Interpreting Uniswap V3: 4 New Features, 2 Drawbacks, and 1 Question

This article is from Chain News, author: Pan Zhixiong.

The highly anticipated Uniswap has finally unveiled its new automated market maker (AMM) solution, version 3.0, and has released the white paper for this version in collaboration with researchers from Paradigm. Uniswap V3 enhances capital efficiency by "4000 times" by adding a feature called "concentrated liquidity" to the original AMM curve.

The team stated that Uniswap V3 has undergone multiple rounds of audits, but due to the significant changes, it will first launch on the testnet in a few days, with plans to officially go live on the Ethereum mainnet on May 5, and then possibly deploy to the Layer 2 solution Optimism network to further reduce gas costs.

In addition to the core feature of concentrated liquidity, the V3 version also introduces multi-tier fee control, range orders, historical oracles, and other functionalities to serve LPs, traders, and third-party application developers.

However, the complexity of the protocol also brings some potential issues or drawbacks, such as the more complex liquidity aggregation possibly increasing gas costs, the non-fungibility of LP tokens potentially affecting composability, and Uniswap changing its software license agreement to protect its early advantages, meaning other commercial applications can only use Uniswap's open-source code after two years.

New Feature: Concentrated Liquidity with Granularity Control

The core highlight of Uniswap V3 is the addition of "granularity control" to the originally bland "XY=K" curve, allowing users to concentrate capital efficiency within the most frequently traded price ranges to maximize returns. For example, since the price of USDC/DAI mostly stays within the range of 0.99 to 1.01, users can place their funds only within the XY=K curve of that range, without needing to consider extreme situations.

Similar operations can be performed for some conventional trading pairs; for instance, ETH/DAI often stays within the range of 1000 to 2000, allowing LPs (liquidity providers) to place their funds only within that range's curve, without considering outside the curve. This way, an LP looking to earn trading fees can cover the vast majority of trading volume with less capital.

Additionally, the introduction of this new mechanism can partially address another issue: impermanent loss. This is one of the drawbacks frequently criticized by the community regarding AMMs, but with granularity control, users can invest their funds into a very narrow range, and if the price deviates outside that range, they will automatically stop loss and not participate in trades outside the range.

New Feature: Multi-Tier Fee Structure

Uniswap V3 offers LPs three tiers of fees: 0.05%, 0.30%, and 1.00%. With these settings, higher fees can be set for riskier trading pairs (ETH/DAI), while lower fees can be set for less risky trading pairs (USDC/DAI).

The Uniswap team believes that a possible scenario is to use a 0.05% fee for assets with smaller price fluctuations, a 0.3% fee for high-volume but more volatile trading pairs like ETH/DAI, and a 1% fee for other types of assets.

New Feature: Range Orders

Uniswap V3 also introduces a new feature for traders and LPs: range orders, which complement the current market orders. This feature is somewhat like an upgraded version of limit orders in exchanges.

Users can deposit a certain asset within a specified price range, and if that asset enters the user's set range, it will gradually be exchanged for another asset in the trading pair. If the asset's price exceeds the price range, it will be fully exchanged for the other type of asset.

All of these can be automatically implemented through the protocol, and the Uniswap team believes this feature can be used in scenarios such as yield farming, buying the dip, or token issuance.

New Feature: Oracles Can Read Multiple Historical Data, Costs Reduced

Uniswap introduced the time-weighted average price (TWAP) oracle feature in version V2 to provide price data for third parties, which has been integrated into dozens of projects.

A significant improvement in version V3 is that third parties can calculate any TWAP price from the past approximately 9 days with a single on-chain call, while overall optimization has reduced gas consumption by 50% compared to V2.

Drawback: Potential Increase in Gas Costs, but Can Be Addressed by Layer 2

Uniswap's gas consumption has always been among the lowest in DEXs, but the launch of the concentrated liquidity feature may increase overall complexity and gas consumption. Fortunately, the launch of Optimism's Layer 2 can address this issue.

Interestingly, the team initially stated in an article that the gas consumption of V3 would be slightly lower than V2, but later in a detailed introduction claimed that "more granular liquidity pools may increase the gas costs of transactions." The specifics may only be known once the mainnet is launched.

Drawback: LP Tokens Become Non-Fungible Tokens, Meaning Positions Are NFTs

Since each LP can provide liquidity for different price ranges, each LP token may be unique, so LP tokens will not be ERC-20 tokens but NFTs. This may pose composability issues for third parties integrating Uniswap LP tokens.

The Uniswap team has also made some considerations, such as shared positions being interchangeable through other contracts or third parties, or tokenizing other complex strategies (standardized as other protocols?), which may involve multiple positions, automatic rebalancing around market prices, etc.

Question: How to Aggregate Liquidity Between Layer 1 and Layer 2?

Although Uniswap is set to launch on the Ethereum mainnet and Optimism Layer 2 as early as May, the liquidity between the two currently appears to be fragmented, and the team has not disclosed much about this matter. Perhaps they have considered mechanisms for this but have not made them public. Another possibility is that they believe liquidity will predominantly move to the Optimism network in the future, so merging liquidity may not be necessary.

Controversy: Software License

Since Uniswap was subjected to a vampire attack by SushiSwap, it has been somewhat passive, especially since their token issuance plan may have been a response to SushiSwap's provocation.

Thus, Uniswap has made significant changes to its software license (Business Source License 1.1). Although it will eventually grant third parties direct usage rights (GPL 2.0), commercial or production-level applications cannot directly use Uniswap V3 code for two years.

This may be a moat set up by the Uniswap team, as after two years, if they can accumulate sufficient liquidity, other protocols may not be able to provide liquidity like theirs even if they directly use their code.

However, since the mechanisms and solutions of Uniswap V3 are public, other DeFi protocols may find ways to implement them without using their specific open-source code. Moreover, some teams may even be anonymous, raising questions about whether these terms can truly be enforced.