A Closer Look at Uniswap V3: The Good, Bad and Ugly

On May 5^th, Uniswap V3, one of the most awaited updates in the decentralized finance (DeFi) space, launched to better liquidity provision, new automated market-making (AMM) features, and a host of other developments. Uniswap V3 has seen its trading volumes grow by more than 80% in less than a month compared to its predecessor, Uniswap V2.

The core feature for Uniswap V3 is the “custom liquidity” ranges which allow users to connect AMMs with traditional limit order books.  This unlocks the passive capital stored on AMMs by making it easier to deposit assets into a pool while “maintaining a strategy helped in bootstrapping long-tail liquidity”, according to a research article by The Block and sponsored by Amber Group, a global crypto finance service provider.

Apart from helping low cap/volume tokens bootstrap liquidity, which allows users to turn their passive capital into active fee-earning assets, Uniswap V3 also offers greater capital efficiency as well as new features such as range orders, non-fungible liquidity, and flexible fee tiers.

While Uniswap V2 AMMs made a case for passive liquidity provision (LP) strategies achieving capital efficiency by giving fungible LP tokens more uses, they still lag behind active LP strategies – a problem the new upgrade is set to solve as liquidity increases.

“The problem with adding features to LP tokens is that while they can increase utility for LPs, those benefits don’t sufficiently carry over to traders” – An Early Look at Uniswap V3 Activity

On DEXes, traders are looking for maximum fees to be collected by holding their LP tokens on the platform and minimizing the price impact on trades. Having passive market strategies at an infinite price range means that the trades are not executed at the optimal range, which means fewer fees from the liquidity pools.

“In normal AMMs such as Uniswap V2 and Sushiswap, the distribution (of liquidity) is much more like a normal distribution where the liquidity is across this infinite range, where it’s across a broader range, whereas in Uniswap V3 you start to see these asset-specific liquidity concentrations essentially form,” Mika Honkasalo, a researcher at The Block stated in an interview with Amber Group on the Crypto Unstacked Podcast.

This issue is further exacerbated as DEX trading moves to cheaper platforms such as Layer-2 solutions (e.g. rollups), sidechains, or alternative L1s to Ethereum. However, as capital gradually migrates from V2 to V3, the move to optimistic rollups or other L2 solutions will lower the capital barrier to liquidity provision – making transactions cheaper and faster – providing a catalyst from DeFi “blue chips” to move to the new upgrade.

On Uniswap V3, liquidity providers will also have the luxury of setting their custom trading fees – ranging anywhere between 0.05% and 1%. These fees could be higher for more volatile pairs in the concentrated liquidity positions. According to the article, UNI token holders will be able to vote to receive a cut from each asset pool – estimates ranging from 10% to 15% of the trading fees.

If passed, it’s most likely the majority of the trading fees will be sent to the UNI Treasury vault. However, if even a small percentage is distributed to UNI token holders, their passive income could increase drastically.

All in all, the launch of Uniswap V3 is set to revolutionize the DeFi industry. However, LP strategies on Uniswap V3 are yet to fully show their potential in the early days, and time will tell how sophisticated they could be in the future.

About Amber Group

Amber Group is a leading global crypto finance service provider, operating 24/7 with a presence in Hong Kong, Taipei, Seoul, and Vancouver. To date, Amber Group has cumulatively traded over $330 B and exceeded $1B in assets under management. In 2019, Amber Group raised $28M in Series A funding led by global crypto heavyweights Paradigm and Pantera Capital, with participation from Polychain Capital, Dragonfly Capital, Blockchain.com, Fenbushi Capital, and Coinbase Ventures.