Uniswap V3 updates the market-making mechanism: What impacts will Curve and SushiSwap face?

This article is from the Plain Language Blockchain, with the original title: "The Benefits Brought by Uniswap V3 May Not Be as Simple as You Think," author: Master Wuhuo Qiu.

Uniswap V3 was released last week, but it’s just a release, and it will take nearly two months to go live. The market reaction has been lukewarm. The Uni Token not only didn’t rise but even dropped, protesting against its "not sufficiently disruptive innovation."

After all, what everyone was thinking before were things like true L2, Rollup, and extremely cheap Gas fees, none of which seem to have been mentioned in V3. It was only stated that after V3 goes live, it may be deployed to the Layer 2 solution Optimism network, which doesn’t count as the core content of V3.

The core content of V3 mainly focuses on several points: granular control of aggregated liquidity, multi-tiered fees, range orders, historical oracles, and software license protection. There have likely been countless articles analyzing or interpreting these points over the past few days, so I won’t elaborate here. Friends who are completely unaware are advised to look it up themselves.

What I want to write about is, what is the difference between how professional DeFi players and ordinary players view V3? In fact, in the senior DeFi circle, everyone is full of praise for the release and design of V3, which is far from the ordinary market's reaction to V3.

In the eyes of these people, when Uniswap takes action, it feels like this is the work designed by a team that has the deepest understanding of AMM, truly elevating AMM to new heights, giving a sense of being the "regular army."

Meanwhile, the various ForkDex and all sorts of improvements to AMM algorithms and impermanent loss in the market may only be considered "small skirmishes" in the face of Uniswap's V3.

Everything Serves Capital Efficiency

If you remember the article "DeFi Trust Empire? Multiple Projects Dominated by AC Have Seen Significant Increases," you might recall it mentioned:

DeFi guru AC publicly stated on Twitter that "he is obsessed with improving capital efficiency," which is why he has acquired many DeFi projects, attempting to build a trust empire to enhance capital efficiency.

It’s not an exaggeration to say that more than half of the incremental market in DeFi in 2021 will come from projects that can effectively enhance capital efficiency, as this has already been demonstrated in traditional financial markets, which is an inevitable result brought about by the essence of capital or finance.

Thus, V3 shows us something much more elegant than all current solutions—granular control of AMM aggregated liquidity. Theoretically, it can increase capital efficiency by up to 4000 times (of course, this is an extreme value and not very meaningful as a reference).

This is similar to grid trading that many players like; if you can accurately judge the most frequently traded price range for a trading pair, such as BTC/USDT, and set the upper and lower limits, you can achieve very attractive annualized returns.

For example, last year when BTC was hovering around 10,000 for several months, if your grid was set at 9000-11000, your returns would definitely be many times higher than those who set a wide grid (like 3000-30000).

Uniswap V3 is the same; it now allows LPs (liquidity providers) to place funds within a specified price range. If LPs can judge prices relatively accurately, they can earn the same fees with much less capital than before.

At the same time, for those LPs who were originally very averse to impermanent loss, they can now fully control the proportion of impermanent loss they can accept through this price range control. This enhancement in capital efficiency is, without exaggeration, "crushing" all current swap solutions on the market.

Of course, one consequence is that LP tokens, due to the introduction of price ranges, are no longer the generic LPs they used to be, transforming into a model similar to NFTs.

Who Is Impacted?

AAVE, Curve, Sushi, and all AMM-based clones.

The first one you might not think of is AAVE. In the circle, the first thing everyone thinks will be impacted is not various swaps, but AAVE. As one of the two giants in the DeFi space, AAVE has always been committed to exploring improvements in capital efficiency.

Recently, AAVE launched LP-based collateral, which is essentially aimed at improving capital utilization. Now that Uniswap, the largest LP token, has directly transformed into a kind of NFT, the applications for borrowing against LPs have been largely blocked.

More importantly, with this granular control mechanism for LPs, those who previously earned 10,000 in fees with 1 million can now earn the same 10,000 in fees with just 100,000 in market-making funds, leaving the remaining 900,000 for other uses.

This enhancement in capital efficiency far exceeds the LP collateral borrowing method, making the latter seem somewhat "useless."

Curve

In addition to granular control of LP ranges, Uniswap also has tiered fees, currently set at 0.05%, 0.30%, and 1.00%.

For example, high-risk new altcoins/ETH could set a fee of 1%, medium-risk ETH/DAI could set 0.3%, and low-risk USDC/DAI could set 0.05%.

