Trader Joe Presents Liquidity Book: A New AMM Design for DeFi | by Avalanche | avalanche

New features such as fungible liquidity buckets and surge pricing aim to maximize AMM efficiency and minimize slippage.

Trader Joe, a Decentralized Exchange (DEX) on Avalanche, has introduced Liquidity Book, a new design for its Automated Market Maker (AMM) with the aim of improving capital efficiency, reducing slippage and minimizing the impact of fickle losses.

The current trading algorithm of DEX is based on the popular x*y=k Automated Market Maker (AMM) formula. Since its launch in July 2021, the exchange has enabled more than $88 billion in daily trading volume for thousands of active users, according to Trader Joe.

While this standard AMM model has been successful for Trader Joe, his team has identified inefficiencies that could be improved with a new model without sacrificing the simple user experience it has become known for.

Let’s dive into Trader Joe’s development with Liquidity Book:

Liquidity should become more efficient, flexible and combinable with Liquidity Book

One difference from the liquidity book is how liquidity is stacked into liquidity pools. Liquidity Providers (LPs) deposit liquidity in discrete price tiers, each tier is assigned a specific price, and liquidity providers can provide liquidity to multiple tiers. A key change is that all liquidity deposited in bins will receive fungible token receipts. By adding non-fungible token revenue with liquidity, its architecture differs from existing concentrated liquidity solutions.

LPs using Liquidity Book can earn more fees while putting less capital at risk. Traders also benefit indirectly from efficiencies by getting better prices and less slippage on their trades. With traditional x*y=k AMMs, the deposited liquidity is spread evenly across all price ranges – from zero to infinity. While this means that the liquidity pool always has tokens to buy and sell, it also means that a large part of the liquidity remains unused.

Liquidity Book tries to solve this problem by allowing users to choose what prices they want to provide liquidity at. The Liquidity Book offers more flexibility by allowing liquidity providers to select any number of bins. Much less liquidity sits idle and efficiencies can be scaled up to 20,000x higher.

LPs providing liquidity receive fungible token receipts thanks to the discrete bin architecture. Fungible token receipts are more composable, opening up new opportunities for DeFi integrations with other protocols and products. The more combinable the design, the bigger DeFi can become.

Surge pricing compensates liquidity providers to mitigate temporary losses

Existing AMMs typically have a flat fee for all trades. Liquidity Book introduces a fee structure consisting of two components, a base fee and a variable fee. The base fee represents the minimum fee rate for all trades and the variable fee is adjusted to account for volatility. The more volatile the assets in a liquidity pool, the higher the variable fee. Trader Joe calls this feature Surge Pricing.

The provision of liquidity on concentrated liquidity exchanges may involve the risk of temporary loss occurring when the prices of assets in the pool deviate from their initial prices. The temporary loss can be viewed as a cost of pricing, so it’s highest during the most volatile times when the market is trying to price the pair’s assets correctly. Surge pricing is a feature applied to trades during market volatility and this feature generates additional fees from trades that are used to compensate LPs for the temporary loss they suffer during market volatility.

Surge pricing is possible due to the novel mechanism called The Volatility Accumulator (VA). The VA is able to calculate instantaneous volatility for each liquidity pool without having to rely on external oracles by tracking transactions across bins. The count from the volatility accumulator determines the variable fee charged by the surge pricing feature for trades executed in the liquidity book.

Discretized bins make zero slippage swaps possible

The Liquidity Book combines bins into one structure and aggregates the liquidity from all of them to form a liquidity pool. Individually, bins act as constant sum pools with their own cash reserves, unlike existing AMM designs that use a constant product formula. This model uses pool reserves to calculate prices, often resulting in traders paying more for fewer tokens.

In the liquidity book, the price is derived from an active bin and is constant within it. Consequently, when the trade is made using reserves from the bin used for a transaction, the trade is executed without slippage.

The price impact occurs when a trade requires a bin change, which happens when the reserves in the currently active bin are insufficient to fill the trade. This feature is particularly beneficial for swaps between stablecoins and other tied assets, as their prices are expected to be the same most of the time.

The AMM model has seen fantastic developments to date, but there are still some notable drawbacks and areas that require solutions and improvements. Liquidity Book strives to provide traders with more efficient trades and liquidity providers with improved efficiency, mitigating volatile losses and maximizing their liquidity’s composability.

Liquidity Book’s new design hopes to enable active liquidity provision without compromising the needs of key stakeholders. This is an exciting step forward for Avalanche DeFi that will unleash a new wave of composable on-chain deployments.

Sources:

https://joecontent.substack.com/p/introducing-liquidity-book

Click to access Joe%20v2%20Liquidity%20Book%20Whitepaper.pdf

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