Trader Joe, the largest decentralized exchange (DEX) on the Avalanche network with 191M in total value locked (TVL), has launched its v2 iteration today.
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 risks for liquidity providers.
“Concentrated liquidity allows liquidity providers to capture more fees with significantly less liquidity,” Trader Joe told The Defiant. “Instead of having one pool with 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 $88B of trades since launching its v1 iteration in July 2021, also generating $265M in revenue for liquidity providers and tokenholders. However, Trader Joe notes that its v1 design is hindered by capital inefficiency and divergent loss (also known as impermanent loss) risks for liquidity providers.
Market leader Uniswap popularized the automated market maker DEX model, with its v2 platform becoming the first decentralized exchange to attract ten figures of liquidity amid the heady days of 2020’s DeFi summer. Simple AMMs allow users to trade against passive asset pools comprising two assets that are supplied by liquidity providers, with LPs earning fees from every trade.
But Uniswap faced increasing competition from rivals taking advantage of the protocol’s General Use License to leverage the same AMM design throughout 2020 and early 2021. SushiSwap notoriously gained significant market share by offering token incentives to users that migrated their assets over from Uniswap in late 2020, while a plethora of AMMs launched on low-cost Layer 1s providing cheaper transaction fees compared to the Ethereum mainnet.
Uniswap responded by launching its v3 iteration in May 2021. The platform offers improved capital efficiency compared to AMMs using concentrated liquidity — meaning that liquidity providers could target specific price ranges in which their assets would be mobilized for trades, opening up new possibilities for advanced LP strategies.
The strategy appears to have paid dividends for Uniswap, with its v3 platform representing more than $1B worth of trades in 24 hours, or 44% of all DEX trading volume, according to CoinGecko. Curve ranks second with an 8.4% market share, followed by Dodo with 6.3%, and PancakeSwap with 6.2%.
While Trader Joe currently ranks 22nd with $16.4M or just 0.7% of the sector’s total, its team believes that the launch of Joe v2 could significantly boost the protocol’s position.
The Liquidity Book design of Joe v2 separates liquidity pools into “price bins.” While a traditional AMM lumps all assets provided for a specific token pair into a single pool, Trader Joe aggregates distinct pools of bins containing pairs that are segregated by price into a larger market.
Trader Joe claims the design minimizes the slippage experienced by traders, meaning they will receive better prices when trading, and also enables advanced and novel strategies for liquidity providers. Trader Joe describes its 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 comprising two separate assets, only the bin corresponding to the current market price comprises both assets in a pairing on Joe v2.
A single asset is provided to bins above the current price, with the second asset provided to bins below the market. Once a particular bin is depleted — meaning that all of one asset has been removed from the pool by traders and only a single asset remains in the bin — the exchange will shift trading to the next bin, also adjusting the asset’s price in the process.
“Concentrated liquidity already offers vast improvements over the traditional AMM model by being very capital efficient,” Trader Joe said. “Because users can choose at what prices they want to provide liquidity, there are much fewer tokens sitting idle and contributing nothing to swaps.”
Increased Impermanent Loss
However, the team told The Defiant that liquidity providers should ensure they understand the risks associated with employing concentrating liquidity-based strategies and potentially explore hedging using other products such as derivatives.
“There is added divergence risk (a.k.a impermanent loss) if the positions are not well managed to stay in 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 Joe v2 is not reliant on external oracles like Chainlink for its prices. The Trader Joe team told The Defiant that fair market value will be maintained by arbitrageurs who will step in to take advantage of price discrepancies between assets traded on Joe v2 and other exchanges.
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 earn higher fees during periods of increased volatility and lower fees when the markets are calm.
The volatility accumulator works by measuring how many bins a trade is executed across, and the time elapsed since a particular asset pairing was last swapped.
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 told The Defiant that variable fees will not reach the maximum threshold due to a limit on the upper bounds of its volatility accumulator.
Trader Joe said the variable fee feature is intended to mitigate the divergent loss suffered by liquidity providers during periods of significant price fluctuations. The team added that while retail users are unlikely to notice a significant change in the price of fees, whales and arbitrage bots “will have to pay their fair share.”
The team emphasized that liquidity positions are represented by fungible tokens that closely resemble the ERC-20 token standard, unlike the nonfungible LP tokens issued to Uniswap v3’s liquidity providers. This enables composability and product integrations with third-party projects.
Trader Joe also told The Defiant it plans to introduce limit order functionality for Joe v2 in the near future.
Transactions executed on Trader Joe will be routed between both the v1 and v2 platforms to provide traders with the best pricing available moving forward.
Trader Joe is not the only DEX to throw its hat into the concentrated liquidity ring, with Orca offering its own solution on Solana in March, and QuickSwap teaming up with Algebra on Polygon last month.
Trader Joe is currently the 15th-ranked DEX by total value locked with $190.7M, according to DeFi Llama. Its JOE token is currently trading at $0.27 with a $86M market cap.