LD Capital: Analysis of L2 Head Liquidity Customization DEX Mechanism of Trader Joe, Izumi, and Maverick

LD Capital analyzed the L2 Head Liquidity Customization DEX mechanism of Trader Joe, Izumi, and Maverick.

Original author: Yilan

Source: LD Capital

Preface

As Uniswap V3 licenses expire, many forked projects of centralized liquidity AMMs (CLMM) are emerging. “Uni v3-Fi” includes Dex (a simple fork of V3 or different strategy models based on V3 for customizing pricing ranges), yield-enhancement protocols (Gammaswap), option-type protocols to solve V3’s impermanent loss, and other protocols. This article mainly introduces Dex—Trader Joe v2, Izumi Finance, and Maverick Protocol, which have optimized pricing ranges based on V3.

The problem with Uni V3

In Uniswap V3, liquidity is concentrated within a specific price range. This means that if the price of an asset deviates from this range, there will be so-called “impermanent loss” (IL) . Impermanent loss refers to the loss suffered by liquidity providers in AMMs relative to holding assets. When the price deviates from the price range selected by the liquidity provider, impermanent loss may increase significantly, even exceeding the loss of the original asset.

The concentration of liquidity in Uni v3 leads to greater IL risk, which involves the gamma concept in option Greeks. Gamma refers to the rate of change of an index’s price relative to the change in its delta value. When gamma is large, it means that delta is very sensitive to changes in the underlying price, so it is necessary to adjust the position in a timely manner to avoid potential losses, which is called gamma risk . Without considering the time factor, it can be said that when the volatility of the underlying asset increases, the price of the option also correspondingly increases because higher volatility increases the probability of realizing option returns, so the market requires higher prices for such options.

The higher the asset volatility, the higher the gamma risk that LPs bear, and the greater the compensation for impermanent loss demand. Therefore, the AMM can be regarded as embedded with a perpetual option market, and LPs are exposed to gamma risk, bearing the risk of impermanent loss to obtain transaction fees or mining revenue.

To address this challenge, liquidity providers need to closely monitor the price of their provided assets and take action in a timely manner, such as withdrawing liquidity and reallocating funds to a new price range, to mitigate the impact of impermanent loss. However, this process is time-consuming and requires gas fees, and there is a risk of setting the wrong price range.

In addition, Uniswap V3 faces a number of other issues. For example, liquidity concentration within specific price ranges can lead to liquidity fragmentation, resulting in increased trading costs. Additionally, due to frequent asset price fluctuations, liquidity providers need to make frequent adjustments and management, which can be challenging for large-scale and frequent trading LPs.

Therefore, although Uniswap V3 can offer higher fees and annualized yields, liquidity providers need to balance these potential challenges and risks. Solutions to the problems with Uniswap V3 can be divided into the following categories: optimization of impermanent loss, tool optimization for LP’s optimal market-making scheme (i.e., adding liquidity selection tools for different risk preferences), and built-in optimization of LP NFT revenue enhancement strategies, etc.

This article mainly analyzes three DEX projects that optimize LP market-making schemes: Trader Joe, Izumi, and Maverick.

Trader Joe v2

The biggest improvement of Trader Joe V2’s LB (Liquidity Book) over Uniswap V3 is the introduction of the concept of “Bin” and making liquidity distribution strategizable. “Bin” is a price range that serves as a unit of liquidity distribution and, in the Liquidity Book, liquidity is divided into discrete “Bin” units. Liquidity within each bin follows a fixed exchange rate. It allows liquidity providers to concentrate funds within specific price ranges to avoid slippage. This means that trades can be executed with zero slippage within the price range, improving trading efficiency and cost-effectiveness. Strategizable liquidity distribution refers to the semi-homogeneous properties of LB Tokens and the vertical liquidity distribution direction that allows LPs to deploy their liquidity according to certain strategies, rather than just evenly distributing it on the bin.

Trader Joe v2.1’s Auto Pool began deployment in June, and The General is the first to be deployed on AVAX-USDC (Avalanche) and ETH-USDC (Arbitrum). The General will automatically rebalance liquidity positions to maximize fee income; and respond to market trends and asset imbalances, making it adaptable to most markets and environments. In the future, The General will also be used in other liquidity pools.

Auto-Pool accumulates a share of the transaction fees collected by the liquidity pool. Tokens can be deposited into a yield farm (to be released in the future). Auto-Pool can provide incentives through partner tokens (to be released in the future). An automation fee is charged each time rebalancing occurs, equivalent to an annualized interest rate of 4.5%. The automation fee is used to pay for operating costs, such as gas fees when rebalancing. In the future, the automation fee may be distributed to sJOE stakers.

Deployed in strategies with different liquidity distributions, LPs can earn more rewards if the strategy judgment is more accurate, that is, the proportion of liquidity falling within the selected interval is higher. In addition, dynamic swap fees allow LPs to charge different fees based on market volatility, thereby better managing risk and return.

Izumi Finance

Izumi’s AMM uses the DL-AMM algorithm, a new discrete concentrated liquidity algorithm, which has centralized liquidity market maker features similar to Uniswap V3, but can accurately distribute liquidity at any fixed price, rather than a price range. This makes iZiSwap more controllable in terms of liquidity management and supports more trading methods, such as limit orders.

In addition to Swap, Liquidbox is also one of Izumi Finance’s core products. LiquidBox is a liquidity mining solution based on Uniswap V3 NFT LP tokens, which attracts liquidity through different liquidity incentive models, allowing project parties to set up trading pairs and liquidity pools more efficiently and provide different rewards at different price ranges.

