Decentralized Exchanges - A Primer

Decentralized Exchanges - A Primer


Youtube is evil. Once you look at one crypto video and four other videos that match that criteria show up. You look at those videos and more crypto videos come up. Pretty soon your old video preferences of van life disappear and you are watching nothing but crypto! This crypto is going to the moon even if it has 6 zeros after the decimal point! The crypto market is about to explode! The crypto market is about to implode! It is enough to drive a person nuts. It also is how I found out about decentralized exchanges, so I do need to give credit where credit is due. Thank you, Youtube, for feeding me a few good nuggets of information in a sea of disinformation and scare tactics.

We covered my experience with Coinbase, a centralized exchange, last time. After being on Coinbase for a couple of weeks, a coworker told me about a hyped-up coin called Safemoon. It was getting a lot of coverage on the news and even put up an advertisement in Times Square. He said I should look into it and try to buy it. "Okay, this will be easy," I thought to myself. I was so wrong.

First things first, I went to Safemoon's website and clicked "Buy Now". That was easy, take my money and give me my crypto! Wait, there wasn't a place to enter my payment information! There were a series of instructions instead. First, it said I had to create a wallet and they recommended Trust Wallet. I downloaded Trust Wallet and created a wallet. Second I had to buy Binance Smart Chain (BSC). So I did that, first buying BNB and then converting it to BSC because I didn't know any better. Third I had to swap for Safemoon. Swap? What the hell is a swap? Okay, I knew I could buy and sell crypto. I could convert from one crypto to another. But swapping? I had no idea. The website mentioned a DApp called Pancakeswap. No mention of how to get there, but luckily at the time my iOS device allowed me to set up a browser in the Trust Wallet application, and in the browser was a favorite link to Pancakeswap. I was on my way!

At first glance, Pancakeswap was plain weird. There were menu items to trade, to farm, predict, a lottery. Trade sounded like what I wanted so I clicked in there. They had other options, Exchange and Liquidity. Coinbase is an exchange, so I clicked that. Back at the Safemoon website they gave instructions on how to get the Safemoon token to appear and how to set the slippage tolerance to 12%. Done and done, I put in $100 in BSC and swapped it for 24 million Safemoon. Wait, 24 million? Suddenly I realized I was a millionaire! At least in the app. 24 million Safemoon was worth $100 US, but saying that isn't as cool as saying you own 24 million of a cryptocurrency.

I had the Safemoon, I wanted to do something with the Safemoon, and I couldn't. Right now it has no utility. It is a meme coin like Dogecoin. You buy it to say you have it. People say awesome, say "What is that?", or say that you are a FOMO'r. Well, I bought more and have 100 million because why not. Cost me a little over $250 in total due to the price skyrocketing in the wrong direction and hey, if it goes from the 5 zeros after the decimal to 1 zero, you will be reading from a fiat millionaire. I won't hold my breath on that one.

Once I found my way into buying Safemoon I wanted to learn what all the other parts of Pancakeswap did. Well, Youtube must have read my mind (or my search engine results) because there were a bunch of videos after Pancakeswap. One of the first things I learned about was liquidity, you know, the other option I had in the Trade area. Liquidity is when an investor provides their assets to be used for transactions on Pancakeswap. For example, I wanted to buy Safemoon and I had BSC. The only reason I was able to buy Safemoon is that there was a liquidity pool with enough assets in it to allow the trade.

For liquidity, generally, you use pairs. A BSC-Safemoon pair probably existed. What that means is someone created a liquidity pair out of an equal share of BSC and Safemoon, and others added to it. When I say equal share, I mean equal. So, by today's market prices, 1 BSC is worth $338.02 and 1 Safemoon is worth $0.0000021278. So what that means is you need 0.0029584 BSC to equal a dollar and 469,968.9820471849 Safemoon to equal a dollar. Therefore if you have 1 BSC and you want to add to the BSC-Safemoon liquidity pool, you will need 158,858,915.3115894 Safemoon. If you happen to have both tokens, you can pair them and you will instantly be part of Pancakeswap's BSC-Safemoon liquidity pool.  What is so great about that?

