Author: YBB Capital Researcher Ac-Core

Introduction:

Compared to the V3 version released two years ago in May 2021, V4 offers more flexible asset composability and significantly reduces the Gas fees required for providing liquidity and trading. With the new feature Hooks, developers no longer need to develop xxSwap; they can simply customize liquidity within Hooks and add a front-end page and elements that meet their needs to establish a "custom venue," while also not having to worry about liquidity shortages in the "custom venue." Let’s explore how Uni V4 is leading DeFi from the "Lego era" into the "Era of Ten Thousand Hooks."

YBB Capital Researcher Ac-Core Original

Uniswap V4 --- One of the Few True Innovations in a Bear Market

The iterative upgrades of Uniswap have shown us the infinite potential of the DeFi world, consistently adhering to the principle and rules of X*Y=K. The innovations of Uniswap V4 mainly focus on providing more customized trading logic, improving Gas efficiency and developer experience, and enhancing the convenience and efficiency of trading. Compared to using V3, both developers and users can enjoy a more open, free, and efficient automated market maker service. The following will comprehensively introduce the upgrades of V4 and the two most important changes: Hooks and Singleton.

The Game-Changing Introduction: Hooks

The core feature of Uniswap V4 - Hooks, allows every developer to create customized DEXs that meet specific scenario requirements, building their own "Lego blocks." Hooks are an important concept introduced in Uniswap V4, serving as plugins for customizing liquidity pools, swaps, fees, and liquidity provider (LP) position interactions. Through the Hooks mechanism, developers can execute specific operations at key moments in the lifecycle of a liquidity pool, such as before/after a swap or before/after an LP position changes.

At the same time, Hooks are also smart contracts that interact with the core contracts of Uniswap V4, allowing execution at different "key points" within the liquidity pool (key points refer to operations before/after a swap or during LP deposits/withdrawals), enabling developers to flexibly define and execute custom logic. Hooks can be bound to specific liquidity pools, controlling the behavior and interaction methods of the pool. For example, developers can create a Hook that verifies specific conditions before each swap or executes additional operations when the LP position changes.

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Through Hooks, pool creators can adjust pool parameters and introduce new features to AMM, even allowing various DeFi strategies to be built on Uniswap, ultimately benefiting LPs/swapper more. It is easy to imagine that the introduction of Hooks will bring greater flexibility and innovation space for developers, enabling them to create unique liquidity pools based on their needs and strategies, providing more innovative and personalized trading experiences, such as:

• Time-Weighted Average Market Maker (TWAMM): Developers can use the Hooks mechanism to create liquidity pools that support TWAMM strategies, allowing large orders to be traded over a period of time to average out.
• Dynamic Fees: Through Hooks, liquidity pools can dynamically adjust fees based on market volatility or other input parameters to better adapt to market conditions.
• On-chain Limit Orders: Hooks can implement on-chain creation and execution of limit orders, allowing users to trade at specified prices.
• Interaction with Lending Protocols: Developers can use Hooks to automatically deposit funds that exceed liquidity limits into lending protocols, maximizing the utility of funds.

Currently, Uniswap V4 supports eight types of Hooks callbacks as shown in the figure below, which can be executed before the start of a trade and after the trade ends, thus enabling the functionality of on-chain limit orders. In practice, a limit can be set before the trade starts, and then after the trade ends, it checks whether this limit is met; if it is met, the trade is executed; if not, the trade is canceled.

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Another Hook in V4 ------ "Action Hooks"

In addition to Hooks, Uniswap V4 also features another type called "Action Hooks." It can only trigger the execution of contracts when the Flag condition is met, allowing it to call logic during contract execution. Refer to the flowchart below for explanation: before we swap assets, the contract needs to check the Flag to assess the volatility of the liquidity pool. If liquidity is high, the Flag becomes True and executes our Hooks; if liquidity is insufficient, the Flag becomes False, thus refusing Hooks to maintain unchanged interactions. The execution of "Action Hooks" as shown below enables a more Gas-efficient method to execute the required Hooks. Next, we will introduce how the Singleton structure and Flash accounting will achieve a cheaper asset swap and contract deployment experience in V4.

