Uniswap v3: What’s changed from v2?
Concentrated Liquidity
In Uniswap v2, liquidity is distributed evenly along an x*y=k price curve, with assets reserved for all prices between 0 and infinity. Because of this, a mere fraction of the liquidity of an LP is active while the rest of it remains inactive. This results in saturation of the trading fees amongst all liquidity providers – it is capital inefficient. In an ETH/DAI pool, as trades occur for ETH between 3500 DAI – 4000 DAI, every single LP earns a portion of the trading fees which results in a lower amount for all.
Uniswap v3 solves this issue of capital inefficiency by allowing for “liquidity concentration”: the protocol allows liquidity providers to select a price range within which they want their assets to be traded. For example, LP1 can add ETH to the ETH/DAI pool to be traded in 3500 DAI – 4000 DAI range, while another slightly more bullish LP2 can add ETH to be traded in the 4000 DAI – 4500 DAI range. As ETH is traded within 3500 – 4000 DAI, only LP1 will earn portions of the trading fees and LP2 will earn nothing! And, only LP2 will earn as ETH is traded between 4000 – 4500 DAI! This lowers the number of LPs between each price range, increasing the fees earned by each LP overall. This drastic increase in capital efficiency is what makes v3 much better than v2.
Let’s say that you had 68,000 DAI and 17 ETH you wanted to deposit into the ETH/DAI pools. You choose to put it inside the $4000-$4500 price range. At the same time, your friend deposited 900,000 DAI and 225 ETH across the entire price curve. What happens is – even though your friend deposited 13.2x as much capital as you, both of you get the same amount of fees as long as the ETH/DAI price stays within the $4000-$4500 range. This means that your capital is 13.2x more efficient.
Uniswap claims that the maximum capital efficiency could reach 4,000x in a 0.10% price range. They also say that when deployed on L2, those gains will go up to mind-blowing 20,000x.
To maintain specific price ranges, LP positions will be represented by non-fungible tokens (ERC721).
Range Orders
Uniswap v3 also allows a liquidity provider to just provide a single token in a price range above or below the current price. For example, if the price of ETH is currently at $3450, an LP can provide ETH to be traded between $3500 – $3750. Between that range, the LP earns trading fees, and at $3750+ the position is liquidated and the LP gets their ETH as well as the fees earned.
Multiple Fee Tiers
0.05% – expected for stablecoin pools like DAI/USDC
0.30% – for standard non-correlated pools like ETH/DAI
1.00% – for exotic non-correlated pairs
Uniswap v3 also allows governance to establish new fee tiers (between 15% - 25% of LP fees).
TWAP Oracles
Uniswap also announced improved TWAP (time-weighted average price) oracles that can calculate any TWAP in the past ~9 days in a single on-chain call, allowing for cheaper calculations around moving averages or outlier analysis. Uniswap also claims that the improved oracles can reduce gas fees due to their efficiency.
Comparing top protocols’ liquidity among top 10 pools.
Overall Volume
With the rollout of UniSwap v3 most of the liquidity has transferred over from Uniswap v2, though v2 still holds considerably more liquidity than major competitor SushiSwap. In fact, the top ten pairs on UniSwap v3 see an average of 2.6x more volume per week than the top ten pairs on UniSwap v2, and 6.4x more than SushiSwap.
Efficiency of Volume
While volume remains paramount for judging the popularity of protocols, what UniSwap v3 has done to improve liquidity utilization in comparison to v2 and SushiSwap is striking.
The graph helps visualize the immense improvement in liquidity utilization that changes made for UniSwap v3 have brought around. In fact, over a 7 day period the volume / TVL is a staggering 5.21, with the next closest being 2.08 for UniSwap v2, and a measly 0.66 for SushiSwap. One interesting note is that SushiSwap had a higher 24 hr volume / TVL compared to UniSwap v2, but UniSwap v3 was still almost 6x more efficient.
Comparing liquidity utilization amongst chains on UniSwap v3
Volume by Chain
Given that UniSwap v3 is by far the most efficient protocol compared to its competitors, our research led us to see which blockchains within UniSwap v3 were the most capital efficient. It must first be noted that obviously Ethereum has much higher total volumes in comparison to those we are comparing against (Abritrum, Optimism, Polygon), however using the ratio of volume / TVL helps eliminate this discrepancy. Moreso, Abritrum, Optimism, and Polygon all have similar 24 hr and 7 day volumes, relative to Ethereum.
Efficiency by Chain & Polygon’s Dominance
Now for the interesting part. Separated by blockchain on UniSwap v3, the Polygon liquidity pools had by far the highest liquidity utilization rates. For 24 hours / TVL, Polygon had a liquidity utilization ratio of 1.57, which was 4.76x more efficient than Arbitrum in second place, and 5.6x more efficient than the Ethereum pools. Over a 7 day period Polygon pools were even more impressive, coming in with a ratio of 14.25, which is 5.99x more efficient than the Ethereum pools, which came in second with a ratio of 2.38. Not only is UniSwap v3 magnitudes more efficient than its competitors, but the liquidity pools with assets on the Polygon network have been unbelievably more efficient than any other type.
Comparing liquidity utilization of similar pools cross-chain
To continue our research, we compared important liquidity pools across Ethereum, Polygon, and Optimism and found that Polygon is more capital efficient, with lesser fee ratios, with respect to its competitors.
Specific liquidity pools highlighted:
This is a side by side comparison of the liquidity utilizations (24H Volume / TVL) of three blockchains on Uniswap v3. It is abundantly clear that Polygon trumps Ethereum & Optimism by a great margin, nearly 2x more efficient than Optimism and 14x more efficient than Ethereum for the ETH-USDT .3% pool. In fact, on average, excluding the MATIC-USDC .3% skew of 1800x more efficiency, Polygon is 12x more efficient than Ethereum. It is also 3x more efficient than Optimism for liquidity utilization.
Uniswap v3: The Future of Staking
The most radical upgrade of Uniswap yet could also become an industry standard in the coming year. Active staking through range orders and concentrated liquidity are exponentially more capital efficient, while generating greater returns for liquidity providers. Upgrades to oracles and allowing governance to set fee tiers could bring in a whole new DeFi world, the only question is: on what layer 1 will this be built?
Polygon’s Success
The changes made to improve upon UniSwap v2 with the release of UniSwap v3 has been a benefit to all DeFi users through its far more efficient use of liquidity, however the real winners are those that have chosen to deposit assets into liquidity pools on the Polygon network. Polygon shows the best efficiency among top 10 liquidity pools and when compared to similar pools on competing networks. Not only is this great news for Polygon, as it is cementing itself as the premier scaling solution for Ethereum, but also for those liquidity providers who are able to make more trading fees per $1 of liquidity deposited.
(All data taken via UniSwap v3 1/04/22 - 1/05/22)
Written by:
Jack McCarthy, a current college student involved in the Boston College Blockchain Club. Especially interested in DeFi and NFT technology.
Twitter: https://twitter.com/offdeblockchain
email: jack@polygon.technology
Akhil Vajhala, a current college student involved in NYU’s Blockchain Club.
email: akhil@polygon.technology