Are you interested in learning more about the commotion that has surrounded Trader Joe's Liquidity Book, the innovative concept for a liquidity pool that has caused a storm in the DeFi world? You're not alone. Even though it has been accessible on the Avalanche blockchain ever since August, many DeFi users have only lately become aware of the existence of the Liquidity Book following its deployment on the Arbitrum network. What exactly is the Liquidity Book, how can you get your hands on a copy of it, and how is it different from other available choices? In this essay, I'll do my best to provide answers to these issues and provide a comparison between Liquidity Book and Uniswap version 3.

Trader Joe background

During the height of the Avalanche Rush in 2021, two decentralized exchanges (DEX) fought tooth and nail on the Avalanche blockchain for the position of most dominant DEX on the chain. Pangolin had the early lead in the competition, introducing their product far sooner than their competitor, Trader Joe. However, only two months after its inception in June 2021, Trader Joe had immediately established a large community and pushed past Pangolin to capture the crown as the top DEX on Avalanche by total value locked (TVL). Pangolin was the previous holder of this position. During the height of the protocol's success, Trader Joe's platform had more than $2.59 billion worth of assets, including liquidity pools (LPs), staked assets, and a money market platform.

Late in 2022, Trader Joe's began their road toward omnichain, and in December of that same year, it deployed its platform on the widely used Ethereum layer two (L2) scaling solution, Arbitrum. This was a significant shift for Trader Joe's, since it was their first move out of Avalanche, a neighborhood that had by that time lost the majority of its TVL and no longer had much activity. At that time, Arbitrum was teeming with activity and new users, which came at a time when rumors about the Arbitrum airdrop were slowly building up heading into the new year. When GMX, another Avalanche decentralized application (DApp), moved to the L2 chain in 2021, Arbitrum was the destination of choice for them as well. GMX was and still is the biggest decentralized application (DApp) on Arbitrum, accounting for more than 23% of the total TVL on the chain.

Not too much time passed between the deployment of Arbitrum and the announcement and subsequent deployment of Trader Joe on the Binance Smart Chain (BSC). BSC is the third biggest chain measured by TVL, and it is home to more than 1,400 decentralized applications (DApps), as well as more than one million users that are active every day. In addition, since the catastrophic collapse of FTX in November 2022, Binance has been making tremendous strides toward solidifying its market dominance. Because of this, BSC's position in the DeFi area was significantly strengthened. Trader Joe's new target was another step in the right way for their omnichain plan since it was another chain that was bustling with activity. Joepegs, Trader Joe's native currency trading platform, was also introduced to BSC as part of this expansion.

Trader Joe's has formed a partnership with LayerZero, an omnichain interoperability protocol, in order to transform their token, JOE, into an omnichain fungible token (OFT). This is part of Trader Joe's larger plan to integrate all of their individual blockchain deployments into a single, cohesive omnichain. This makes it possible to move JOE from one chain to another on a 1:1 basis, eliminating the conventional security problems associated with bridge tokens. Additionally, frictionless transfers of JOE were made possible as a result of the integration, which improved JOE liquidity throughout chains.

What is concentrated liquidity?

Since the creation of the x*y=k formula, which was a crucial invention in the early days of decentralized finance (DeFi), there has been very little advancement in automated market maker (AMM) designs until Uniswap's introduction of concentrated liquidity in version 3 (v3). Uniswap's introduction of concentrated liquidity was a key innovation in the early days of decentralized finance (DeFi). AMMs are an essential component of DeFi because they provide decentralized exchanges to offer liquidity to customers without the need for an order book. This is one of the main advantages of AMMs. Other AMM designs have also come into existence, such as those created by Curve and Balancer, although they have not proven to be as efficient with regard to the use of capital as centralized order book exchanges (CLOBs).

As a solution to this problem, Uniswap came up with a hybrid model that incorporates characteristics of both AMMs and CLOBs. Instead of spreading it throughout the whole price range of zero to infinity, Uniswap v2 enables liquidity providers (LPs) to select a particular price range within which they want to supply liquidity. This is in contrast to the previous version, which spread it across the entire price range. This strategy has been shown to be quite effective in boosting the efficiency with which money is used, but it does come with a few drawbacks, which we shall get into further in this article.

Comparison with Uniswap v3

About a year and a half after the introduction of Uniswap v3, Trader JOE launched Liquidity Book, a concentrated liquidity design that can also be defined as a "modular liquidity" system. Liquidity Book is an example of a "modular liquidity" system. It would appear that the team at Trader JOE gave careful consideration to the Uniswap v3 in order to develop a design that is competitive. The AMM design has been revamped to create a new and enhanced Liquidity Book, which is beneficial to traders as well as liquidity suppliers.

In Liquidity Book, liquidity providers have the flexibility to pick any price range in which they want to provide liquidity and earn fees, while traders have the ability to trade without having any price effect within the same price range, sometimes known as a "bin." Changes in the active bin or price range might potentially have an effect on prices. At first glance, LB may appear to be quite similar to UniV3, yet there are a number of significant advancements and distinctions between the two.

