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Uniswap v1 was launched in November 2018 as a proof of concept for automated market makers (AMMs), a type of exchange where anyone can pool assets into shared market making strategies.
In May 2020, Uniswap v2 introduced new features and optimizations, setting the stage for exponential growth in AMM adoption. Less than one year since its launch, v2 has facilitated over $135bn in trading volume, ranking as one of the largest cryptocurrency spot 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.
Today, we are excited to present an overview of Uniswap v3. We are targeting an L1 Ethereum mainnet launch on May 5, with an L2 deployment on Optimism set to follow shortly after.
Uniswap v3 introduces:
- 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 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
Uniswap's oracles are now far easier and cheaper to integrate. V3 oracles are capable of providing time-weighted average prices (TWAPs) on demand for any period within the last ~9 days. This removes the need for integrators to checkpoint historical values.
Even with these groundbreaking design improvements, the gas cost of v3 swaps on Ethereum mainnet is slightly cheaper than v2. Transactions made on the Optimism deployment will likely be significantly cheaper!
Read on for more details on Uniswap v3. For a deeper technical overview check out the Uniswap v3 Core whitepaper, the Uniswap v3 Core smart contracts.
In Uniswap v2, liquidity is distributed evenly along an x*y=k price curve, with assets reserved for all prices between 0 and infinity. For most pools, a majority of this liquidity is never put to use. As an example, the v2 DAI/USDC pair reserves just ~0.50% of capital for trading between $0.99 and $1.01 , the price range in which LPs would expect to see the most volume and consequently earn the most fees.
V2 LPs only earn fees on a small portion of their capital, which can fail to appropriately compensate for the price risk ("impermanent loss") they take by holding large inventories in both tokens. Additionally, traders are often subject to high degrees of slippage as liquidity is spread thin across all price ranges.
In Uniswap v3, LP's can concentrate their capital within custom price ranges, providing greater amounts of liquidity at desired prices. In doing so, LPs construct individualized price curves that reflect their own preferences.
LPs can combine any number of distinct concentrated positions within a single pool. For example, an LP in the ETH/DAI pool may choose to allocate $100 to the price ranges $1,000-$2,000 and an additional $50 to the ranges $1,500-$1,750.
By doing so, an LP can approximate the shape of any automated market maker or active order book.
Users trade against the combined liquidity of all individual curves with no gas cost increase per liquidity provider. Trading fees collected at a given price range are split pro-rata by LPs proportional to the amount of liquidity they contributed to that range.
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.
Let's illustrate with an example:
Alice and Bob both want to provide liquidity in an ETH/DAI pool on Uniswap v3. They each have $1m. The current price of ETH is 1,500 DAI.
Alice decides to deploy her capital across the entire price range (as she would have in Uniswap v2). She deposits 500,000 DAI and 333.33 ETH (worth a total of $1m).
Bob instead creates a concentrated position, depositing only within the price range from 1,000 to 2,250. He deposits 91,751 DAI and 61.17 ETH, worth a total of about $183,500. He keeps the other $816,500 himself, investing it however he prefers.
While Alice has put down 5.44x as much capital as Bob, they earn the same amount of fees, as long as the ETH/DAI price stays within the 1,000 to 2,250 range.