These liquidity incentive models include:

1) Concentrated Liquidity Mining Model, which generally has a capital efficiency of more than 50 times higher than the xy=k model for a specific range, while concentrated liquidity usually increases the impermanent loss of non-stablecoin pairs, and is more friendly to stablecoin pairs with limited fluctuation intervals.

2) One-sided Non-Impermanent Loss Mining Model, the specific operation is that when LP deposits 3000 USDC and 3 ETH, izumi manages it by placing 3000 USDC on Uniswap V3 in the (0,3) price range, and forms a purchase order with USDC when the XYZ price falls. 3 ETH is placed in the izumi pledge module to lock liquidity (the pledged part is not in Uniswap V3), and will not be passively sold when the ETH price rises, so as not to cause impermanent loss or passive selling pressure on the project party.

3) Dynamic Range Model, the project aims to incentivize liquidity providers to provide effective liquidity around the current price.

When users stake Uniswap V3 LP tokens in the Izumi protocol for farming, LiquidBox automatically determines whether the value range of the LP token is within the liquidity incentives range set by the project owner. This value range is set to ensure that liquidity providers provide liquidity within the desired price range.

This is a strategy to create more profits for Uniswap v3 LPs, and it also provides a way for project owners to bribe LPs to create liquidity for their tokens. At the same time, the group that deposits LP NFTs can manage their liquidity positions based on their own judgment of the future trend of the benchmark, using the fixed range, dynamic range, and one-sided functions to avoid IL in appropriate situations.

Maverick Protocol

Maverick AMM’s Automatic Liquidity Placement (ALP) mechanism is similar to Uniswap V3, but the important difference is that the ALP mechanism can automatically achieve dynamic rebalancing of centralized liquidity to ensure that the transaction slippage is lower than that of non-centralized AMM models, while the impermanent loss is lower than that of centralized AMM models (the scenario where the single-sided liquidity mechanism reduces impermanent loss).

The key mechanism is to manage liquidity by using “Bins,” which are the smallest available price intervals. In Maverick, LPs can choose to add their liquidity to specific bins. LPs can choose four different modes: Right mode, Left mode, Both mode, and Static mode, to determine how their liquidity changes with price.

When an LP adds liquidity to a bin, they must add the base asset and quote asset in the same proportion as the existing ratio in the bin. LPs will receive the corresponding LP tokens representing their liquidity share in that bin.

In Maverick, when the price changes, the non-static bin can move to the right or left according to the price change. When a bin moves to overlap with another bin of the same type, the two bins are merged, and the merged bin will receive the liquidity share of the two bins before the merger.

When an LP wants to remove liquidity from a bin, they can extract their share in that bin by providing the corresponding LP tokens. If the bin is a merged bin, LPs need to perform recursive calculations and pass their withdrawal requests to the active bins in the merged chain, and extract assets from the liquidity share of the merged bin in proportion.

Summary

Trader Joe v2 and v2.1 achieve three things: 1) no slippage trading within the bin. 2) Liquidity Book introduces dynamic swap fee pricing, and the fee rate will be applied to the swap amount in each bin and proportionally allocated to the liquidity providers in that bin. LPs can hedge against impermanent loss in high volatility markets through fees. From the perspective of AMM’s built-in perpetual options market, such a setting is also reasonable. Using the instantaneous price volatility function for high-volatility pricing is similar to the option market’s premium compensation to the option seller (LP). 3) Auto pool automatically rebalances liquidity positions to maximize fee income. Later, similar farming strategies to Izumi Liquidbox and the function of project owners building pools to incentivize liquidity will be introduced.

Izumi Finance achieves the following three things: 1) Accurate value range: LiquidBox allows project owners to set the value range of the incentive LP token. This means that liquidity providers can more accurately understand the value range of the liquidity they provide, better manage risks, and receive corresponding rewards. 2) Enhanced liquidity management: LiquidBox allows liquidity to be better focused on specific prices, not just price ranges, by setting a value range. This enhanced liquidity management makes the Izumi protocol easier to manage liquidity and supports more trading methods such as limit orders. 3) Different liquidity reward models are good liquidity management tools for project parties.

Maverick adjusts the way liquidity changes with price by providing different patterns. When the price changes, the bins can be moved and merged to maintain the effectiveness of liquidity. This mechanism allows LPs to better manage impermanent losses and obtain better returns in price changes. AMM underlying automatic movement of native liquidity, custom movement direction of centralized liquidity, LP fee automatic compound interest, and allowing project parties to incentivize specific price ranges are several features that make Maverick AMM a tool for maximizing capital efficiency and accurately managing liquidity for DeFi users such as liquidity providers, DAO treasuries, and project development teams.

In terms of data performance, Maverick had a volume of 164 million in the past week, Trader Joe had 308 million, and Izumi had 54.16 million. In terms of TVL, Maverick was 27.83 million, Trader Joe was 140 million, and Izumi was 57 million. Comparatively speaking, Maverick can capture more volume with lower TVL, so its capital efficiency is very high, and most of the trading volume is routed through 1inch, which also represents Maverick’s stronger price discovery ability.

Compared with Uniswap V3, Trader Joe V2, Izumi, and Maverick are all upgrades to the Concentrated Liquidity (CLMM) model, mainly improving the LP market-making end. In summary, the similarities of several protocols are that they all introduce the function of custom price intervals. This allows liquidity providers to choose specific price ranges to provide liquidity. By customizing the price range, liquidity providers can more precisely control the liquidity they provide, establish a strategy portfolio, meet specific point position building requirements, find the best market-making solution and strategy. The difference lies in the degree of customization of liquidity management tools of the three protocols and the stage of development in their respective ecosystems.

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