A Look At Uniswap V3 | Concentrated Liquidity

LeoFinance
27 days ago
(edited)
6 Min Read
1225 Words

Uniswap just introduced the V3 version of their protocol with some new interesting stuff in it.

Uniswap has been the on the frontend of innovation when it comes to AMMs and this new update just proves that. A lot of action is now happening on the BSC, due to the small fees and fast operations, but ETH and Uniswap are still leading when it comes to innovation.

Let’s take a look what Uniswap V3 brings with a closer look at Concentrated liquidity

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https://app.uniswap.org/#/

The main new features of Uniswap V3 are:

  • Concentrated liquidity
  • Multiple fee tiers

These features make Uniswap v3 the most flexible and efficient AMM ever designed:

  • LPs can provide liquidity with up to 4000x capital efficiency relative to Uniswap v2, earning higher returns on their capital
  • Capital efficiency paves the way for low-slippage trade execution that can surpass both centralized exchanges and stablecoin-focused AMMs
  • LPs can significantly increase their exposure to preferred assets and reduce their downside risk
  • LPs can sell one asset for another by adding liquidity to a price range entirely above or below the market price, approximating a fee-earning limit order that executes along a smooth curve

Concentrated Liquidity

One thing that most of the regular Uniswap users don’t pay attention is that when you provide a liquidity for a certain pair, up until now, your liquidity can be traded in the range from zero to infinity.

With setup like this there is a share of the capital that will most liquidity never be used.
For example, if you provide liquidity on the ETH – USDC pair, you are providing liquidity for ETH to be traded for 5$ per ETH and for 1M per ETH. The thing is ETH will most likely never go to these prices, at least in a near future and that share of your liquidity (capital) will never be used and you will never earn trading fees on that.

Now if you provide liquidity in the range of 100$ to 2000$ per ETH, you will basically have covered the range in which ETH has been in the last three or more years and earn more fees.

Capital efficiency

Capital efficiency seems to be the new buzz word in AMMs. Other protocols like Balancer have been also mentioning this on there roadmaps and introduction of a single vault for all assets.

With the concentrated liquidity Uniswap is trying to increase the capital efficiency giving the user options and possibilities to choose the range where they want to put their liquidity for a certain pair.
In theory this should allow for LPs to collect the same amount of fees for less capital, or simply put, higher APR.

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As the image above shows the range for the liquidity is 250$ to 12000. This is an example, not a specific coin. The liquidity provider can choose its range and maximize the fees earned for the period. If the pair exits the range, all the liquidity is swapped into one of the coins and no more fees are collected till the pair is back in the range of the liquidity.

LPs and price predictions?

What this means, in order for LPs to have the highest possible APR on their capital, they will need to predict the range for a certain pair where the trading will happen the most in the near future and put their liquidity there. The closer they predict the range of the pair the highest the APY for them.

There are some pairs that have determine price.
Yes stablecoins!

Concentrated liquidity will be very efficient when it comes to stablecoins. Curve is now leading in the field, but with concentrated liquidity Uniswap can compete very well.

For example, at the current model, when liquidity is provided for the DAI/USDC pair, only 0.5% is allocated in the range of 0.99 to 1.01$, that is actually the most traded zone.

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With concentrated liquidity, LPs can adjust their liquidity very tight in the range around 1$, that will boost their APR.

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An example how concentrated liquidity increases capital efficiency.

More competition = same APR?

This is something to thing about. If everyone adjust their liquidity around the 1$ (0.99 to 1.01) there will be a massive amount of liquidity in this range and a massive competition, resulting in less fees for everyone, or the end result might be around the same as now.

I expect this to be the case for stablecoins. However, for the other pools, ETH, BTC etc, the efficiency of the liquidity and the APR will be dependent of the accurate price ranges predictions from the LPs.

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The chart above shows an example where a 1M dollars capital, spread across the full price range earns the same as a 183.5k dollars spread around the 1k to 2.5k range for ETH, resulting in 314% APR.

This of course is very hypothetical, because as mentioned already it is most likely that the competition will be higher at the most obvious price ranges, resulting in lower amount of fees collected for everyone.

Further the custom ranges for LPs also provide some protection against impairment loss.

Market orders?

Or how they call them in Uniswap V3 Range Orders.
The inability to make market orders has been one of the greatest disadvantages of the AMMs protocols like Uniswap. You can just swap a token at the current price, but can’t make orders, that is the basic tool for traders.

With the concentrated liquidity, LPs can deposit a single token in a narrow custom price range. If the market price enters into their specified range, they sell one asset for another. After the swapping is done the LP will then need to exit the pool to avoid swapping back to the previous asset if the prices moves again in that direction.

This will most likely require more tools to be automated and made easy for users but at some point, it will be available.

All the above sounds very interesting. Uniswap keeps on innovating in the space, and the concentrated liquidity looks like a very cool thing.
As mentioned above, it will probably result in a lot of liquidity providers adjusting their ranges and the final result will not be as fancy as in the numbers above and the presentation from Uniswap. But it will still be better and especially for LPs who will adjust and optimize their price ranges right. LPs will now play the market in a certain sense.

It will be interesting to see how this all plays out. The V3 is not live yet, it should be on a testnet soon and later live.

One final note. The new V3 is under a Business Source License 1.1, that make it not totally available for everyone to use the code. It should be free to use after two years. I don’t know all the details about the license, but it seems that Uniswap want to protect them self from copycats and give them self a 2 years head start. Will this be possible in crypto, where anon teams are all over the place, will see.

I have focused here more on the concentrated liquidity, more details in the Uniswap V3 Introduction Post.

All the best
@dalz

Posted Using LeoFinance Beta