UNISWAP V3 - New Era Of AMMs? Architecture Explained

so what is the long-awaited uni swap v3 all about how is it different from v2 will this be a game changer when it comes to the automated market maker space and will it launch directly on layer 2. you'll find answers to these questions in this video before we begin if you want to learn more about decentralized finance and the technology behind it make sure you subscribe to my channel hit the bell icon and enable all notifications you can also consider joining us on patreon and learning even more about d5 although uni swap as one of the core d5 projects doesn't need much of an introduction let's quickly go through a few major points before we jump into v3 uni swap in essence is a protocol for decentralized and permissionless exchange of tokens on the ethereum blockchain the initial version of uni swap was launched in november 2018 and slowly started building users interest in may 2020 at the beginning of defy summer uniswap launched a second version of the protocol called uniswap v2 the main feature was the addition of erc20 to erc20 liquidity pools on top of erc20 to eat pools present in v1 in the second half of 2020 uni swap v2 went through a period of parabolic growth and quickly became the most popular application on ethereum it also became pretty much a standard for automated market makers making it one of the most forked projects in the whole device space less than a year since its launch v2 has facilitated over 135 billion dollars in trading volume an astonishing number that is comparable with top centralized cryptocurrency exchanges you can learn more about the full story behind uni swap v1 and v2 in this video here also the concept of liquidity pools and automated market makers are worth understanding if you need a quick recap here is a video just before releasing v2 the team behind uni swap had already started working on a new version of the protocol details of which were announced just now at the end of march 2021 the team decided to launch uni-swap v3 on both the ethereum mainnet and optimism and ethereum layer 2 scaling solution targeting early may for the release this was clearly one of the most anticipated announcements in device history and it looks like v3 can completely revolutionize the amm space so what are the main changes uni swap v3 focuses on maximizing capital efficiency when compared to v2 this not only allows lps to earn a higher return on their capital but also dramatically improves trade execution that can now be compared or even surpass the quality of both centralized exchanges and stable coin-focused amms on top of this because of better capital efficiency lps can create overall portfolios that significantly increase exposure to preferred assets and reduce their downside risk they can also add single assets as liquidity to a price range that is above or below the current market price which basically creates a fee earning limit order that executes along a smooth curve this is all possible by introducing a new concept of concentrated liquidity more on this in a second besides this v3 introduces multiple feet tiers and improves uniswap oracles now let's go through some of the unislope v3 features one by one to understand them a bit better concentrated liquidity is the main concept behind v3 when lps provide liquidity to a v2 pool liquidity is distributed evenly along the price curve although this allows for handling all price ranges between 0 and infinity it makes the capital quite inefficient this is because most assets usually trade within certain price ranges this is especially visible in pools with stable assets that trade within a very narrow range as an example unisop die usdc pool only uses around half a percent of capital for trading between 99 cents and one dollar and one cent a price range where the vast majority of trading volume goes through this is also the volume that makes the majority of trading fees for the lps this means that in this particular example 99.5 of the remaining capital is pretty much never used in v3 lps can choose a custom price range when providing liquidity this allows for concentrating capital within ranges where most of the trading activity occurs to achieve this v3 creates individualized price curves for each of the liquidity providers before v3 the only way to allow lps to have individual curves was to create a separate pool per curve these poles if not aggregated together resulted in high gas costs if a trade had to be routed across multiple pools what is important is that users trade against combined liquidity that is available at a certain price point this combined liquidity comes from all the price curves that overlap at this specific price point lps earn trading fees that are directly proportional to their liquidity contribution in a given range concentrating liquidity offers much better capital efficiency for liquidity providers to understand it better let's go through a quick example alice and bob both decide to provide liquidity in the 8th dipole on uni swap v3 they each have 10 000 and the current price of eth seven hundred and fifty dollars alice splits her entire capital between heath and dye and deploys it across the entire price range similar to v2 she deposits 5000 die and 2.85 eat bob instead of using his entire capital decides to concentrate his liquidity and provides capital within the price range from 1500 to 2500. he deposits 600 die and 0.37 each a total of 1 200 and keeps the remaining 8 800 for other purposes what is interesting is that as long as the eth die price stays within the 1500 and 2500 range they both earn the same amount of trading fees this means that bob is able to provide only 12 percent of alice's capital and still makes the same returns making his capital 8.34 times more efficient than alice's capital on top of that bob is putting less of his overall capital at risk in case of a quite unlikely scenario of heath going to zero dollars bob's and alice's entire liquidity would move into eth although they would both lose their entire capital bob puts a much smaller amount at risk lps in more stable pools will most likely provide liquidity in particularly narrow ranges if the 25 million dollars currently held in the uni swap v2 die usdc pool were instead concentrated between 0.99 and 1.01 price range in v3 it would provide the same depth as 5 billion dollars in unislope v2 as long as prices stayed within that range when v3 launches the maximum capital efficiency will be at 4000 x when compared to v2 this will be achievable when providing liquidity within a single 0.1 percent price range on top of that the v3 pool factory will be able to support ranges as granular as 0.02 percent which translates to a maximum of 20 000 x capital efficiency relative to v2 v3 also introduces the concept of active liquidity if the price of assets trading in a specific liquidity pool moves outside of the lp's price range the lp's liquidity is effectively removed from the pool and stops earning fees when this happens the lps liquidity shifts completely towards one of the assets and they end up holding only one of them at this point the lp can