For stablecoin swaps, Uniswap V3, due to granular control, can achieve similar slippage to Curve with a very small amount of capital (for example, USDC/DAI, where the vast majority of LPs will likely set their ranges at 0.99-1.01).

At the same time, due to the tiered fee structure, the fees are cheaper than Curve, and the Gas costs of Curve’s contract-calling method are significantly higher than those of Uniswap.

So it can be anticipated that if Curve does not make corresponding adjustments, once V3 goes live, Uniswap will take a large chunk of the stablecoin swap market!

Sushi and Other Uniswap Clones

In addition to various technical innovations, Uniswap V3 also has software license protection, which states that commercial or production-level applications cannot directly use Uniswap V3 code for two years. In simple terms, you cannot fork it for commercial purposes within two years.

This is a clear moat strategy; although it seems somewhat "not so blockchain," causing some controversy, they have set it up this way, and you cannot say they are "wrong." This leaves teams like Sushi with a dilemma: after V3 goes live, they will have only three choices:

Shamelessly ignore the protocol and copy it. Large DEX platforms like Sushi probably won’t do this, as their software license is legally protected.

If they blatantly copy, they face lawsuits, and it would create a very negative impression among users. If you took it without restrictions before, now that you are told you can’t take it, continuing to do so would be "theft."

Some anonymous small DEX teams might fork it, as they are anonymous and not afraid of lawsuits, and initially, they have nothing to lose. However, after forking, under the pressure from Uniswap V3 and Sushi, there may not be much space for small and medium DEXs to survive.

Do nothing. Now that Uniswap has established its dominance, other DEXs wanting to carve out a niche must face the onslaught of Uniswap V3. If they do nothing, the consequences…

Copy the ideas but not the code. This may be the only way out, or even innovate further based on V3, which is what the entire industry hopes to see.

However, this is destined to be the hardest path, as it means you need to have better ideas than the Uniswap team, a deeper understanding of AMM, and stronger engineering capabilities, all of which are very difficult…

Think of those CEX founders who claimed to "surpass Binance in six months" or shouted similar slogans; I am not very optimistic about this.

Uniswap V3 Will Destroy Some Things and Create New Ones

Uniswap V3 is predictably going to destroy some things.

For example, the currently popular liquidity mining may become unmanageable due to the complete transformation of LP tokens; either it won’t work, or users will have to use V2 or Sushi LPs, and the composability of V3 LPs will be compromised.

For instance, the projects focused on stablecoin swaps, like Curve. Even providing liquidity for DAI/USDC between the prices of 0.999 and 1.001, V3's positions could completely replace MakerDAO's stable module.

Uniswap V3 is predictably going to create new things.

For example, new DeFi combinations or gameplay based on the new LP tokens. For instance, the enhanced oracle functionality in V3 allows for the calculation of any TWAP price over the past nine days through a single on-chain call, meaning Uniswap doesn’t need an oracle and is itself a better oracle.

Moreover, since the impact of price range judgments on LP earnings is significant, the days of simply throwing funds into trading pairs for fees or mining may be gone forever.

The market may shift towards more professional Uniswap V3 LPs or new projects that adjust based on various LP data statistics.

Optimism Mainnet Delay, A Blessing in Disguise?

Recently, there has been a closely related piece of news regarding V3: the star L2 project Optimism (hereinafter referred to as OP), originally scheduled to launch its mainnet in March, has been postponed to July.

It’s worth noting that OP's ecosystem includes top DeFi projects like Uniswap, SNX, and Compound, so everyone has high hopes for it. SNX has already been running on OP's testnet for a while, and aside from occasional minor bugs, the overall response has been positive.

Initially, everyone thought this might be a negative for V3, as V3 is set to go live in May and has stated that it will begin deploying to OP's Layer 2 after a successful launch. Now that OP has been postponed to July, Uniswap's L2 deployment seems unlikely before then.

However, as the saying goes, "A blessing in disguise." What if things develop in this way?

V God did not say it must be this way, only that it is technically feasible.

If this is indeed the case, Uniswap, as a whitelisted project, could be the first to log onto OP in May. At that time, in addition to being the largest DEX with the deepest trading volume, combined with a host of technical innovations from V3, it would also benefit from ultra-low Gas fees and ultra-fast transaction speeds on L2. Meanwhile, other DEXs would still have to operate on ETH L1 before OP officially launches, enduring the expensive and slow trading experience…

Uniswap would truly crush all DEXs. Of course, all of this is extremely irresponsible speculation or guesswork.