Trader Joe proposes a solution to the impermanent loss problem in DeFi

Developers of the Trader Joe AMM protocol said they have found a solution to one of DeFi’s main problems — impermanent losses.

The wait is finally over….

Introducing: Liquidity Book 🌊📘

A next gen AMM protocol that is highly efficient, flexible and built for #DeFihttps://t.co/6l2FoaJ0xo

— Trader Joe🔺 | New AMM Soon 🌊📘 (@traderjoe_xyz) August 22, 2022

In a white paper published under the name Joe v2, the team describes using the Liquidity Book with a variable swap fee.

Trader Joe has assured that the feature will provide traders with trades at zero or minimal slippage.

The solution will reduce losses suffered by many liquidity providers (LPs) on DEXs during market turbulence, the developers said.

Impermanent losses arise from holding assets in liquidity pools, when one of them is more volatile than the other.

The DeFi Investor analyst noted that on many DEXs impermanent loss often exceeds swap fees. For example, about 50% of liquidity providers on Uniswap V3 lose money due to this problem, according to a Bancor study.

/4 Impermanent Loss

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.

— The DeFi Investor🦇🔊 (@TheDeFinvestor) August 23, 2022

Liquidity Book distributes a pair’s liquidity in the pool across price cells. During a swap, trades execute at the price in the bucket. If funds are insufficient, the swap moves to the next cell.

The solution envisages two components of the fee: fixed and variable. The latter will depend on the volatility of assets in each pair, encouraging LPs to respond to price movements. Influx of liquidity into the pair will deepen the order book, reducing slippage.

Marcus Tilen, investment director at IDEG Asset Management, told Cointelegraph that impermanent loss is one reason institutional investors are wary of DeFi. The firm, like many others, is reluctant to engage with AMM protocols because of this, he added.

“I must admit that the Joe v2 white paper offers a new idea, and LPs generate 30 bps on trades. It’s an attractive income when the future growth of the industry is unclear. We will see how much liquidity v2 will attract and how TVL will improve,” said Tilen.

ForkLog analysed in cards how the second generation of DeFi projects is addressing the problems of the first version, including centralisation, impermanent losses and other issues.

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