On May 5, 2021, the Uniswap team officially deployed the third version of the Uniswap platform on the Ethereum mainnet and released it. Uniswap was upgraded to the second version last May, and the third version comes a year later. Uniswap V3 protocol is expected to provide users with more control over the liquidity they deposit and riskier transactions with much room for increase.
Uniswap V3 (hereinafter referred to as Uni v3) brings many new features, including Concentrated Liquidity, Range Order, long positions, and multiple fee tiers, which can greatly improve the efficiency of funds. Since the announcement of Uni v3, there have been mixed reviews from the outside, but some keen third-party teams have begun to develop innovative applications with novel features on Uni v3 as complements to its performance. This article is divided into two parts: First, we will analyze the innovative functions of Uni V3, and second, we will introduce some noteworthy projects built on Uni v3.
I. What are the innovative features of Uniswap v3?
1. Concentrated Liquidity
In Uni v2, liquidity is evenly distributed along an X*Y=K price curve, that is, the liquidity provided by each price is the same, which can be visually represented in the following figure. A majority of this liquidity is never put to use in most liquidity pools, and only a small part of the liquidity provided by LPs can generate income from transaction fees, resulting in extremely low capital efficiency.
This mechanism has been improved in Uni v3. In its mechanism of Concentrated Liquidity, LPs can deposit liquidity within a specific price range, and thus gather market-making funds in the most concentrated range of transactions, as shown in the figure below. Therefore, an LP can construct a personalized price curve that reflects his or her own preferences, and in the meantime earn transaction fees proportional to his or her liquidity contribution within a specific range.
2 . Range Order
Uni v3 introduces a function similar to "limit order", allowing users to provide liquidity within a specific price range. If the market price exceeds the price range specified by LPs, they sell one asset for another along a smooth curve while earning swap fees in the process. Trading of range orders is reversible. If the LP does not withdraw liquidity after the asset exceeds the price range, the position will return to the original level when the price enters the range again.
As shown in Figure 3, suppose the current price of DAI is below 1.001 USDC. An LP can deposit his or her DAI to a narrow range between 1.001 and 1.002. Once DAI trades above 1.002DAI/USDC, the LP’s liquidity will have fully converted into USDC. He or she must withdraw the liquidity to avoid automatically converting back into DAI if DAI/USDC starts trading below 1.002. In this way, theoretically, LPs can continuously update the price range to match the current market price.
3. Non-fungible Liquidity
Since each LP can make a market and obtain income in a different price range according to their contribution to liquidity, the liquidity position is not interchangeable, and each LP Token may be unique. Considering the above, LP positions are represented by non-fungible tokens (NFTs) in Uni v3. Additionally, transaction fees are no longer automatically reinvested back into the pool on LPs’ behalf, but are collected and held by a single pool.
4. Multiple fee tiers
Uni V3 offers LPs three separate fee tiers per pair – 0.05%, 0.3%, and 1%. LPs can set higher fees on trading pairs with greater volatility and higher risks (such as ETH/DAI), and, conversely, set lower fees on trading pairs with lower volatility and lower risks (such as USDC/DAI). The community can also add additional fee tiers through governance as needed.
II. What Advantages Does Uni V3 Bring?
1. Capital efficiency improved
Uni v3's concentrated liquidity mechanism can improve capital efficiency. For protocols, Uni v3 can be launched with fewer funds, which quickly forms an advantage in common trading pairs, and the migration of LPs could be faster; for traders, the slippage they face when they provide liquidity within a small range will be lowered. But in the long-tail market, price fluctuations in the short term will be more likely to exhaust liquidity due to LPs’ liquidity switching.
From the perspective of unit capital, LPs can provide the same depth of liquidity as Uni V2 within a specified price range using fewer tokens. Then the remaining funds can be used to increase the risk exposure within the specified price range to earn more transaction fees, or they can be invested in other assets or DeFi protocols to obtain income. At this time, the best strategy for LPs is to actively make the market and continue to concentrate its funds near the market price to earn more income. However, in this case, the balance between ordinary LPs and professional LPs will be broken. In Uni v2, each LP can easily provide liquidity and share the yields of the liquidity pool in proportion, without any competition mechanism.