either wait until the market price moves back into their specified price range or they may decide to update the range to account for current prices although it's entirely possible that there will be no liquidity at the specific price range in practice this would create an enormous opportunity for liquidity providers to indeed provide liquidity to that price range and start collecting all trading fees from the game theory point of view we should be able to see a reasonable distribution of capital with some lps focusing on narrow price ranges others focusing on less likely but more profitable ranges and yet another ones choosing to update their price range if the price moves out of the previous range range limit orders is the next feature enabled by concentrated liquidity this allows lps to provide a single token as liquidity in a custom price range above or below the current market price when the market price enters into the specified range one asset is sold for another along a smooth curve all while still earning swap fees in the process this feature when used together with a narrow range allows for achieving a similar goal to a standard limit order that can be set at a specific price for example let's assume that the usdc trades below 1.001 and lp can decide to deposit their die to a narrow range between 1.001 and 1.002 once die trades above 1.002 by usdc the whole lp's liquidity is converted into usdc at this point the lp has to withdraw their liquidity to avoid automatically converting back into die once thai usdc goes back to trading below 1.002 lps can also decide to provide liquidity in multiple price ranges that may or may not overlap for example an lp can provide liquidity to the following price ranges in the eighth dipole two thousand dollars between fifteen hundred and twenty five hundred dollars one thousand between two thousand and three thousand dollars five hundred between thirty five hundred and five thousand dollars being able to enter multiple lp positions within different price ranges allows for approximating pretty much any price curve or even an order book this also enables creating more sophisticated market making strategies as each lp can basically create their own price curve their liquidity positions are no longer fungible and cannot be represented by well-known erc20 lp tokens instead providing liquidity is tracked by non-fungible erc721 tokens despite this it looks like lp positions that fall within the same price range will be able to be represented by erc20 tokens either via peripheral contracts or through other partner protocols on top of this trading fees are no longer automatically reinvested back into the liquidity pool on lp's behalf instead peripheral contracts can be created to offer such functionality the next new feature is the flexibility when it comes to trading fees instead of offering the standard 0.3 trading fee known from uni swap v2 v3 initially offers three separate fee tiers 0.05 percent 0.3 percent and 1 this allows lp's to choose the pools according to the risk they are willing to take the theme behind uni swap expects the 0.05 fee to be predominantly used for pools with similar assets such as different stable coins 0.3 percent for other standard pairs like eath die and one percent for more exotic pairs similarly to v2 v3 can also enable a protocol fee switch where part of the trading fee would be redirected from lps instead of having a fixed percentage like in v2 v3 offers between 10 and 25 of lp fees on a per pool basis this will be switched off at launch although it can be switched on at any time as per uni-swap governance last but not least is a significant improvement to the two of oracles introduced by uniswap v2 v3 makes it possible to calculate any recent tue up within the past 9 days in a single on-chain call on top of this the cost of keeping oracles up to date has been reduced by around 50 percent when compared to v2 these are pretty much all the main features behind unislope v3 what is interesting is that all of these features haven't caused an increase in the gas cost rather the opposite the most common feature a simple swap will be around 30 cheaper than its v2 equivalent it looks like uni-swap v3 can be a game changer when it comes to amms it basically combines the benefits of a standard amm with the benefits of a stable asset amm all of this while making capital way more efficient this makes v3 a super flexible protocol able to accommodate a whole range of different assets it will be interesting to see how v3 could affect other mms especially the ones that v2 couldn't earlier compete with for example stablecoin amms like curve it is also crucial that v3 launches in parallel on optimism optimism is an optimistic rollup based layer 2 scaling solution that enables fast and cheap transactions without sacrificing layer 1's security at the moment optimism is partially rolled out and has started integrating with a few selected partners like synthetics uni swap on layer 2 should be able to attract even more users who might have been priced out by high gas fees on layer 1. exchanges enabling withdrawals to optimism would be another big step towards the quick adoption of v3 on layer 2. on top of the v3 launch an imminent full launch of optimism will clearly be another highly anticipated event to wait for besides this the migration from v2 to v3 will be done on a fully voluntary basis in case of v1 to v2 migration it took just over 2 weeks for v2 to surpass v1's liquidity it would be also interesting to see if unisop's governance decides to further encourage lps by voting in some kind of incentives only present in v3 maybe another liquidity mining program with the super high capital efficiency of v3 even if the existing liquidity is split between v2 v3 and v3 on optimism it should still be way more than enough to facilitate trading with load slippage across all of these three protocols one challenge of v3 is that providing liquidity may become a bit harder especially for less sophisticated users choosing a wrong price range may magnify the chances of being affected by impermanent laws and it will be interesting to see a development of third-party services that could help with choosing optimal strategies for allocating liquidity so what do you think about uni swap v3 will this be a game changer in the amm space will uni-swap on optimism bring even more users to defy comment down below and as always if you enjoyed this video smash the like button subscribe to my channel and check out cinematics on patreon to join our defy community thanks for watching

Channel: Finematics

Views: 119,437

Keywords: uniswap v3, uniswap, uni tokens, amms, automated market makers, defi, crypto, ethereum, price curve, liquidity

Id: Ehm-OYBmlPM

Length: 16min 49sec (1009 seconds)

Published: Tue Mar 23 2021

Reddit Comments

[u/klock23s]

Ha, that was ridiculously fast!

[u/JollySno]

Whoa! V3 is a game changer!

[u/potcasso]

Absolute game changer for DEFI. The v3 whitepaper also mentions enabling the uniswap dao to vote on setting a « protocol fee » redeemable with UNI tokens

[u/Kendrydouble07]

This is very interesting. Thanks for sharing