Trader Joe has come up with a new feature called ‘Liquidity Book,’ which has introduced:

A whole new architecture for AMM

• It divides the liquidity for an LP into different price bins and aggregates the pools for each pair
• Composable architecture due to the fungibility of Liquidity Book (LB) tokens, which are very similar to ERC-20 tokens
• Starts with one pool for each pair, but subsequently allows the creation of multiple markets for different price bins.

New volatility accumulator

• An internal mechanism that measures market volatility
• It can react to market movements without delay or lag, providing a very accurate mechanism that measures instantaneous volatility
• It has no dependence on external data or algorithms

Variable Fees

• They increase during periods of market volatility and decrease during calmer periods
• They help mitigate the impermanent loss (IL) suffered by LP during market turbulence
• Customizable parameters that allow the implementation of variable fees (these are customized for each individual market)

What are the functions of the Liquidity Book?

Concentrated liquidity

• Improving capital efficiency for LP by allowing a higher return on capital
• Reduces the impact on the price of tokens with zero or minimal slippage for traders
• Smart routing between v1 and v2 ensures that traders always get the best possible prices

Efficient liquidity management

• This feature allows users to adjust positions in one quick transaction

Users can create bespoke liquidity positions

• With Liquidity Book AMM, users have LP completely in their control, with the ability to create any type of liquidity structure
• Users can create unique strategies to suit their risk profile and target

Capital efficiency and swap fees

Trader Joe presents itself by offering swaps with zero or minimal slippage for any trade size.

Together with Liquidity Book, they have introduced concentrated liquidity (which is also used by Uniswap v3). This method of providing liquidity is more capital efficient than the original AMM DEX models. Users can choose for which prices they want to provide liquidity, instead of a range from 0 to infinity. On Trader Joe, you can provide liquidity to a pool; e.g., USDC/USDC.e, as well as being able to decide in which range this liquidity will be placed; e.g., in the range of $0.98 - $1.02.

Users typically benefit from taking advantage of concentrated liquidity because this prevents the majority of their assets in the pool from lying inactive and not contributing in any way to swapping on the platform. Concentrated liquidity ensures that traders get significantly better prices with zero or minimal slippage, even in pairs with relatively low TVL.

The Liquidity Book intelligently routes trades across new concentrated and traditional liquidity pools for even better prices. It also provides on-chain oracles with all values.

Liquidity Bins

In the Liquidity Book, liquidity is split into different bins, each with a specific price assigned to the bin. The individual bins function as constant-sum pools, containing either one or both of the tokens in a pair. This is an example of a bonding curve for one of the baskets containing tokens X and Y:

The Liquidity Book combines the bins into one structure, aggregating the liquidity from all of them. The current market price of asset X can therefore be described as the price associated with the bin containing both assets X and Y (P14 in the figure below). All bins below it would consist of asset Y (P11-P13) and all above it, of asset X (P15-P17). When the liquidity from the current bin is completely depleted, meaning that it consists of only one of the assets, the price moves to the next one. Since each bin represents a fixed price point, the impact on the exchange price only occurs during bin changes.

Customizable liquidity

Customizable liquidity means that you can structure and adjust the liquidity you provide to best suit your strategy.

The Liquidity Book design allows liquidity providers to easily create their own strategies to match their objectives and risk profile. Instead of a single pool with unspecified price spreads, the Liquidity Book has multiple separate bins with different prices. Those who want to earn maximum fees, and who are willing to take some risk, can place all their tokens in one bin. Others can take a more balanced approach and split it into multiple bins. Users can choose any number of specific bins and deposit any amount of liquidity into them.

Efficient liquidity management

The liquidity book concept differs from existing concentrated liquidity models in that assets deposited into Liquidity Book pools receive confirmation in the form of a fungible token. One of the key advantages of this is that users will be able to easily rebalance their LP through a single transaction, which can result in significant savings on fees.

Volatility Accumulator - A new mechanism to measure instantaneous volatility

The volatility accumulator is an innovation that arrived at the same time as the Liquidity Book. It works as a mechanism to measure the instantaneous volatility of the market, keeping track of how many price bins are affected by a particular swap and how much time has elapsed since the last swap. Each price bin change made by a swap represents a fixed increase / decrease in price, and the volatility accumulator does not rely on any external data sources. When swaps occur in a short time sequence, the accumulator will increase. When activity slows, it starts to decrease, and if no swaps occur in a certain timeframe, it resets to zero.

Variable Fee

The Liquidity Book has introduced an innovative approach to mitigating impermanent loss in the form of variable fees. These fees are collected during each swap in the Liquidity Book and depend on a volatility accumulator that tracks market volatility. If volatility is high, the fee is increased to better compensate users for the risks and costs associated with providing liquidity. On the other hand, when volatility is low, the fee is reduced.

The Liquidity Book was developed by Trader Joe's core development team. It is a new approach to AMM that aims to remove the inefficiencies of the original x*y=k formula while maintaining the accessibility that has been the foundation of the success of previous AMM models.
If you are passionate about calculations and technology and want to dig even deeper into the workings of the Liquidity Book, read the Trader Joe whitepaper, in which everything is explained with specific calculations and formulas. The whitepaper can be found here.