4000x more capital efficient: Uniswap team reveals details for v3

4000x more capital efficient: Uniswap team reveals details for v3

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March 24, 2021 by Kofi Ahmed
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The third iteration of the market-leading decentralized exchange Uniswap is coming this spring, according to new details of the so-called v3 launch published Tuesday.
4000x more capital efficient: Uniswap team reveals details for v3

Quick Take

  • New details about Uniswap’s next iteration, v3, were made public on Tuesday.
  • V3 focuses heavily on making the decentralized exchange as capital efficient as possible.
  • V3 is expected to launch on Ethereum on May 5th and on Optimism in mid-May.

Last week, Hayden Adams, Uniswap’s founder, captured what was perhaps the spirit of anticipation around the long-sought details of v3 in a tweet: “If I have to go another week without publicly announcing details of Uniswap v3 I might go insane.”

Adams was far from alone. Across the industry, market pundits have been pondering over the improvement features of v3 over v2, the current iteration. The new details published Tuesday are set to be implemented in May.

At the heart of the upgrade is the ability for liquidity providers (LPs) to make markets within customized price ranges, an approach dubbed concentrated liquidity. LPs are responsible for placing their assets into liquidity pools, against which Uniswap users trade. This is comparable to Wall Street market makers, who provide liquidity and thereby help traders move in and out of positions.

Previously, LPs were required to have capital on stand-by for an infinite range of prices (for instance, ETH trading from unlikely prices like $500,000 to $1 million), which means it would sit idle rather than being put to work to earn fees at more specific prices. As such, the only fee-generating capital for LPs would be that which is designated for the prices at which a given asset is trading.

“In Uniswap v3, LPs can allocate capital within custom price ranges, creating individualized price curves in the process,” the company said in a document shared exclusively with The Block ahead of publication. For example, an LP could decide to provide liquidity only for ether when it trades at, let’s say, $1,800 to $2,000.

“The story of Uniswap v3 is that execution quality is about to improve by an order of magnitude, if not more,” said Adams.

The new approach effectively makes the job of a liquidity provider more capital efficient. LPs can direct their liquidity towards the price range at which trades are occurring, and in turn, earn a higher rate of return on their capital.

“You can put up the same amount of capital to earn more fees or use marginal capital saved to invest in any other strategy of choice,” explained Uniswap strategy lead Teo Leibowitz. This change is meant to decrease slippage on Uniswap, which would improve the overall trading experience. From a strategic standpoint, this focus on capital efficiency will perhaps further cement Uniswap’s dominant position in the market.

Uniswap already accounts for 20% to 25% of transactions on Ethereum on any given day. Last month, the project saw more than $30 billion in trade volume. The platform makes up 60% of the DEX market and has about 15x more users than any other Ethereum DEX.

Efficiency, efficiency, efficiency

The LP capital efficiency problem is one that Uniswap has been tackling since its inception. In a broader sense, it’s an issue that in some ways encapsulates the arc of DEX development to date.

Across the market, competing projects from Curve to DODO to Balancer have been examining the same issue: how to make providing liquidity on DEX more efficient. Most other issues tied to DEXs — slippage and trade execution, for instance — stem from this problem, in addition to the scaling limitations inherent to the Ethereum network.

Curve, for instance, has made some advancements on this front. But the efficiencies achieved have applied to only stablecoin-to-stablecoin transfers. Balancer, meanwhile, has made it easier to provide liquidity to weighted baskets of cryptos. But in Uniswap’s view, no one has tackled the heart of the problem.

As for scaling, the project is targeting an Ethereum Layer 1 mainnet launch on May 5 with a layer-two deployment of Optimistic Rollup in mid-May. This particular Layer 2 application, the brainchild of scaling startup Optimism, aims to increase throughput and lowers gas fees to effectively zero.

Aside from addressing scaling and the addition of customizable liquidity ranges, v3 includes a number of other features aimed at strengthening the platform against would-be competitors.

An updated fee structure is another new feature for v3. Rather than a one-size-fits-all pricing structure, v3 will offer LPs three distinct fee tiers: 0.05%, 0.30%, and 1.00%.

LPs, as such, will generate more in fees from making markets in assets that are more volatile. This approach will make it easier to trade thinly traded and longtail assets. Those same LPs have the flexibility to engage in whichever assets they want and will be compensated in line with the volatility or risk of those assets.

“For the protocol to serve all sorts of markets and be the best platform for every trader, different pairs need to have different fee tiers,” Leibowitz told The Block.

Even Uniswap admits there are some small drawbacks of v3, including the fact that it’s harder to make liquidity fungible (meaning LP tokens will not be interchangeable with one another). Furthermore, fees are not continuously re-invested into the pool. Leibowitz said third-parties can write contracts tied to the protocol that does this on their behalf and make tokens fungible.

It’s also not lost on the Uniswap team that its open-source nature comes with its drawbacks, namely that anyone can take the publicly available code and build their own versions.

That’s already happened in the case of Uniswap clone SushiSwap. By copying Uniswap and introducing its own governance token, SushiSwap quickly became one of the largest DEXs on the market. According to data collected by The Block, SushiSwap accounted for just over 20% of DEX volume in February.

The Uniswap v3 Core protocol is licensed under BSL 1.1, which will give the project more teeth in protecting commercial ventures from copying it outright. This license does not affect integrations with wallets or other mobile apps looking to plug into the platform.

In the future, Uniswap’s governance token holders will be able to adjust these licenses as they see fit. In two years, this license will lapse unless accelerated by UNI governance participants.

Still, it doesn’t completely fend off anonymous actors.

On that front, however, Leibowitz is of the opinion that the team has enough of a head start with the tech to fend off such competitors.

In addition to being specialized on the complex mathematics behind v3, the project has a war chest of $2 billion vested in its treasury for grants to spur development. Over the course of the next 3.5 years—if prices stay constant–the project would have nearly $20 billion.

Furthermore, v3 represents the last major update to occur outside of public view. From here, the development team will hand the reins over to the community.

“The first wave of $750,000 worth of grants has been distributed to 20+ projects,” Leibowitz said. “A second wave is about to kick off.”

Source: TheBlock

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