Avalanche-based decentralized finance (DeFi) protocol Trader Joe claims it may have found a way to mitigate one of DeFi’s biggest weaknesses — impermanent loss.
In a newly released white paper on Tuesday called the JOE v2 Liquidity Book, authored by Quant developers and researchers Adam Sturges, TraderWaWa, Hanzo and software engineer Louis MeMyself, the developers outlined the use of Liquidity Book (LB) with an additional variable fee swap feature to “provide traders with zero or low slippage trades.”
/4 Impermanent Loss— The DeFi Investor (@TheDeFinvestor) August 23, 2022
One of the most critical issues of Uniswap V3 is that impermanent loss often exceeds swap fees.
A study effectuated by the @Bancor team showed that 50% of Uniswap V3 LPs lose money.
Liquidity Book solves this problem by introducing variable swap fees.
Trader Joe said the new strategy will mitigate impermanent loss “suffered by so many liquidity providers (LPs) on other DEXs during market turbulence.”
Impermanent loss, which has been seen as one of DeFi’s greatest weaknesses, happens when the price of token changes after one deposits it in a liquidity pool-based automated market maker as part of yield farming — a type of investment in which one lends tokens to earn rewards (not the same as staking).
It’s also one of the reasons that institutional investors have been treading with caution in the DeFi space, according to digital-asset management firm IDEG’s chief investment officer Markus Thielen.
Speaking to Cointelegraph, Thielen said that his firm and other institutional investors “have been less engaged with automated market makers (AMMs) as the risk of impermanent loss is too high,” adding:
“I must admit that Trader Joe’s v2 whitepaper offers a novel idea and liquidity providers have generated 30bps for facilitating trades, which is an attractive return when future growth is uncertain for the industry. We want to see how much liquidity v2 is now attracting and how Trader Joe's TVL will improve.”
Thielen added that in order to get a competitive edge in the digital asset sector, investors need to look for alternative investments with good fundamentals, rather than just relying on blue-chip assets:
“As a crypto fund, we can’t just rely on ETH and BTC, we want other layer ones and alt coins to thrive, so we applaud the Trader Joe team for keeping developing and other AMM on their toes.”
According to the paper, Trader Joe’s Liquidity Book (LB) is a type of liquidity pool (LP) that arranges the liquidity of an asset pair into price bins, which are exchanged at a constant price.
The LB introduces a new variable swap fee, which is designed to protect traders from impermanent loss by compensating LPs in the event of extreme market volatility so that the liquidity can be more efficiently managed in response to sudden price movements.
Trader Joe’s LB will also offer zero to low slippage trades, which will serve to offer traders better buying rates.
If properly executed, this may represent a significant breakthrough in DeFi. A recent study showed that over 50% of Uniswap v3 LPs lose money in times of market turbulence because impermanent loss exceeded the swap fees.
Thorchain is another DeFi protocol providing impermanent loss protection for LP deposits after the first 100 days (with partial protection before that point).
The Trader Joe protocol dubs itself as a “one-stop decentralized trading platform” that is built on smart contract platform Avalanche.
The protocol is currently the largest decentralized exchange (DEX) on Avalanche, with $191 million in total value locked (TVL) on the protocol.
The DeFi protocol allows users to trade, farm, lend and stake among other things.
Trader Joe’s token, JOE, saw its price briefly spike following the white paper release and is trading at $0.28 at the time of writing, though it’s still down 94.5% from its all-time-high, according to CoinMarketCap.