In Uni v3, professional LPs can concentrate funds near the market price through analysis and judgment of trading pairs to obtain higher income; while ordinary LPs who do not actively provide liquidity may add liquidity to a wider range. As a result, most of the liquidity needs will be covered by professional LPs, and ordinary LPs can only get a low share of income. What’s worse, a wrong price range may magnify the impact of impermanent losses. In other words, in Uni v3, every LP faces competition. A bad strategy generates negligible income. Therefore, professional LPs will get more income, enjoying an incomparable advantage over their ordinary counterparts. Uni v3 endows professional LPs with a greater advantage.
Against this backdrop, there may be more efficient aggregation protocols or market-making tools for ordinary LPs like HummingBot, which can provide functions such as automatic concentration based on market prices, reinvestment of transaction fees, and optimization of long positions, or, in a more general way, dynamically adjust all LP funds around the market price range, bringing ordinary LP and professional LP back to the same starting line. For example, DODO's PMM algorithm can actively adjust the bid-ask price, and actively make the market according to external market prices, so that a larger part of the liquidity is concentrated around the market price of assets, thereby improving capital efficiency and reducing impermanent losses; AMM of MCDEX V3 has introduced an index price to guide the transaction price, which can concentrate more liquidity near the index price.
2. AMM-style order book on the chain
Uni v3 provides AMM-style limit orders. Compared with simple limit orders, range limit orders adopt a liquidity pool to provide a wider price range. But one thing to note is that the trading of range limit orders can be switched between the two assets. If the traditional order-book market-making strategy continues, its effectiveness may be reduced. More tiers of market-making strategies may evolve in the future. For example, an LP can specify a range of price changes, create long positions and use spread orders to cover this range, combining passive and active strategies; or there may be peripheral contracts that automatically match market-making strategies through quantification. However, such complex market-making strategies may come with high gas costs. But this issue can be solved after the Optimism Layer-2 network is launched, making Uni v3 more user-friendly.
3. LP NFT
Uni v3 converts LP tokens into LP NFTs. Besides converting LP tokens in Uni v2 into LP NFTs, it will theoretically bring the composability issue to third parties that integrate Uniswap LP tokens. It can be solved through other contracts or peripheral contracts, thus converting LP tokens into NFTs and then realizing staking and other functions of LP NFTs. Take staking as an example. Users can stake their assets with only a signature. Only when the collateral is insolvent will the owner of the NFT be transferred and liquidation is executed. Transfers of the NFT staked in peripheral contracts that have been signed yet not substantially executed can, to a certain extent, solve the problem of high gas fees. In addition to staking, the combination of NFT and DeFi can also give birth to more complex derivatives contracts.
III. Competition
Uni v3 brings a brand new battlefield to LPs, where they can gain high profits only by actively making the market. Demands for protocols vary among participants, so Uni v3 also faces liquidity competition.
For professional LPs, Uni v3 is an arena where they can grab incomes of ordinary LPs. It is estimated that most of the fee income in Uni v3 will eventually go to professional LPs’ pockets. But still, Uni v3 has rivals in this regard. KyberPro, launched by the Kyber network as early as late October 2020, has deployed an on-chain professional market maker framework where professional LPs can efficiently make the market through Kyber’s professional liquidity protocol without the need to deploy or maintain their reserve contracts. In this way, they can weigh high revenue against the easy operation.
How to get more income and reduce the impact of impermanent losses are bigger concerns of ordinary LPs. Before Uni v3, Balancer released the second version, improving asset efficiency, flexibility, and gas efficiency. By lending unused assets in the AMM pool to the lending agreement, capital efficiency and yield can be improved. In addition, the Bancor v2 protocol launched in April 2020 is also one of the first solutions to capital efficiency and impermanent losses. With the fixed liquidity reserves, it dynamically adjusts the weight of the AMM pool in light of the price update of the oracle, so that the internal concentrated price is consistent with the external market price, thereby preventing arbitrageurs from stealing value from LPs in the form of impermanent losses.