Token Standard

For the purpose of describing and diversifying LP holdings, UniV3 makes use of NFTs, which adhere to the ERC-721 token standard. On the other hand, Trader JOE's LB employs a new kind of token standard that was developed just for LB. This token standard was established specifically for LB. It is more comparable to ERC-1155, although it does not include NFTs. Therefore, you might be wondering what the benefits and drawbacks are to selecting one of those two alternatives. Let's cover it up.

Interoperability

For non-fungible tokens, the ERC-721 standard is utilized. This ensures that each LP position has its individuality and cannot be composed of other parts. Because of this, it is difficult to develop protocols on top of them, such as auto compounders or aggregators, which restricts the amount of interoperability that can be achieved. The constraints of ERC-721 make it difficult to develop new protocols and features, despite the fact that there are some choices available, such as Arrakis Finance for UniV3.

On the other hand, ERC-1155 has improved composability due to the fact that LP tokens are given an ID that corresponds to the bin in which they are stored. In all other respects, the behavior of ERC-1155 tokens is quite similar to that of ERC-20 fungible tokens, which contributes to their increased interoperability. This indicates that protocols will have an easier time constructing additional functionalities atop Liquidity Book in comparison to UniV3. One such protocol is SteakHut Finance, which is in the process of creating a decentralized application (dapp) to simplify LP management.

The efficiency of gas usage

The gas efficiency of utilizing the Liquidity Book is one of the potential problems that might arise. Because of the large quantity of ERC-1155 tokens that need to be mined, the token standard that is utilized for LP positions, which is called ERC-1155, demands a substantial amount of gas. Uniswap v3, on the other hand, is more gas efficient since it mints just a single NFT to represent an LP position rather than many NFTs.

In Uniswap version 3, the management and composting of numerous LB positions may prove to be more cost-effective over a longer period of time than the management of individual NFT positions.

There is a reason that we should refer to Liquidity Book as "Modular Liquidity" rather than "Concentrated Liquidity." The next part will explain the reason for this preference.

Divide type: Ticks versus Bins

uni joe comparison

Source: Medium

Instead of using ticks, Liquidity Book prefers to employ bins that "discretize" liquidity for the purpose of describing pricing. The UniV3 platform takes advantage of ticks and "concentrates" liquidity within a range. These bins are available for usage by liquidity providers so that they can develop their own complex strategies on the Liquidity Book platform. You may be thinking the same thing with UniV3, but you should keep in mind that each and every distinct position on UniV3 results in a unique NFT, even while playing at the same pool, whereas the bins in Liquidity Book can be composted. You may build a variety of tactics by composing or separating your places in the LP process.

Consider each bin to be a box or a piece of Lego; with the Lego pieces, you might construct a tall skyscraper or a large pool. Each bin serves as a building block. This gives it a modular structure. You have access to modules, which are similar to bins, and you may use them to construct anything you choose.

liquidity book bin

Source: Trader Joe

You may also think of bins as being similar to an order book. There are certain orders that are waiting for bins to be filled, but those orders will remain there until the LP source removes them from the system.

Liquidity position control

As opposed to Uniswap v3, which enables positions to be spread out throughout a range, the modular design of Liquidity Book enables liquidity providers to have more granular control over their holdings. With the use of the Liquidity Book, an LP has the ability to directly intervene in their position at a particular bin, as opposed to a range.

Price reflection

When it comes to price reflection, the utilization of ticks and a constant product formula in Uniswap v3 makes it possible for a larger range of prices to be displayed on the bonding curve. In contrast, the price of bins is predefined in Liquidity Book, and the price can only take into account the value of the bins as a whole; it cannot take into account the value between individual bins. Because of this, Uniswap v3 has the potential to be a more efficient solution for price reflection.

Price impact

Primitive automated market maker (AMM) models, such as those that employ the formula x*y=k, are susceptible to the issue of price impact. This is a prevalent problem. Deep liquidity is required for these AMMs in order to reduce the influence that price swings have on their operations. This implies that there must be a significant quantity of both supply and demand for the asset in question. Price impact can be reduced effectively by both Liquidity Book and Uniswap v3, but Liquidity Book is able to totally eradicate it at the bin level. Uniswap v3 does not have this capability.

In Liquidity Book, assets are partitioned into different containers and given labels like "token X" and "token Y." The tokens X and Y are both located in the active bin, however, the bins located higher up contain just token X and the bins located lower down include only token Y. In order for the price to change, one of the tokens that are currently contained within the active bin has to become depleted. When this occurs, the price will advance to the next available bin. This indicates that the price effect does not take place when traders are trading inside the same bin; rather, it only takes place when the active bin changes.

