Joe V2 introduces concentrated liquidity
Trader Joe, the largest Decentralized Exchange (DEX) on the Avalanche network with 191M Total Value Locked (TVL), today launched its v2 iteration.
The Joe v2 protocol introduces a “Liquidity Book” design to improve capital efficiency through concentrated liquidity and a variable fee that adjusts in response to market volatility to offset risk for liquidity providers.
“Concentrated liquidity allows liquidity providers to earn more fees with significantly less liquidity,” Trader Joe told The Defiant. “Rather than having a pool of unbound price ranges, Liquidity Book has multiple separate bins with different prices that can be used as building blocks for a liquidity position.”
Trader Joe has facilitated more than $88 billion in transactions since launching its v1 iteration in July 2021 and has also generated $265 million in revenue for liquidity providers and token holders. However, Trader Joe notes that his v1 design is hampered by capital inefficiency and divergent risk of loss (aka fickle loss) for liquidity providers.
AMM model
Market leader Uniswap popularized the automated market-maker DEX model, with its v2 platform being the first decentralized exchange to attract ten-figure liquidity in the heady days of DeFi summer 2020. Simple AMMs allow users to trade against passive asset pools consisting of two assets provided by liquidity providers, with LPs earning fees on each trade.
But Uniswap faced increasing competition from competitors using the protocol’s general use license to leverage the same AMM design throughout 2020 and early 2021. while a variety of AMMs have been launched on low-cost Layer 1s and offer cheaper transaction fees compared to the Ethereum mainnet.
Concentrated liquidity
Uniswap responded by launching its v3 iteration in May 2021. The platform offers improved capital efficiency compared to AMMs using concentrated liquidity – meaning liquidity providers could target specific price ranges where their assets would be mobilized for trading, which opens up new possibilities for advanced LP strategies.
The strategy appears to have paid off for Uniswap, as its v3 platform accounts for more than $1 billion in trades in 24 hours, or 44% of total DEX trading volume, according to CoinGecko. Curve ranks second with an 8.4% market share, followed by Dodo at 6.3% and PancakeSwap at 6.2%.
While Trader Joe is currently ranked 22nd with $16.4M, or just 0.7% of the sector’s total value, his team believes the launch of Joe v2 could significantly strengthen the protocol’s position.
liquidity book
Joe v2’s liquidity book design separates liquidity pools into “price brackets”. While a traditional AMM aggregates all assets provided for a given token pair into a single pool, Trader Joe aggregates various pools of bins containing pairs separated by price into a larger market.
Trader Joe claims that the design minimizes the slippage that traders experience, meaning they get better prices when trading, and also allows for advanced and novel strategies for liquidity providers. Trader Joe describes his price bins as providing a “discretized concentrated liquidity” mechanism, invoking a term introduced by Izumi Finance’s iZiSwap AMM design.
While most AMMs host liquidity pools consisting of two separate assets, only the bucket that corresponds to the current market price includes both assets in a pairing on Joe v2.
A single asset is provided for bins above the current price, while the second asset is provided for bins below the market price. Once a particular bucket is depleted – meaning that an asset has been completely removed from the pool by traders and only a single asset remains in the bucket – the exchange will move trading to the next bucket, also adjusting the asset’s price in the process.
“Concentrated Liquidity already offers huge improvements over the traditional AMM model as it is very capital efficient,” said Trader Joe. “Because users can choose what prices they want to provide liquidity at, there are far fewer tokens lying around unused contributing nothing to swaps.”
Increased temporary loss
However, the team told The Defiant that liquidity providers should ensure they understand the risks involved in using concentrated liquidity-based strategies and may consider hedging with other products such as derivatives.
“There is additional risk of divergence (aka temporary loss) if positions are not managed well to stay within the market range,” the team said. “For less-savvy users, we also plan to offer an automated vault that will help users manage their liquidity positions automatically.”
The Liquidity Book design means that Joe v2 does not rely on external oracles like Chainlink for its pricing. The Trader Joe team told The Defiant that fair market value will be maintained by arbitrageurs who will intervene to exploit price differentials between assets traded on Joe v2 and other exchanges.
volatility accumulator
Joe v2 also introduces an internal “volatility accumulator” mechanism designed to measure market volatility and inform the platform’s variable fee without using external data feeds.
Liquidity providers deserve higher fees during periods of heightened volatility and lower fees when markets are calm.
The volatility accumulator measures how many bins a trade is executed over and the time that has elapsed since a given asset pair was last exchanged.
Variable Fees
Swap fees are split between a base fee and a variable fee, with variable fees theoretically capped at a maximum of 10%. However, Trader Joe informed The Defiant that the variable fees will not reach the maximum threshold due to a cap on the volatility accumulator.
Trader Joe said the variable fee feature is designed to mitigate the divergent losses liquidity providers experience during periods of significant price volatility. The team added that while retail users are unlikely to notice a significant change in the fee price, whales and arbitrage bots “will have to pay their fair share.”
The team emphasized that liquidity positions will be represented by fungible tokens, which are very similar to the ERC-20 token standard, in contrast to the non-fungible LP tokens issued to Uniswap v3 liquidity providers. This enables composability and product integrations with third-party projects.
limit orders
Trader Joe also informed The Defiant that he plans to introduce limit order functionality to Joe v2 in the near future.
Transactions executed on Trader Joe are routed between both the v1 and v2 platforms to provide traders with the best available prices going forward.
Trader Joe isn’t the only DEX tossing his hat in the concentrated liquidity ring, with Orca offering its own solution on Solana in March and QuickSwap partnering with Algebra on Polygon last month.
Trader Joe is currently the 15th DEX by total value locked at $190.7M according to DeFi Llama. Its JOE token is currently trading at $0.27 with a market cap of $86 million.
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