For traders, one of the biggest influencing factors behind transaction demands is slippage. The DEX aggregation protocol is the best choice for traders as it can integrate liquidity and intelligently transfer orders so that users can access the best trading path, including speed, cost and efficiency. At present, the most important liquidity aggregators are 1inch and Matcha. 1inch’s proprietary off-chain Pathfinder API is used to optimize trading paths for users who ultimately execute transactions on 1inch’s on-chain contracts, while Matcha is a consumer-oriented aggregator, built by the 0x protocol, that aggregates liquidity and provides the optimal trading path using Ox API and smart order routing.
To conclude, DEX needs to win the favor of the majority of users and satisfy their various demands before it can gain liquidity. Whether Uni v3 can surpass other DEX protocols in this innovation to obtain more liquidity remains a question. Who will be the final winner? Let’s stay tuned.
Classification of Derivatives LP NFTs
Based on the above analysis, despite the many groundbreaking features that Uni v3 brings, it still needs some peripheral contracts to facilitate its performance. At present, some third-party projects have been developed and designed on Uni v3, including NFT yield farming, yield-farming solutions, and trading tools. Below are some projects worthy of attention.
1. Alchemist
Token: Mist
Website: https://alchemist.farm/
Alchemist originated from a tweet by @thegostep. There is no "development team" or company behind this project, but only an Alchemist community for decision-making. The community is mainly built on Discord. The icon of its official Twitter account is said to be a philosopher refining a stone with a crucible to explore the universe and achieve immortality. It sounds unreasonable and incomprehensible, but actually, it requires users to forge NFTs and deposit NFTs in Uniswap for profits.
The core developer of Alchemist @thegostep is one of the core developers of Ethereum, Ampleforth, and flashbots. Flashbots solves the MEV issue and greatly reduces the Ethereum gas.
According to the news released on Twitter, MIST is composed of Alchemist, Aludel Vault, and Crucible NFT (furnace NFT). Aludel Vault is a small vault that provides rewards for projects and liquidity providers who deposit NFTs in it. Crucible NFT is forged at the moment an LP deposits NFT. The NFT will be gradually upgraded according to the amount of funds and the depositing duration of the LP.
According to its official announcement on Twitter, Crucible NFT can be mined in Ample, Uniswap, Sushiswap and Aludel Vault simultaneously in the future, yet only on Uniswap in the current version.
MIST is the token of Alchemist. 1 million MIST coins are in initial circulation, inflation running at 1% (10,000 MIST coins put into circulation) every two weeks. 50% of the new coins are allocated to the Aludel Vault, 25% to the $mist community Multisig, and the remaining 25% to the $mist treasury. The burning plan is still soliciting opinions from the community.
Projects such as Alchemist provide liquidity through NFTs and can be well integrated with Uni v3. In the future, anonymous developers or communities can roll out more interesting features to attract more liquidity.
2. Visor
Token: VISR
Website: https://www.visor.finance/
Visor Finance is a smart vault. Users can deposit assets such as NFTs in it and interact with other smart contracts or external DeFi protocols. Visor NFT is based on Alchemist's Universal Vault, and users can lock their assets in multiple yield farming reward programs that run simultaneously.
The Visor system architecture can be divided into three parts. Visor Vault is a smart vault in which users can deposit funds and interact with smart contracts and other protocols securely. Such interaction with other protocols requires no transaction but only a signature for authorization; the management program Hypervisor is a compatible smart mining contract that can interact with Visor Vault and its funds. A Hypervisor contract can read the amount of assets in Visor Vault, perform targeted analysis, and reward a participant based on the required assets deposited in the vault. Instead of leaving the smart mining pool, assets in the same Visor Vault can participate in multiple similar mining at the same time to simultaneously generate more yields from multiple mining pools, thereby improving the efficiency of assets; Supervisor, a monitoring program, allows users to update/change certain defined variables in the Hypervisor contract to manage assets and implement strategies. An example of this would be a Supervisor that chooses to re-invest and change price ranges of a liquidity position on Uni v3.
