recently a member of the MSC Reddit community (yandi23) asked me to address this question: “When can you make a post on the liquidity of Mastercoin?”

Thanks for the question yandi23. I’ve been working up plans on how the community can build up the liquidity of MSC and so your question is well timed and I work to address it in detail below in this post.

Utility is what gives a token organic demand, which in turn drives increased value and liquidity in a market. The first feature creating direct utility for the MSC token is the Meta Decentralized Exchange (Meta DEx). As more tokens are listed on the Master Protocol and MSC is required for the common trading pair on the Meta DEx, organic demand for MSC will build and the market cap and liquidity will be a reflection of the level of this organic demand. Here is the link to the OmniWallet feedback Google Doc if you want to add your suggestions or report bugs to enhance the utility of the DEx and soon the Meta DEx. https://docs.google.com/document/d/1LgDz4Z_kb_WIRE9kpv-iGivgBHT2JiekemhzZcET9d8/edit?usp=sharing

Happy testing : )

Context and History:
Lets start by examining the past. In the beginning, at the founding of the Bitcoin network, the bitcoin tokens had virtually no utility and thus no demand for the use of its token and as it logically follows, no liquidity in the market.

As more users acquired bitcoins and began trading them among themselves, eventually offering to purchase goods and services with their bitcoins, the utility of the bitcoin token began to materialize as a payment network. It took several years before the utility of bitcoin grew enough for a meaningful market price for the tokens to emerge and even then the small market cap and liquidity of the Bitcoin network really limited the use of the bitcoin token to fairly small purchases of real world or digital goods.

As user growth continued an organic process of building the market cap and liquidity of bitcoin emerged and resulted in many exchanges actively listing it for trade, many professional traders coming into the market, a large ecosystem of merchants accepting it, and users holding bitcoin over the long term as a store of value.

The Path for MSC:
In many ways the Master Protocol has been on a similar journey the past year. Since the crowdsale last August the MSC community has been working to build the reference client (MasterCore) and users have begun issuing tokens on the platform as of April 22nd 2014 (MaidSafe, API Network, soon Merchant Coin, Real Coin and many others).

Since the launch of the Decentralized Exchange (DEx) feature, users have been able to trade MSC and BTC with zero third party exchange risk and extremely low fees based on bitcoin dust level transactions.

The next step is to extend the Meta DEx feature to support all user issued tokens on the MSC protocol to trade against MSC as a common trading pair. Finally the world will be free of any future “Gox” type event because this feature will permanently remove third parties from the trading equation and bring a full P2P architecture into reality.

The launch of the Meta Dex is the first time that anyone has an organic reason to purchase MSC (to use as the common trading pair) and thus the first direct utility the token has provided in the system. Before that time users held MSC because they believed that the MSC system would develop utility as some point in the future.

It was expected at first that every feature of the protocol (for example the creation of tokens) would require some amount of MSC, however it was decided in May 2014 that in order to avoid creating unneeded friction in the system, only those features requiring MSC for solid technical reasons would require their use. The Meta DEx is the first of the features that meets this standard.

The Math About The Importance of Liquidity:
So the reason that liquidity is key for the Meta DEx is that while the fees are limited to the dust level transactions required to run the system, if the “spread” between buys and sells are greater on the Meta DEx than a centralized exchange, then that adds a cost to the user of the Meta DEx. As liquidity increases the “spread” becomes more narrow and it becomes more efficient for the user. In our case the key to liquidity is the depth of offers on the order book.

Lets use some math to give an example. User Bob wants to purchase 1 BTC worth of XAP on the Meta DEx. First he has to grab some MSC on the DEx to buy the XAP with (since MSC is the common trading pair). If there are 10 BTC worth of MSC on the order book and the sell offers are evenly spread up the price curve, then by purchasing 1 BTC worth of MSC, Bob will have moved the price of MSC by 10%. This is a substantial move and has in essence cost Bob an extra 10% on the price of his trade.

If the order book has 100 BTC worth of MSC sell offers, then Bob’s purchase would only move the market price 1%.
If the order book has 1,000 BTC worth of MSC sell offers, then Bob’s purchase would only move the market price 0.1%

So with an order book 1,000 BTC deep, a user can easily make trades in the 1 to 10 BTC range and move the market less than 1%. Thus at this order book depth the Meta DEx becomes competitive with a centralized exchange on direct and indirect costs of conducting a trade.

At the time of writing (2014/09/11) the depth of the BTC / MSC order book on the DEx is 163 BTC between the 200 to 46 mBTC price ranges. This is an important number to watch and will need to increase toward the 1,000 BTC range for traders doing exchanges larger than 1 BTC to be attracted to using the DEx and Meta DEx.


Action Items To Improve Liquidity / Order Book Depth: 
1. Educate traders and market makers on how to use the Omni Wallet Decentralized Exchange.

2. Build the API and RPC calls for MasterCore / OmniWallet according to the best practices of established exchanges for pro users to access.

3. Make the Omni Wallet API pull-able for third parties, such as Coinmarketcap.com to list all volume and price on the decentralized exchange.

4. Community testing of the OmniWallet interface and reporting suggestions to the OmniWallet team to improve the trading experience is key. Here is the link to the Google Doc for feedback: https://docs.google.com/document/d/1LgDz4Z_kb_WIRE9kpv-iGivgBHT2JiekemhzZcET9d8/edit?usp=sharing

I believe we can address these fundamental drivers of order book depth and liquidity in the coming weeks and months. This is a major priority for me as the Chairman of the Foundation and generally for the DEx and Meta DEx features of the OmniWallet and MasterCore to be successful in the market.

I’ve been spending a lot of hours testing the OmniWallet and DEx features the past few weeks.

I hope you will join me in this testing and most importantly report your feedback to the devs via the Google Doc.

Best Regards,

David A. Johnston
Chairman of the Board MSC Foundation

David (at) Mastercoin.org

Utility is the Mother of Liquidity

One thought on “Utility is the Mother of Liquidity

Comments are closed.