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The New Singleton Structure: Singleton

In previous versions of Uniswap, the Factory-Pool was a contract architecture inherited from V1 and is one of the most commonly used contract architectures in many DEXs and derivatives in the DeFi world. However, in V4, it has replaced the Factory-Pool with the Singleton contract structure. In V3, creating a liquidity pool required redeploying a new contract each time, which was very costly. In V4, the Singleton structure keeps all liquidity pools within a single contract, significantly reducing the Gas consumption for creating liquidity and cross-chain pools (contracts), meaning token trades do not need to transfer between different contracts, potentially reducing Gas fees by 99% compared to V3.

This Singleton architecture is also equipped with a new "Flash Accounting" system. In V3, assets needed to be transferred between liquidity pools at the end of each interaction, while in V4, this system only transfers assets based on the "net balance," meaning each operation (swap/deploy) only leads to changes in internal balances. Asset balances are represented in units of "delta," and at the end of a swap, it only exchanges the net "delta" balance after a series of calculations, resulting in a more efficient system that provides additional Gas savings for Uniswap V4.

With "Singleton" and "Flash Accounting," Uniswap V4 supports Native ETH. Users can directly trade with Ether (ETH) without needing additional conversion operations, enhancing trading convenience and saving Gas fees. This tightly binds Uni and the ETH ecosystem, benefiting Ethereum.

In terms of contract structure, the storage and encapsulation of liquidity position data in V4 have undergone significant changes. In V2, liquidity was distributed across the entire range (as shown in Figure 1), so the Uni protocol used homogeneous tokens (ERC-20) as liquidity certificates. In V3, due to the introduction of limit price liquidity, the display of corresponding liquidity changed to non-homogeneous tokens (ERC-721). In V4, we speculate that liquidity display will not be represented in a tokenized manner but will be managed using each wallet's address. Additionally, the "transient storage" in EIP-1153 from the Cancun upgrade also benefits the V4 system, aiding in further cost optimization.

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How to Allow Customized Oracles and Distribute Internalized MEV to LP Holders

UniSwap V4 is a decentralized trading protocol designed to enable trustless token trading on Ethereum. It achieves higher liquidity and better trading experiences by utilizing customized Oracles and an internalized MEV (Maximal Extractable Value) distribution mechanism. To allow customized Oracle implementations and distribute internalized MEV to liquidity providers (LP holders), consider the following steps:

1. Design Customized Oracles: You need to develop an Oracle that can provide customized price data. An Oracle is a contract that retrieves external data, providing real-time market prices and other information to smart contracts. You can develop an Oracle contract tailored to your needs based on trading pairs, time, or other factors.

2. Implement Internalized MEV Distribution Mechanism: MEV refers to the profits generated from changes in transaction order in blockchain transactions. UniSwap V4 distributes these profits directly to liquidity providers through an internalized MEV distribution mechanism. You can design a mechanism that allocates a portion of the profits to the corresponding LP holders when MEV occurs.

3. Contract Integration and Deployment: Integrate the customized Oracle and internalized MEV distribution mechanism into the smart contracts of UniSwap V4. You only need to modify and extend the relevant contracts to support these features. Ensure that security best practices are followed during contract development and modification, and conduct thorough testing and auditing.

4. Notification and Incentive Mechanism: Promote this new feature to liquidity providers and provide them with appropriate incentives. You can communicate with users through social media channels or other means to inform them of the benefits of the new customized Oracle and internalized MEV distribution mechanism.

5. Monitoring and Improvement: After deployment, closely monitor the system's operation. Track the effects of trading and MEV distribution, and make improvements as needed. Feedback and participation from the community are crucial for further optimizing this mechanism.

Advantages of Customized Liquidity Pools

Uniswap V4 introduces the concept of customized liquidity pools, but customization is suggested to be based on concentrated liquidity. Therefore, this shift not only affects the development pattern of Fork Swap and the significance of aggregators but also brings many advantages to liquidity providers and traders.

• Expanding Choices for Liquidity Provision: Traditional AMM models typically have fixed rules and parameters, limiting the choices for liquidity providers. However, Uniswap V4 allows customized liquidity pools through the Hooks mechanism, enabling liquidity providers to create different types of liquidity pools based on their preferences and strategies. This allows for a variety of liquidity pools in the market, providing users with more choices and flexibility.

• Reducing Costs and Improving Efficiency: The architecture of Uniswap V4 introduces the "Singleton" contract, centralizing all liquidity pools within a single smart contract. This architecture can reduce transaction costs, improve transaction efficiency, and simplify contract deployment and maintenance. Additionally, customized liquidity pools can set more suitable fee structures based on specific needs to meet different user demands.

