Protocol Resilience in AMMs: How Small Trades Can Trigger Liquidity Crises

Automated Market Makers (AMMs) have revolutionized decentralized finance (DeFi) by enabling trustless, permissionless trading. However, their mathematical underpinnings and reliance on liquidity pools expose them to unique risks. A single small trade-or a sequence of seemingly inconsequential transactions-can destabilize an AMM, triggering cascading liquidity crises. The November 2025 collapse of Stream Finance's xUSD stablecoin offers a stark case study of how protocol fragility, opaque fund management, and interconnected DeFi systems can amplify minor disruptions into systemic failures.

The Mechanics of AMMs and the Illusion of Liquidity

AMMs operate on mathematical formulas, such as the constant product model (x*y=k), to price assets dynamically. While this eliminates the need for order books, it introduces a critical vulnerability: liquidity is not infinite. When trades occur, reserves shift along the AMM curve, causing slippage. In low-liquidity pools, even modest trades can distort prices dramatically. For example, a $10,000 trade in a $1 million pool may cause a 1% price shift, but the same trade in a $100,000 pool could trigger a 10% swing, according to a ScienceDirect paper. This non-linear relationship between trade size and price impact is often underestimated, especially in protocols prioritizing yield over stability.

The Stream Finance Case Study: A $93M Loss and xUSD's Depeg

In November 2025, Stream Finance-a yield-focused DeFi protocol-experienced a catastrophic liquidity crisis. An external fund manager overseeing its assets disclosed a $93 million loss, prompting the platform to suspend all deposits and withdrawals, according to a Coinotag report. This revelation triggered an immediate depeg of its stablecoin, xUSD, which plummeted from $1 to as low as $0.26 within 24 hours, as reported by Invezz. The collapse was not due to a smart contract exploit but rather mismanagement of off-chain assets, exposing vulnerabilities in hybrid CeDeFi models that blend decentralized protocols with opaque third-party fund managers, as detailed in a FinanceFeeds article.

The depegging was exacerbated by recursive looping strategies-where assets are repeatedly redeployed to maximize returns-without adequate transparency or collateral monitoring. As xUSD's value eroded, users rushed to withdraw funds, further draining liquidity. By the time Stream Finance froze operations, its Total Value Locked (TVL) had already fallen from $204 million to $98 million, reflecting pre-existing leverage risks, according to a Coinotag report.

Systemic Risks and Interconnectedness

The Stream Finance crisis rippled across DeFi. Elixir Network, which held 65% of its reserves in Stream Finance assets, suspended support for its deUSD stablecoin, which collapsed to $0.177, as reported by a Yahoo Finance article. Morpho and Euler faced similar risks due to $285 million in interconnected debt exposures, as noted in a Coinfomania article. This highlights a critical flaw in DeFi's ecosystem: protocols often assume siloed risk, yet their financial instruments are deeply intertwined. A single point of failure-like an undercapitalized fund manager-can trigger a domino effect.

Lessons for Protocol Resilience

The Stream Finance incident underscores three key lessons for AMM resilience:
1. Transparency Over Yield Chasing: Protocols must prioritize real-time risk dashboards and on-chain collateral monitoring. Opaque fund management, as seen in Stream Finance, creates blind spots that bad actors or misjudged strategies can exploit, according to a CryptoSlate article.
2. Liquidity Depth and Pool Design: AMMs should avoid shallow pools for high-leverage assets. Deeper pools or dynamic fee structures can mitigate slippage during volatile periods.
3. Systemic Risk Mitigation: Interconnected protocols need stress tests and contingency plans. Projects like Sprinter are developing cross-chain liquidity tools to reduce single points of failure, as reported in a Yahoo Finance article.

Conclusion

The November 2025 crisis serves as a cautionary tale for DeFi. Small trades, when executed in fragile systems, can morph into existential threats. As AMMs evolve, resilience must become a core design principle-not an afterthought. Investors and developers alike must recognize that liquidity is not a static metric but a dynamic, fragile resource that demands constant vigilance.