Dogey Inu: Theory of Low Liquidity, AMMs, and Volatility.
News from the DINU Coin Development team on November 21, 2021
Before you start, there are a few terms I would like to define because you’ve likely never needed to understand them before being in crypto.
Slippage — The % the price moves against you on a buy or sell.
AMM (Automated Market Makers) — This refers to an on-chain exchange such as Uniswap. If you are the first to add a token to an AMM, you determine its value by the ratio of other tokens you pair against it, forming a pool.
i.e., GIGA_TOKEN — ETH would be a pair. If I were the first to add liquidity to that pair, I would put 100 GIGA and 100 ETH in; this is now a “pool.” Let’s say you pay 10 ETH for GIGA; you would affect the value of GIGA because you’re trying to remove 10% of GIGA supply and adding 10 ETH. Your actual return would be closer to 9% of the GIGA in the pool (9 GIGA for your 10 ETH). The result of this transaction is that the price of 91 GIGA is now worth 110 ETH or 1 GIGA = 1.2 ETH.
Many new crypto users measure the “legitimacy” of tokens basing it on the idea that a larger liquidity pool means the reduced likelihood of losing their money/ETH. Nothing could be further from the truth; the thickness of the AMM liquidity pool will only determine one thing: Volatility. Whoever provided that liquidity could remove it if they wanted unless it’s locked in a different contract (like Unicrypt) or if they control a large majority of the supply to effectively remove the ETH by selling a massive portion of their tokens even with insane slippage.
Large liquidity pools, specifically with low-volume tokens, cripple the token’s ability to appreciate or depreciate. Suppose you have an infinitely large liquidity pool; the price cannot move in either direction. So the question stands, why have LOW liquidity then? Low liquidity enables volatility (that’s both appreciation and depreciation). Large holders can sell and do significant damage to the chart but, it is usually the impatient. They will perform market-sells, take a big slippage hit, and receive a considerable % LESS of the value than they held. This high % of slippage incentivizes limit-sells, sets the price, lets the price move into it, and then executes the order. High slippage will reduce the downside on a chart, especially if you consider the opposite: you may have many ETH and want to buy some Dogey Inu. If you purchase at the market price, you will move the price against yourself, paying a much higher premium. However, if you place a limit buy at the price you determined to enter, you will receive your tokens 1:1 current value without any slippage. Limit orders help prop the price up and distribute tokens to those less likely to sell or those looking to do the least harm to the chart.
As Dogey Inu grows into a more vibrant community and appreciates, these ratios change in favor of the “average value buyer.” Slippage becomes less of an issue for average market buys/sells. These factors are why the initial liquidity pool for $DINU was provided with the smallest amount of ETH possible for most tracking sites to display a price. Widen the distribution of tokens while increasing the locked value of the pool, and you’ve created the perfect environment for a decentralized community to thrive.