• Providing a Wider Range of Trading Strategies and Risk Management Tools: Customized liquidity pools offer traders more opportunities for trading strategies and risk management tools. For example, by supporting TWAMM strategies, large orders can be traded over a period of time, reducing market price impact. Furthermore, customized liquidity pools can integrate with other DeFi protocols, such as lending protocols and custom oracles, providing users with more comprehensive trading solutions.

• Overall Enhancement of Flexibility and Creativity: Customized liquidity pools provide liquidity providers with greater flexibility. They can manage their liquidity according to market demands and strategies. This flexibility and potential for innovation can encourage more liquidity providers to participate, offering traders diverse liquidity options.

Questions Worth Considering

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1. What Problems Does Curve Solve for Uni V3?

The Uni V3 AMM model is based on the trading model of X*Y=K. In our actual LP composition process, we find that during extreme market conditions, not only is there a risk of impermanent loss in total value, but there can also be situations where the exchange rate of the liquidity pool exceeds the range. Curve and Uniswap V3 are two different decentralized trading protocols that face slightly different problems and goals.

Compared to V3, Curve solves the following problems:

1. Earning Profits in Low Liquidity Ranges: The characteristic of Uniswap V3 is that it concentrates liquidity within specific price ranges, influenced by its AMM model, while other price ranges lack liquidity. This leads to high trading costs and limited liquidity when trading over a larger price range. In contrast, Curve focuses on trading between stablecoins and increases liquidity within price ranges by using adaptive liquidity curves. This means users can trade stablecoins over a larger price range with lower slippage.

2. Low-Cost Trading: Since Curve focuses on trading between stablecoins, which include assets with fixed price relationships, it employs specific algorithms and strategies to reduce trading slippage and costs. This allows users to trade stablecoins at more competitive prices.

3. Better Price Discovery: Curve provides liquidity over a larger range, especially when trading between stablecoins, enabling better price discovery. This means users can obtain more accurate market prices for stablecoins, leading to better trading decisions.

4. Efficient Stablecoin Trading: Curve uses specially optimized algorithms and liquidity curves designed to provide efficient stablecoin trading. This allows users to quickly and securely exchange between stablecoins without excessive price slippage or costs.

2. Utilizing the Dual-Token Economic Model DEX Created by Uni V2: Camelot

Camelot was originally a project launched on Fantom, initially named Excalibur, but later collapsed due to the use of UST as a stablecoin and randomly migrated to the Arbitrum ecosystem, rebranding as Camelot. Unlike GMX, Camelot focuses more on guiding liquidity for new projects, with its main innovative mechanism being permissionless "Nitro Pools," allowing projects to fully control incentive measures to establish the liquidity types needed for their development.

It is important to emphasize Camelot's dual-token economic model, which combines the decentralized trading protocols of Uniswap V2 and Curve, while simultaneously supporting both volatile and stable tokens for trading, dispersing liquidity across the entire range from zero to infinity. Most importantly, it allows project parties to set the proportion of trading fees based on market conditions and the specific situation of the protocol, achieving the goal of managing dynamically directed trading fees.

In addition, Camelot's custom Launchpad is also permissionless, allowing projects to issue tokens and guide more liquidity. Moreover, every project that launches or collaborates with Camelot AMM can configure specific trading rates for its LPs to meet its own liquidity strategy needs.

Summary of the Above

As an important upgrade for decentralized exchanges, Uniswap V4 introduces the concepts of Hooks and customized liquidity pools, bringing greater flexibility and creative space to the DeFi ecosystem. The Hooks mechanism allows developers to create unique liquidity pools based on their needs and strategies, providing a wealth of trading strategies and risk management tools. Customized liquidity pools expand choices for liquidity provision, reduce costs and improve efficiency, as well as provide a wider range of trading strategies and risk management tools.

However, the emergence of V4 will undoubtedly rebuild the underlying foundation of DeFi once again. It provides a super large liquidity pool that developers can utilize to deploy their Hooks or ecosystems, even without needing a single-function xxSwap to obtain high liquidity, allowing more developers to create various multifunctional ecosystems on the Uniswap platform. Whether Hooks + Singleton will combine the advantages of Curve + Camelot to influence the next development trend of DeFi remains to be seen.