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With the maturity of professional market-making teams and active market-making agreements, Uniswap V3 may bring huge profits to professional institutions, but it will become increasingly difficult for ordinary retail investors to participate.
Original title: “Understanding the development trend of Uniswap V3: Can high capital utilization and low handling fees disrupt centralized exchanges? 》
Written by: PANews
Uniswap has been iterating from V1 to the current V3, and it has always been a surprise. Uniswap V3 updates include granular control of aggregate liquidity, range orders, multi-level rates, advanced oracles, etc. Uniswap V3 gives users more autonomy. Among them, allowing users to customize the liquidity range can realize the functions of liquidity aggregation, range orders, and limit orders.
In Uniswap V2, all liquidity is allocated in the interval from 0 to positive infinity according to the constant product curve k=x*y, but the prices on both sides of the interval are difficult to reach, so a large amount of funds are idle. For some specific trading pairs, price fluctuations may be limited to a very small range. If funds are still allocated in the entire range, it will cause great waste. Many projects have been optimized on this basis and have also been successful. For example, Curve has chosen to optimize the joint curve to concentrate liquidity in a specific range for the trading of similar assets such as stablecoins.
In this upgrade of Uniswap V3, the concept of “Tick” is introduced, which also makes Uniswap and traditional order book transactions more and more similar.
Tick is not unique to Uniswap. In traditional futures trading, Tick is used to refer to the smallest fluctuations in contract prices. Uniswap V3 allows liquidity providers (LPs) to customize the liquidity range. The minimum and maximum prices set by LPs represent the minimum and maximum values of Tick. The liquidity of LPs is distributed on each Tick in the range. , These data are reflected in the NFT generated after providing liquidity. Transaction fees are calculated separately in each tick and allocated to users according to the proportion of each user’s liquidity on that tick.
When the market price fluctuates due to a transaction, it may pass through several ticks, and after the original liquidity is exhausted, it will become liquidity in the opposite direction. For example, for a USDT/WETH trading pair with a handling fee of 0.3%, the ETH price within the range of 1204.8 to 3904.9 corresponds to a tick of -205380 to -193620. When the price falls below the corresponding price of Tick -205380, the liquidity of a buy order above the Tick It will become a sell order liquidity.
By customizing the liquidity range and rate, Uniswap V3 will double the utilization of funds.
Higher capital utilization
Comparing the data of Uniswap V3 and Uniswap V2, Uniswap V3 currently captures more transaction volume by virtue of lower liquidity than V2. Taking the data on May 28 as an example, as shown in the figure below, Uniswap V3’s lock-up volume was only 1.58 billion U.S. dollars, but the trading volume in the past 24 hours was 923 million U.S. dollars. Uniswap V2 has a lock-up volume of 5.72 billion U.S. dollars, and the trading volume in the past 24 hours is only 741 million U.S. dollars.
Similarly, in comparison with other exchanges, Uniswap V3’s data is also very eye-catching.
SushiSwap’s lock-up volume on Ethereum is 3.32 billion U.S. dollars, and the 24-hour trading volume is 142 million U.S. dollars.
The PancakeSwap lock-up volume on BSC was US$8.2 billion, and the 24-hour trading volume was US$920 million.
The QuickSwap lock-up volume on Polygon is US$940 million, and the 24-hour trading volume is US$229 million.
From the perspective of capital utilization, Uniswap V3 deserves to be the best decentralized exchange. Even from the perspective of trading volume alone, Uniswap V3 has become the DEX with the highest trading volume currently due to its not high lock-up volume.
Similar asset transactions
In the transaction of similar assets, among the decentralized exchanges, Curve firmly occupies the main market by virtue of its low slippage and low handling fee (0.04%). Other decentralized exchanges usually require a 0.3% handling fee, which is completely uncompetitive for transactions such as stable coins that usually have a large amount. In terms of centralized exchanges, Binance waived the handling fees between its own BUSD and other stable currency trading pairs to maximize the application scope of BUSD.