Whenever you swap from one token to another on Pancakeswap you will pay fees. These fees are liquidity provider fees. According to Pancakeswap, the liquidity provider fee is .25%. What that means is if someone swaps BSC for Safemoon, the BSC-Safemoon liquidity pool providers get that .25% fee. That does not mean you alone, but the overall pool. When you create your liquidity pair, you are given your percentage of the pool. If for example, you have a 10% stake in the pool, every transaction will pay you 10% of the .25% fee. If you have 1%, you get 1% of the fee. It's not a lot, at least by the looks of things, because if someone spent 1 BSC to buy Safemoon, that means the fee is 0.0025 and if you are 1% of the pool you get 0.000025 BSC. With BSC being worth $338.02, you just earned $0.0084505 US. Not even close to a penny. So what makes this worth it to anyone? Well, if there are 1,000 transactions of 1 BSC paid to buy Safemoon, you now have made $8.4505. If you had 10% of the pool you would have $84.505. Now we are talking! It goes the same the other way. You earn .25% if someone buys BSC with Safemoon. 

The problem is if you paired today with 1 BSC and 158,858,915.3115894 Safemoon you will not get 10% of the pool. You will not get 1% of the pool. You will get less than 0.01% of the pool. That means your earnings for a 1 BSC transaction is $0.000084505 US. That means with 1,000 transactions you earned $0.084505 US or around 8 cents. If you let it sit all year, you will make around $30.844325 US. Nowadays you can get a hamburger, fries, and an extra-large Diet Coke at McDonald's for that. It looks small. Hell, it is small. That is why you start with your initial deposit in the pool and over time you add more liquidity. More liquidity means more of a share in the pool. A greater share in the pool means more profit. The investor with 10% of the pool makes $84.505 a day. Over a year that is $30,844.325. Now you can buy a new (not a Lambo) car every year with cash. You can pay for a lot of things with that much money. That is passive income. That is something a centralized exchange doesn't give you.

With a decentralized exchange, the investors are what make the exchange run. Without the liquidity pools, investors can't exchange their crypto. The pools are the power of the exchange. Two big values matter and are readily available to review with decentralized exchanges, the total value of liquidity (TVL) and volume in a 24 hour period. TVL is how much liquidity is stored in an exchange. Pancakeswap's TVL is $408,564,132 and their volume is $1,014,054,933. That is right, $408M in liquidity pairs allowing for a lot of opportunities for buying and selling crypto, and $1B in volume meaning that much value is running through the exchange in a 24 hour period. This is big money. That's $2.5M in liquidity fees paid out per day. This is money that Coinbase makes as a centralized exchange and keeps as profit. With a decentralized exchange, the investors keep the fee.

Back to the fee you are making. We call that passive income. The great thing about crypto is it isn't like the stock market. The exchanges don't close for anything. 24-hour trading. Income generated 24 hours a day, 7 days a week, 365 days a year. The income generated may seem small, but the totals go up over time. There are some negatives that go along with holding liquidity on a decentralized exchange and I will be going into them, but it truly can be said that by providing liquidity you are owning a part of a decentralized exchange. These exchanges have evolved from banks, taking the bad parts and throwing them away and taking the good parts and making them better.

Pancakeswap may have been the first decentralized exchange I entered, but it definitely wasn't the last. In the next article, I will be doing a deep dive into one exchange in particular. Spoiler, I am a fan so take what I say with a grain of salt, but I will get into the nuts and bolts of a true decentralized exchange where community and money come together with hopes of changing the landscape.

 

 Reference Links

Safemoon Website - https://safemoon.net/

Pancakeswap Website - https://pancakeswap.finance/

 

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Devo H
Devo H

Crypto Investor and not your financial advisor!


The Adventures of a Crypto Investor
The Adventures of a Crypto Investor

This blog is meant to describe my adventures in cryptocurrency. It is not meant to be financial advice. It is a way for me to educate others through my experiences. There will be personal stories along the way. I hope we can all become a little wiser along the way!

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