Uniswap v3 Explained: A DeFi DEX On The Ethereum Network
When Uniswap was first created by Hayden Adams in November of 2018 as v1 it was simply a proof of concept for automated market makers. This would allow users to pool their assets into market making strategies with ERC-20 standard tokens and of course, Ethereum. It had a great UX but was very limited and respectively primitive, relative to other exchanges. In May of 2020, Adams, with his newly acquired team of devs and supporters, released their new Uniswap-Version 2, solidifying his proof of concept to reality, introducing an exponential growth in the AMM adoption. To stomp competition, in a fair way, they airdropped a mass amount of their governance tokens to users — a move never before seen in the crypto industry. Everyone who interacted with the protocol received (400 UNI tokens). In less than a year since launch, Uniswap facilitated over $135 Billion in trading volume. Competing, if not surpassing, a few of the largest leading centralized crypto exchanges in the world.
Uniswap now serves as critical infrastructure for decentralized finance, empowering developers, traders, and liquidity providers to participate in a secure and robust financial marketplace.
In May, the largest decentralized exchange in the world recently released their THIRD version. Uniswap v3. Presenting a slew of new technical and UX features. They’ve built new layers of their protocol upon utilizing Optimism, Ethereum’s Layer 2.
So what’s all the fuss about v3? I’ve struggled with holding myself back from exaggerating on the unprecedented technicalities of what Uniswap v3 actually is under the hood- and instead, I summarize the most prevalent features into 3 important sections; Concentrated liquidity, capital efficiency and non-fungible liquidity.
Concentrated Liquidity and Capital Efficiency
Perhaps one of the best and most notable features of v3 is the ability for users to provide liquidity as you normally would in v2 but this time, users are capable of selecting their own price range on a curve, in a price band, relevant to the asset’s market price at that time.
In addition, users actually have the ability to activate their liquidity at a certain price point and this goes in harmony with my second point.
Capital Efficiency
Normally, you would be supplying stable coins, which are never intended to pass the range of $0.95–$1.05 and are supposed to stay as tight as possible supplying ETH/DAI. Typically, you would be supplying your liquidity on a full spectrum range of pricing, exposing yourself to high slippage fees, bots and market movers.
Uniswap v3 removes all of that. Initially eliminating slippage for stable coins, and then eventually applying the same feature for the rest of the assets on Uniswap v3. The capital saved can be held externally and deposited elsewhere in DeFi, strengthening the positions of liquidity providers while increasing their exposure safely, like never before.
By concentrating their liquidity, LPs can provide the same liquidity depth as v2 within specified price ranges while putting far less capital at risk. The capital saved can be held externally, invested in different assets, deposited elsewhere in DeFi, or used to increase exposure within the specified price range to earn more trading fees.
Think of it as “Stop loss liquidity.” As shown cleverly in the short clips on their website https://uniswap.org/blog/uniswap-v3/
Notice in these examples, even insufficient strategies become efficient within the concentrated liquidity.
The LPs can approximate any conceivable order book or AMM curve by composing multiple positions per pair.
Check a more nuanced example here.
Exponential curve of concentrated liquidity changes the algorithm to bring in capital efficiency, achieving the same result as previous but with higher liquidity within tighter price points.
Simply put, it gives the Uniswap user a seamless feel, as if they were utilizing centralized exchanges! Each transaction is completed instantly, as if you were on Coinbase or Robinhood. Best features of both worlds.
NON-FUNGIBLE LIQUIDITY
Fungibility will no longer be present and will not be represented as ERC-20 in the core protocol. Instead, users will be able to represent their LP positions via non-fungible tokens — you guessed it, NFTs. This will automate trading fees and even reinvest them back into your original LP position. Soon, even 3rd party contracts and integrations will be added, allowing users to spread their LP-token position and lock it into other participating protocols like AAVE, Compound and other money markets leaders. All of which will be possible by deploying on the Ethereum layer 2 solution…Optimism. Deploying on mainnet but also upon the optimism roll up.
This, I will certainly go into detail in another Medium.
Needless to say Hayden has opened an entirely new window into DeFi opportunities, yet again. Soon, other protocols will follow, tinker, innovate and present more layers and compatibility within Uniswap’s usage, even more innovation and strategies are to come.
Uniswap v3 is full of features and new technology that can be very overwhelming, even to the experienced in the space. While I tried my best to summarize the peripheral important features of Uniswap v3, I do feel that I can still expand more on the new slew of features and/or nuances that the DEX brings, and may not have justified its technical capabilities to its fullest in this article alone. I highly advise you to take a look at the blog and if you dare, the Uniswap v3 Core whitepaper and Uniswap v3 Core Smart contracts.
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Cheers from ShaYo and the The Crypto Lifestyle team.