After Uniswap V3 is launched this time, users can set the liquidity between stable currency trading pairs with small fluctuations to a very small range. For example, the USDC/USDT trading pair can limit the liquidity range to a small range of 0.994～1.005. Within range. Through the extremely high capital utilization rate in a small area, LPs can gain profits and have a stable currency trading experience comparable to Curve.
Compare 100000 USDT to USDC, get 100006 USDC in Uniswap and 100018 USDC in Curve. If considering the gas fee gap between the two transactions, Uniswap V3 may bring a better experience.
The income of stablecoins on decentralized platforms also decreases with the inflow of funds and the maturity of the platform. Take the data of May 28 as an example, the return rate of the Y pool in Curve is 2.18% of the basic APY of the transaction plus the CRV reward 0.88%～2.21%. If CRV tokens are not pledged, then the comprehensive annual return rate of the Y pool Only 3.07%.
Compare the three stable currency trading pairs USDC/USDT, DAI/USDC, DAI/USDT with a transaction fee of 0.05% in Uniswap V3, based only on the TVL on May 28 and the 24-hour trading volume, in the absence of token incentives Below, the APY is calculated to be 8.7%, 5.7%, and 12.1%, respectively, which exceeds the return rate of most stablecoin pools in Curve. Therefore, for LPs, the liquidity of stablecoin trading pairs provided in Uniswap V3 can also obtain higher returns than Curve.
Cross-asset transactions with low handling fees
After the success of Uniswap’s AMM mechanism, various DEXs that imitated Uniswap will set the transaction fee to be the same 0.3% as Uniswap, which makes the friction of on-chain transactions far greater than that of centralized exchanges. Taking Binance as an example, in the absence of invitation rebates or other fee reductions, the currency transaction fee is only 0.1%. If BNB is used for deduction, the fee can be reduced to 0.075%.
Uniswap V3 can customize the handling fee ratio, and currently there are three levels of 0.05%, 0.3%, and 1% to choose from. If the transaction volume is greater through lower handling fees, and the final APY of LPs is not lower than other gears, it is likely to attract LPs to choose a handling fee ratio of 0.05%.
From the figure below, the liquidity of the ETH/stable currency trading pair is still concentrated in the trading pair with a fee of 0.3%. Among the trading pairs with a handling fee ratio of 0.05%, the yields of ETH/USDC and ETH/USDT are lower than most other trading pairs, while the yields of ETH/DAI are much higher than other trading pairs. In the case of insufficient liquidity, the daily fee income will fluctuate greatly. In general, the return rate of the 0.05% ETH/stable currency transaction pair may be slightly lower than 0.3%.
According to Uniswap founder Hayden Adams at the Consensus 2021 conference, Uniswap is providing funds through grants to allow the community to build a liquidity mining smart contract. Any project that wants to incentivize liquidity can use this contract. If the community governance passes, UNI A liquidity mining plan may be launched.
If liquidity mining rewards can be used for major trading pairs that require the most incentives with a fee of 0.05%, then Uniswap’s trading friction may be much lower than that of centralized exchanges, thereby subverting the existing decentralized exchanges. The centralized and centralized exchange makes Uniswap the biggest competitor of Coinbase, as reported by the Wall Street Journal.
In less than a month since Uniswap V3 went online, the daily trading volume of Uniswap V3 has almost surpassed all decentralized exchanges. From this, we can also see some future trends.
- Uniswap V3’s liquidity will continue to grow. After the 5.19 drop, the TVL of decentralized platforms such as Uniswap V2 was greatly affected, and the liquidity of Uniswap V2 is now only about half of the highest point. The liquidity of Uniswap V3 continued to grow after a short period of decline.
- The growth rate of transaction volume may not keep up with the growth of liquidity. In recent days, while liquidity has grown, Uniswap V3’s trading volume has continued to decrease due to the overall inactivity of the market.
