Thread by @Samichpunch

1: A quick thread🧵on decentralized exchanges, AMMs and impermanent loss, and explaining a gross misunderstanding among beginners in #DeFi about liquidity pools and AMMs:

"I'll yield farm with a stable coin pairing, that way at least half of my money is safe."

2: Decentralized exchanges ("DEX") use what is called an "automated market maker" rather than an order book to complete your order when you submit swap on a DEX. An order book is what you see on centralized exchanges like Binance, Kucoin, etc, where you can see all the orders.

3: On a centralized exchange, an over simplified explanation of when sales is that they occur when buy/sale limit orders overlap or when someone buys/sells using a "market order".

4: A centralized exchange market order just means "give me whatever the next buy or sell limit order is, as applicable". This is how you can get some crazy candle wicks when there is a bank run on market orders and someone has some crazy low buy limit order.

5: Back to DEX's and AMMs, unlike a CEX that has an order book, there is a constant pool of the tokens used for swaps (both buys and sells) and there are no limit orders (without some additional protocol).

6: When you click swap on the DEX, you put in one token of the pairing and you take out one token of the pairing, and then the AMM (which is really just an algorithm) adjusts the price accordingly.

Several things impact how much the price moves, but the largest being (1) the size of your swap and (2) how much liquidity is in the pool.

7: Many argue that this is how the term "rug pull" originated in DeFi, because the protocol owners "pull" the liquidity out, making it impossible to swap or leaving such small liquidity left that your tokens become worthless with one small swap.

8: Back to the misconception of pairing with stable coins. So if you pair with a stable coin you are safe right? At least half of your money will always be safe? Wrong. This is because of how an AMM works.

9. You can use any impermanent loss calculator and try it out, but here are your general rules of thumb. If Token A price goes down, and Token B stays constant from the time you paired them, when you unpair, you will get more token A and less token B than you started with.

10: Here's a numerical example that probably hits home for some. You paired Luna (classic) with USDC. Luna nukes and now your stable coin is gone too. Here's a screenshot of an IL calculator:

In this case - even your stables are 99.99% gone, even though its price remain stable.

11: Sure, its not a loss until you unpair, but lets be real folks, some of you are pairing your stables with some highly speculative tokens, and you need to realize your stables are not safe. Yes, high risk=high reward, but we're in a risk off environment so stay safe my friends.