Erik Weijers, 7 months ago
Last week Trader Joe launched a new iteration of its trading platform, called Liquidity Book. Trader Joe is a decentralized exchange that is an example of Avalanche's (AVAX) thriving developer community. The new version proposes some interesting improvements for liquidity providers. Long story short, it will lead to higher fees and less risk of impermanent loss.
Trader Joe is a decentralized exchange (dex) running on Avalanche. It's a top 20 dex, only a year after its launch in July 2021. It has generated a trading volume of more than $88 billion. 0.3% of that sum has gone to users who have pooled their capital for others to trade. It can be a profitable business to be a user of such a protocol - if you know how to navigate the risks, mainly the risk of impermanent loss (see below). And the new version of the protocol helps user to manage this.
Trader Joe is one of the many dexes inspired by the success of Uniswap, the first widely successful liquidity pool-based dex. Liquidity Pools are automated market makers. The difference with a traditional exchange is that there are no order books with buy and sell orders at certain price points. Instead, liquidity pools determine the price of each coin by keeping the product of the price of the two coins constant:
Coin A x Coin B = constant
The users who make sure there is enough in the pool, are called liquidity providers (LP's). They get paid trading fees for their service. So, it's a decentralized trading platform, where the users and the automatically executed software work together to set a price. For this reason, these systems are called automated market makers (AMM's).
New: liquidity in a certain price range
So, what's new? The main difference that Trader Joe's Liquidity Book introduces, is that it lets traders provide liquidity for a specific price range. These price ranges are called bins. This takes care of higher fees AND takes care of the risk of impermanent loss that traders may experience if one of the tokens they put in a pool jumps up in price compared to the other.
What is impermanent loss? Let's say the price of Ether goes up in the Ether/USDC pair. In that case, Ether will be sold out of the pool to keep the product constant (see formula above). And traders would lose some of their ETH. They will of course get USDC in return. But that still leads to a loss if ETH is pumping, compared to simply holding the coins outside of a pool. Being an LP in price ranges reduces the size of the impermanent loss.
Another perk of Liquidity Book is compensation in the form of higher trading fees when there is high price volatility. Again, this is a way to help offset the risk of impermanent loss.
The Defi ecosystem keeps evolving and Avalanche is no exception. Even though the total value locked in the defi ecosystem has gone down during thebear market, the developers keep on making this space more user-friendly. The bear market is for building.
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