- The attractiveness of transaction fees to ordinary users will continue to decrease, and the risk/benefit ratio will increase. Without a sufficiently good strategy, the current risk of providing liquidity in Uniswap’s inter-community areas is extremely high. Although Uniswap can double the efficiency of capital use, the impermanence loss is also doubled. According to the calculation of htdefi-lab.xyz/simulator, if the liquidity is concentrated at half to twice the market price, and the capital utilization rate is 3.41 times the original, then the impermanence loss will increase proportionally when the market fluctuates. According to actual experience, the average liquidity of the current ETH/USDT trading pair with a handling fee of 0.3% is far more concentrated than this. Under the circumstances that the current market price fluctuates greatly, after the liquidity is aggregated, the impermanence loss may not be enough to make up for the fee income.
- Liquidity will continue to gather near the market price and change with changes in market prices. Taking the current ETH/USDC trading pair with the best liquidity as an example, the price of ETH is 2505 USDC, and the liquidity is mostly distributed in the range of 2,000 to 3,400 US dollars. It can also be seen from the figure below that in the range of 2560-2600 US dollars, there are large orders here to provide liquidity. When the price rises above this range, all ETH of the user is sold, providing liquidity and order trading. Time is no longer inseparable.
- Uniswap V3 will benefit from the development of Layer 2. Uniswap V3’s market-making strategy will be more flexible on Layer 2, reducing the impact of gas fees. Uniswap had originally maintained a good cooperative relationship with Optimism, but due to the delay of Optimism’s main network, Uniswap V3 failed to be launched on Layer 2. And another Layer 2 star project, Arbitrum, is about to go online and may usher in a first-mover advantage. Uniswap has voted on Snapshot and is preparing to deploy Uniswap V3 on Arbitrum, which was passed with a 100% approval rate.
- New professional market-making institutions and active market-making strategies based on Uniswap V3 will continue to emerge, and there may be an excellent pool of market-making machine guns. A number of outstanding projects have emerged, such as Lixir, Charm Alpha Vault, Visor, Method Finance, etc. A brief introduction will be made below.
Lixir: Uniswap V3 is a market-making strategy provider that can keep market-making funds concentrated, and as market prices move, ensure more liquidity near the market price and help reduce impermanent losses.
Charm Alpha Vault: to help liquidity rebalance funds. For example, the initial value of ETH and USDC is 1:1. When the market price drops and the ratio of ETH increases, Alpha Vault will first withdraw its liquidity and re-provide liquidity based on the available funds of ETH and USDC 1:1. In the high price range, only ETH is used to provide liquidity.
Visor: An active liquidity management tool. Provide self-hosted mining, reward fee accumulation and time locking functions, including three components: Visor Vault, Hypervisor, and Supervisor. The Visor machine gun pool can lock the LP NFT to prevent the project team from withdrawing funds and running away. Hypervisor can obtain liquidity rewards according to the predetermined transaction range. Supervisor can update Hypervisor preset parameters, manage assets, and execute strategies.
Method Finance: Close to Visor, allowing users to self-host Uniswap LP NFT in the form of an NFT treasury.
Uniswap V3 significantly improved the capital utilization rate, enabling Uniswap V3 to obtain a larger transaction volume when TVL only had 27.6% of Uniswap V2. With the maturity of the professional market-making team and the active market-making agreement, Uniswap V3 may bring huge profits to professional institutions, but it will become increasingly difficult for ordinary retail investors to participate, and the risk of impermanent loss is difficult for retail investors to control.
In general, Uniswap V3 is a beneficial update for most people. Traders have better liquidity. Professional market makers can use their own technology and capital advantages to obtain a higher fee ratio than centralized exchanges. Projects In the initial stage, you can also customize the rate and liquidity range to reduce the impact of previous price fluctuations.
If Uniswap V3 can push the 0.05% fee ratio to the mainstream, it is likely to truly subvert the existing cryptocurrency trading system. From the current data, the difference between the LPs income of the ETH/stable currency trading pair with a handling fee of 0.05% and the 0.3% is not obvious. If compensation can be obtained from Uniswap V3’s liquidity mining, it may increase the market share of 0.05% fee transactions.