DEX and AMM

have been of the most fascinating DE-FI invention. They are challenging factors to the conventional financial system. There are hundreds of DEXes where you can provide liquidity and earn passive interest in the liquidity or swap your tokens without depositing the tokens in the centralized exchanges.

Although they are one of the greatest invention and are challenging factors, there are some risks involved in the process. I have seen many people jumping for these crazy APY without understanding the concepts. So, this article will make them understand and be able to do research before investing.

1. CRAZY APY:

In itself, the CRAZY APY is not the problem and it won't put your assets at the risk but you have to understand that the CRAZY APY isn't stable things and the more users staked their tokens into the pool, the CRAZY APY won't remain crazy and will start to plummet. Moreover, the theory of SUPPLY AND DEMAND clear states that if the supply is increasing because of the CRAZY APY, the price of an asset will start to go in the negative direction. So, Don't jump directly for CRAZY APY only.

2. IMPERMANENT LOSS:

This is the concept used in the liquidity pools and at the beginning, I have also struggled to understand the concept of it. In a pool there are two tokens and you have to stake your tokens in the ratio of 50-50 and it will always remain 50-50 no matter what the price of an asset goes.

While the price is going in the upward direction of one asset among two in a pool, the token whose price is increasing gets converted to another token and balances the position.
While the price is decreasing of one asset among two in a pool, the token whose price is stable gets converted into the token whose price is decreasing and balances the position. The impermanent loss will affect your position significantly so you must be sure about the volatility of the pair you are looking for before jumping to provide your liquidity.

3. BUGS IN SMART CONTRACTS:

Smart Contracts are the basis of the AMM and DEXes. Smart Contracts aren't hackable and are really secured but if there are any bugs or glitches in the smart contracts codes there can be the chance of the failure of the whole platform in case there is an attack. There have been several cases of bugs and even audited projects have been hacked. That's why we must know that there is a chance of hacks for our fund to take that with the grain of salt.

4. RUG PULLS:

This is one of the most hyped terms in the DE-FI and billion $ worth of funds of investors has been faded within seconds because of this. There have been many projects whose creator has done rug pool and few have publicly mocked the investors who have invested in the platform. It happens when the creator of the platform creates hype around social media and lures people to provide liquidity into the platform. Eventually, He sells all of these tokens and drains the liquidity of the pool which makes the user's LP tokens illiquid because of no fund available in the pool.

5. COLLATERAL RISKS:

This one is a new risk and I haven't heard about it before the MARK CUBAN loss. This happens when there are tokens being created on the collateral of another token and when everyone wants to exchange their tokens to the collateral, the shortage of liquidity makes the users not able to do so. Recently, there has been the case in IRON FINANCE, where its tokens which were pegged crashes 100%. To be honest, the algorithm behind the pegging was really difficult and I don't understand the mathematics but it was clear that there was a shortage of collateral funds when everyone was trying to sell their tokens. Personally, I love DEXes and AMM and I have invested in a few of them and the passive income they offer is really awesome but I always prepare myself before investing in these platforms which you must do and understand the risks. If I have missed anything, Please correct me in the comments or you can raise your queries regarding any of the points mentioned above in the comments. @ridam

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