The third version of Uniswap, the main DeFi Crypto Exchange (DEX), is almost here.
- Concentrated liquidity, giving individual LPs granular control over what price ranges their capital is allocated to. Individual positions are aggregated together into a single pool, forming one combined curve for users to trade against
- Multiple fee tiers , allowing LPs to be appropriately compensated for taking on varying degrees of risk
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 stable coin-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
Last week, Hayden Adams, Uniswap Founder, captured what may be the spirit of anticipation about the long-awaited details of the third version in one Tweet:
However, Adams was not the only one with this excitation. Throughout the Industry, specialists were speculating about the improvements on the resources from the V3 over V2 (the current one).
The new details were released today and will be implemented next May 2021.
In the Core of the update, it is the capacity of the liquidity providers (LP) to form markets in customized price ranges, an approach called “concentrated liquidity”.
LPs are responsible for presenting their assets in liquidity pools, where Uniswap users trade. This can be comparable to Wall Street market makers, who provide liquidity and thus help traders to enter and exit positions.
Previously, LPs should have reserve capital for a multitude of price ranges (for example, the ether deal for unlikely prices, such as $ 500,000 and $ 1 million), indicating that that capital would be inactive instead of being applied to obtaining rates at more specific prices.
Thus, the only capital to generate fees for LPs would be this, designated for prices at which an asset would be being traded.
For example, an LP could decide to provide liquidity only for ether when it is traded, for example, between $ 1,800 and $ 2,000.
The new approach makes the role of an LP more efficient in terms of capital. LPs can direct their liquidity to the price range in which trades are taking place and, in turn, earn a higher rate of return on their capital.
This change aims to reduce the “slippage” – the difference between the estimated price and the price obtained – at Uniswap V3, improving the trading experience as a whole.
From a strategic point of view, this focus on capital efficiency could pave Uniswap’s dominant position in the market. Uniswap is already responsible for 20% to 25% of transactions on Ethereum on any given day. In February, the project had more than US$30 billion in traded volume.
The platform makes up 60% of the DEX market and has 15 times more users than any other DEX platform developed at Ethereum.
The capital efficiency problem of LPs is one that Uniswap has been trying to solve since its inception. It is an issue that, in a way, encompasses the arc of DEX development to this day.
Other problems related to DEXs – slippage and execution of negotiations, for example – came from this problem, in addition to the scalability limitations inherent to the Ethereum network.
Curve, for example, has made some progress in this regard. However, the efficiencies obtained apply only to transfers between stablecoins. Meanwhile, Balancer has facilitated the provision of liquidity to weighted crypto baskets. However, for Uniswap, no one solved the central problem.
Regarding scalability, the project aims to launch a main first-tier network at Ethereum on May 5, with a second-tier application from Optimistic Rollup in the same month.
This specific second-tier application, created by the startup Optimism, aims to increase the processing rate and lower gas rates to practically zero.
In addition to solving the scalability and adding customizable liquidity ranges, the third version includes numerous other features that aim to strengthen the platform against potential opponents.
An updated fee structure is another feature of Uniswap V3. Instead of a pricing structure that adapts to everything, the third version will offer LPs three different rate levels: 0.05%, 0.30% and 1.00%.
In this way, LPs will generate more fees for market formation for assets that are more volatile. This approach will facilitate the trading of long-tailed and thin-tailed assets.
These same LPs will have the flexibility to participate in any assets they want and will be compensated for the volatility or risk of those assets.
Even Uniswap admits that there are certain disadvantages in the third version, including the fact that it is more difficult to make liquidity fungible – LP tokens will not be interchangeable with each other.
In addition, fees are not continually reinvested in the pool. Leibowitz said that third parties can write contracts linked to the protocol that does this in their place, making the tokens fungible.
These disadvantages in the open source nature have not gone unnoticed by the Uniswap team, as anyone can use the publicly available code and develop their own versions.
This has already happened in the case of the SushiSwap clone. By copying Uniswap and presenting its own governance token, SushiSwap soon became one of the largest decentralized brokers on the market.
The main protocol of the third version is licensed under BSL 1.1, which protects the project to prevent commercial enterprises from copying it directly. This license does not affect integrations with wallets or other mobile applications that wish to connect to the platform.
In the future, Uniswap V3 governance token holders will be able to adjust these licenses as they wish. Two years from now, this license will expire, unless accelerated by UNI governance participants.
Still, it does not completely exclude anonymous agents.
However, in this regard, Leibowitz thinks that the team had a great advantage in terms of technology to keep these opponents away.
In addition to specializing in the complex mathematics behind the third version, the project has a $ 2 million budget in its treasury for bonuses that boost its development.
Over the next three and a half years – if prices remain constant – the project will have almost $ 20 billion.
Besides, the third version represents the latest update to happen publicly. From then on, the development team will hand over the reins to the community.