Consider the example of a liquidity pool that contains ETH and USDC in order to better understand this idea. There will be no influence on prices if the active bin already contains both ETH and USDC and traders are buying and selling inside that bin. However, if traders sell a significant quantity of ETH in exchange for USDC, the current bin can run out of USDC. If this happens, the price will transfer to the next bin, and the active bin will be replaced.

trader joe formula

Source: Trader Joe

Formula

The "x*y=k" formula used by UniV3 is a version of the constant product formula used for certain ranges. The liquidity providers are able to choose a range for their capital, and there is a possibility that the liquidity may run out while the price is fluctuating; ultimately, the liquidity providers will only have one token. The same thing happens in Liquidity Book as well; however, instead of using a variable sum formula at bins, it utilizes an "x+y=k" formula. What are the key distinctions that distinguish them? Let's find out.

LP token distribution

As a liquidity provider, users on UniV3 are unable to select the token ratio they like from the available options. If you go to the "Add Liquidity" page and enter the amount of Token X, the system will automatically fill in the quantity of Token Y for you. On the other hand, you have the ability to set your capital at any ratio you like using the Liquidity Book.

Let's imagine you have 1k worth of tokens and you want to invest some funds in the ETH-USDC pair at the price range of 1200-1250 for both UniV3 and LB. In this example, we'll assume that the price of ETH is between 1200 and 1250.

The ratio is computed by Univ3, and you are given the option to provide a fixed quantity of each token within the range.

LB allows you to place any number of tokens in the range, and it will then distribute them across the various bins.

Capital Efficiency

At this level, both of them, with their own designs, are good answers for efficiently allocating capital. We only want to point out that the constant product formula has an influence on prices even within a relatively narrow range, but the constant sum formula does not have any effect on prices. Because of this, it is more advantageous for traders. Additionally, the constant product equation is more prone to impermanent losses, which is not beneficial for vendors of LP.

Impermanent Loss

There are tools available in both Liquidity Book (LB) and Uniswap v3 (UniV3) that can assist liquidity providers (LPs) in lowering their exposure to the possibility of experiencing an impermanent loss (IL). These features are as follows:

Provision of liquidity based on a range Rather than having to commit to a specific ratio between assets, both LB and UniV3 provide liquidity providers the option of indicating a range, or a band, within which they are willing to supply liquidity. This allows LPs to lessen their sensitivity to changes in the market and lowers the likelihood of incurring IL.

Liquidity Book

Accumulator of market volatility: The internal process at LB that measures market volatility and modifies the fees charged to traders in response to such volatility. The volatility accumulator contributes to the reduction of IL risk for LPs. It does this by raising fees during times of high volatility and lowering them during times of lower volatility.

Tiered fees: In addition to flat costs, LB also provides tiered fees, which do not operate without consent and are determined by the TJ core team.

Uniswap v3

The costs for UniV3 are structured in tiers, and liquidity providers have the option of selecting one of three fee levels: 1%, 0.3%, or 0.05%. This makes it possible for LPs to lessen their sensitivity to changes in the market and lowers the likelihood of incurring IL. However, the downside of using a tiered fee structure is that it separates the available liquidity into three distinct pools, and there are no other alternatives available beyond these three levels. In addition, there is no alternative to LB's volatility accumulator, which allows for larger fees to be assessed during periods of extreme market volatility.

In principle, both Liquidity Book and Uniswap v3 offer mechanisms to minimize the risk of impermanent loss; however, the specific approach and efficacy of these mechanisms may differ depending on the unique market circumstances and the strategies utilized by liquidity providers. Nevertheless, all of these solutions offer methods to mitigate the risk of temporary loss.

Trader JOE's Liquidity Book platform does not presently support the establishment of random pools. The team, however, has only recently established a governance architecture that enables the creation of additional pools and leaves the choice about the creation of new pools up to holders of the $JOE token. At the moment, the $yyavax-$avax pair is going through the process of being evaluated for addition to the Liquidity Book as part of an ongoing proposal.

On the other hand, Uniswap enables the formation of any pool on its UniV3 platform, which, in our view, gives it a more decentralized structure. However, as most of us are aware, individuals are able to influence token values on UniV3 while constructing a buy-sell wall, and this is especially true for tokens that have a low volume. Because of this, traders might end up losing money and becoming unsuitable. I am weighing this as a potential market risk, and you should do the same. When trading on any platform, it is essential for traders to do their own research and be aware of the many hazards that might arise.

Conclusion

In conclusion, Trader JOE's Liquidity Book has a number of advantages over other AMM designs. These advantages include the ability for liquidity providers to select any price range in which they want to provide liquidity and earn fees, as well as the ability for traders to trade without experiencing any price impact within the same price range, also known as a "bin." Additionally, the usage of ERC-1155 tokens for LP positions enables improved compatibility with other protocols. Furthermore, a variable fee model that is based on the volatility accumulator serves to motivate liquidity providers to offer liquidity during periods of high volatility. Even if there are some reservations about the Liquidity Book's gas efficiency, the overall concept seems to be a viable competitor in the DeFi area and is worthy of consideration for both traders and liquidity providers.

Disclaimer:
This article is intended for and only to be used for reference purposes only. No such information provided constitutes advice or a recommendation that any investment or trading strategy is suitable for any specific name.

Trader Joe: The secret lies in the liquidity book