Liquidity pooling explained with Settlers of Catan

Glenn Stovall -

I've been studying Decentralized Finance(DeFi) for two months, playing board games since I was six. So here's Liquidity Pooling in  explained with Settlers of Catan:

"Wood for Sheep?"

Catan has a liquidity problem. Settlers had trouble bartering for what they needed. No one can build infrastructure. economic progress stagnantes.

First, Tokenized Resources

The different values of resources are a problem. Settlers create coins representing divisible resources. "1.6 WoodCoin for 1 BrickCoin." Trade increases.

Finding like buyers is another challenge. Two settlers have to have matching needs and wants.  Today, the only solution is to pay exorbitant conversion rates:  3:1 to traders or 4:1 to bankers.

Then, SettlerCoin Emerges

The settlers have another idea: an exchange market where settlers can trade any coin for any other. The exchange can take a small fee in exchange for convenience.

The settlers want to share in the exchange's ownership and have a common currency for fees and incentives. SettlerCoin ($SET) is created. pairs including $SET appear on the exchange.

For this to work, the exchange would need a pool of all coins that could fulfill trades. But on one settler is rich enough front enough resources. So instead, the exchange offers a cut of the fees collected in exchange for lending their resources.

Next, Liquidity Pooling

Now settlers can trade anything for anything without paying outrageous prices. In addition, Settlers can earn from resources while holding onto them. To keep the market balanced, the exchange asks for people to lend in pairs.

There's a pair where the market is short. They are having trouble meeting the demand of people who want to trade BrickCoin for SheepCoin.

The market decides to offer additional incentives for people to lend BrickCoin/SheepCoin pairs. To increase the liquidity of $SET, it may also incentivize pairs that include it.

In the old days, a settler who had excess grain and wanted ore, but couldn't find another settler, would have to lose wealth trading with merchants and banks.

Today?

The New Catan Financial System

that settler could go to the market and exchange his WoodCoin for SheepCoin, OR: that settler takes his WoodCoin, swaps some for $SET, and stakes a WoodCoin/$SET pair. The settler then buys Sheep with the $SET he earns.

The second step is more complicated, but all the settlers end up wealthier with no merchants or bankers taking massive cuts.

That is, until someone rolls a 7.

In The Real World

There are systems that exist like this in the cryptocurrency space. Sites like Alchemix and Tulip Garden allow you to loan pairs of coins, and receive rewards in return. It's not without risks, but if you are looking for a way to further leverage your cryptocurrency, it's worth investigating.