The biggest advantage of Uniswap V3 lies in higher capital efficiency, but if there is a large amount of arbitrage, liquidity providers will still face major impermanence losses.
Original Title: “IOSG Weekly Brief | Uniswap V3 Savage Growth #76”
Written by: IOSG Ventures
The most anticipated upgrade of top-level AMM is finally here! On May 4, the Uniswap V3 contract was officially launched on the Ethereum mainnet. After full demonstration, we finally have some views on the advantages of Uniswap V3.
The biggest advantage of Uniswap V3 is higher capital efficiency. With the same amount of funds, V3 has a lower slippage than V2. Therefore, V3 can mobilize more stock funds than V2. In order to verify the capital efficiency of Uniswap V3, we compare the total lock-up turnover rate with Uniswap V2 and Sushiswap.
Image source: IOSG Ventures
In general, Uniswap V3 does have higher financial efficiency in a short period of time. As shown in the figure, the TVL turnover rate of V3 is higher than that of V2 and Sushiswap. At the highest point, the TVL turnover rate of V3 is much larger than that of V2. In V3, every 1 USD of TVL can generate a daily trading volume of 0.7 USD, while the same funds in V2 can only generate a daily trading volume of 0.2 USD. In addition, the data after the launch of V3 shows that Uniswap generates a transaction volume of $5 for every $1 added to the pledged fund pool, while in the same situation, Sushiswap can only generate a transaction volume of $1.3.
The capital efficiency advantage of V3 is obvious, what is the price that comes with it?
As we all know, one of the problems of V2 is the impermanence loss faced by liquidity providers, and V3 also has this problem. But the size of the loss in V3 depends on the behavior of the liquidity provider. In other words, in V2, LP is quite static relative to arbitrage, while in V3, both parties can actively manage their positions.
So there are two possible scenarios. The first situation is that liquidity providers have better prices, which will crowd out arbitrageurs from the market. This requires mature LPs to continuously adjust their price ranges to correctly map market price changes before the arbitrageur takes any action. However, although this can ensure that the LP will not be lost, it will also reduce the potential transaction volume of the agreement, because automatic trading occupies a large proportion in Uniswap v2 and Sushiswap.
The second case is for the less mature LP. Assuming that there is still price discovery in centralized exchanges such as Binance, liquidity providers with too narrow price adjustment ranges and slow actions will be defeated by arbitrageurs. A narrow price range means greater depth of liquidity, because the greater the price volatility, the higher the risk of loss.
For example, if the price of ETH is 3,500 US dollars, LP can set a price range of 3490 US dollars-3510 US dollars. If the external price of ETH rises to 3600 USD. A rational LP will immediately adjust its price range to around $3,600. Otherwise, due to price differences, she will expose her selling risk exposure to arbitrageurs. Conversely, if the price drops to $3,300, unless the LP adjusts her price downward, it will not provide liquidity and will not receive transaction fees.
So what is the current situation?
Although it is too early to judge, based on experience, we can check the trading volume of the top 10 arbitrageurs in Uniswap V3 and V2. The more professional the LP’s market making, the less arbitrage activities, and the less loss of liquidity providers. If there is a lot of arbitrage, the situation is just the opposite.
As shown in the table below, the total transaction volume of the largest arbitrageur on Uniswap V3 accounts for 12% of the total volume since V3 was launched! This means that this address alone has generated more than $670 million in funds (identified as Wintermute by Nansen.ai). In addition, the top 5 arbitrage robots account for about 22% of the total transaction volume, which is much higher than the V2 level. In the V2 version, the top 5 arbitrageurs accounted for almost less than 5% of the total transaction volume. This also shows that LP suffered heavy losses in the early stage of V3.
Image source: IOSG Ventures
Image source: IOSG Ventures
With the huge volume of early-stage arbitrage trading on V3, Uniswap introduced Visor Finance, an active liquidity management tool, to manage multiple positions, automatically balance liquidity according to market prices, reinvest commissions, and rewards. Therefore, there are currently two paths. In the first case, mature LPs are completely specialized; in the second case, less-professional LPs rely on tools such as Visor to actively manage liquidity.
How will it develop in the future?
We expect that arbitrage participation in the V3 version will gradually decrease over time for the following reasons:
Risk control: LP can better grasp risks after learning from the past
Innovative design: Visor, an active liquidity management tool
Deploy Layer 2: Can make frequent adjustments at low cost
In addition, the Uniswap ecology cannot be underestimated. Take the Grants project as an example, which devotes a lot of resources to creating key developer tools, adding high-quality data, and launching key services in the Uniswap ecosystem.
Some ecological projects of Uniswap Grantee
For complete project details, please click the link: https://www.notion.so/3430a00270ea4d79be5c70d4ca99680a?v=cb2ce86b52194b759428b458f9717749
Uniswap V3 has made a good start. Although there are areas for continuous improvement, we are still optimistic about the future development of V3. Eventually we will see more professional market makers become liquidity providers, squeezing out arbitrageurs with better pricing. The brutal growth of V3 has just begun. Will it become the end point of the DEX competition? let us wait and see.
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