Visor, combined with Uni v3, builds a smart mining pool based on LP NFT. Visor can tackle the insufficient liquidity of NFT in Uni v3 by integrating LP tokens in Uni v2 into Uni v3 to analyze NFT deposited by users and reward specific users based on their share of tokens. In addition, Visor has three main features: self-hosting mining, reward accumulation, and timelocks. Uni v3's LP NFT can be deposited in Visor to obtain yields from yield farming, and such yields can be reinvested into other protocols. The Visor smart mining pool allows users to time-lock their LP NFT to ensure the security of assets.
Visor has established Gamma, a new organization that will fund the research and implementation of strategies related to active LPs in Uni v3. Gamma is mainly to obtain appropriate data science and financial modeling resources, construct an effective and active market-making strategy, and provide services for Visor Finance users.
Visor can provide convenient operation for ordinary LPs, and, while improving the rate of return on assets, ensure ease of use, flexibility and security, so that LPs can customize functions according to their needs. It can also efficiently match resources for project developers. The concept of the project is novel and friendly to ordinary LPs. In the future, more functions may be derived to interoperate with other protocols.
3. Solv Finance
Token: SOLV
Website: https://solv.finance/
vNFT is a new token protocol created by the Solv team, specifically used to describe note tokens. vNFT is compatible with ERC721. It can describe multi-dimensional asset information, enable differentiated operations for each asset, and express complex lock-up conditions and release modes. Moreover, it supports free split and merge and shares assets, with each share available for further operations and status changes, so that complex NFT financial products can also become very flexible.
vNFT comes as a solution to interoperability and lack of liquidity in Uni v3.It introduces quantitative attributes and the functions of split, merge and partial transfer. If an LP wants to transfer part of the position to another price range, he or she only needs to divide tokens corresponding to the existing position into two parts according to the amount, and then wing one part of the price range, instead of withdrawing assets and then regenerating a new market-making position. Similar processing can also be carried out for operations such as transfer, staking, and transaction. Since there is a corresponding relationship between the number of LP Tokens and the underlying assets, the price of this asset is so transparent that it eliminates the trouble using other peripheral contracts or packaging assets into ERC20. In this way, both users and other DeFi protocols can be capable of processing, similar to ERC-20 LPs.
The ability of vNFT to describe the underlying assets at the protocol layer makes the mapping relationship between tokens and underlying assets as flexible as ERC-20, and makes it easy for Uni V3 to integrate LP tokens and the liquidity pool, bringing the simple and clear "two-layer asset" model, adopted by Uni v2 and most DeFi protocols, back into play.
4. Charm Alpha Vaults
Token: Cube
Website: https://charm.fi/?source=collection_home
Charm Finance, an on-chain option contract, launched a new contract named Alpha Vaults, which can automatically manage the liquidity of Uni v3 for higher yields from its centralized liquidity and regular rebalancing to reduce impermanent losses. At the same time, it can automatically charge transaction fees of Uni v3. Alpha Vaults shares are in the form of ERC-20, thus combinable and replaceable.
Alpha Vaults applies a passive rebalancing strategy. When providing liquidity in Uni v3, if the price fluctuates violently, the two initial assets deposited will gradually become a single asset, and it will no longer be possible to keep providing liquidity to get yields from transaction fees. The rebalancing strategy can rebalance the assets to 50/50. At this time, the liquidity on both sides will not be exhausted and will continue to gain yields. The active rebalancing strategy will bring 0.3% transaction fees and price shock, while the passive rebalancing strategy is to place a narrow range of orders at the current price to avoid token exchange, fees and price shocks. Therefore, passive rebalancing strategies can improve overall efficiency. According to their backtesting data, passive rebalancing strategies outperform active ones.
VI. Conclusion
Many new features of Uniswap v3 can improve capital efficiency and market-making flexibility, and, after Layer 2 is launched, it may significantly reduce gas fees and shorten transaction time, creating a smoother experience for Uniswap users. However, Uni v3 is still faced with many rivals as many AMM projects in the DEX field are also actively seeking liquidity. In the end, it still takes time to see which protocol can draw more liquidity and meet multiple demands for transactions or market making.
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