Uniswap V3 continues where V2 left off: leading the DEX space and showing continued growth. This should come as little surprise IF you understand what makes V3 even better than its predecessors. Below is a short explanation of exactly that and where V3 aims to improve yet again!

Overview

Uniswap is a DeFi project built on Ethereum and serves as the largest decentralized exchange and automated market maker (AMM), which is a type of decentralized exchange protocol that relies on a mathematical formula to price assets. Uniswap V1 launched in 2018 enabling liquidity providers (‘LPs’) to deposit ERC-20 cryptocurrencies into liquidity pools and provide the underlying liquidity for the trades in the exchange. These LPs are incentivized to do so because they earn fees on any trades that happen within their pool. Additionally, Uniswap is completely open-sourced. This on-chain platform enables trustless token swaps executed from smart contracts for small fees. The UNI token itself can be earned by staking pre-determined pairs of other tokens and serves as an adoption and incentive tool for its ecosystem.

UNI Strengths

• One of the top Ethereum dApps by nearly any metric: users, volume, TVL, revenue, etc.
• One of the few truly permissionless, decentralized, and unstoppable protocols with no backdoor vulnerabilities in DeFi
• Impressive team with a stellar record of continually improving the product and shipping new versions (V1 vs V2 vs V3)
• Anyone is able to create a market on Uniswap allowing it to list long tail ERC-20 assets long before centralized exchanges are able

UNI Weaknesses

• UNI token is solely a governance token and does not accrue fees generated by the protocol.
• Uniswap and DEXs, in general, can be copied/knocked off (SushiSwap and PancakeSwap) due to their open-source nature, losing market share.
• Traders may suffer impermanent loss when providing liquidity to Uniswap, deterring a portion of potential users.
• Uniswap only trades Ethereum ERC-20 tokens and future cross-chain DEXs like Thorchain and Gravity DEX (Cosmos) may interest more traders looking to trade across blockchains. 

Important Links

• Website
• Whitepaper
• Twitter
• Reddit
• Github
• Trading dashboard
• Voting portal
• Wallets - Ledger and TREZOR
• Where to buy? Coinbase and Gemini

Technology

Uniswap is one of the largest decentralized exchanges and automatic market makers built on Ethereum. As open-source software, Uniswap doesn’t use an order book and works on a constant product market maker model by manipulating smart contracts that hold liquidity pools. Anyone can exchange their tokens or provide liquidity to pools by depositing two tokens as principal to incur share-based interest.

An automated market maker (AMM) is a specific type of decentralized exchange (DEX) that relies on a mathematical formula to price assets instead of an order book where buys and sells are matched like on Coinbase or Gemini. Traditional market-making utilizes giant firms with extensive resources to create a tight bid-ask spread on an order book exchange. Automated market makers decentralize this process, enabling anyone to create a market for any two tokens on a blockchain. 

Uniswap V3

There are two significant differences that V3 introduces in its design: more concentrated liquidity and multiple fee tiers. On Uniswap V2, users provide liquidity evenly along all of its markets’ price curves. This is somewhat inefficient since there does not need to be equal amounts of liquidity for ETH at $1 vs $2500. The concentrated liquidity gives individual liquidity pools control over what price range their funds are allocated to. This allows for individual positions to be fused together into a single pool to make one combined curve for traders to trade against. Liquidity pools can focus capital within a custom price range so pools can provide larger amounts of liquidity at desired prices. This mechanism allows for individualized price curves. In doing so, traders can trade against the combined liquidity pool of all curves with no gas increase per liquidity provider. Trading fees are then collected and dispersed at a given range appropriately. 

Multiple fee tiers allow for liquidity pools to be compensated for taking risks. There are three fee tiers per pair: 0.05%, 0.30%, and 1%. These options make sure that liquidity pools are customized to their margins according to certain pair volatility of the tokens. This may lead to some liquidity fragmentation, but the Uniswap team believes that most pairs will calibrate to an appropriate fee tier. Uniswap expects for liquidity pools to take more risk on non-correlated pairs like ETH/DAI and to take on less risk in correlated pairs like USDC/DAI. Correlated pairs are expected to sit at around 0.05% fees and .30% fees for pairs like ETH/DAI. 1% swap fees will be more appropriate for riskier pairs. Fees in V3 are more flexible and can be turned on by governance for each pool; these fees can be between 10% and 25% in liquidity pools fees.

The V3 upgrade also introduces more characteristics to make Uniswap one of the most flexible and efficient automatic market markers in this space. The liquidity pools can give liquidity with up to 4000x capital efficiency relative to Uniswap V2 so providers can earn higher returns. By concentrating liquidity, users can acquire the same increases as V2 within a certain price range while putting down less principal.  V3 also offers a way for low slippage trade execution compared to centralized exchanges and stablecoin AMMs. In order to help protect pool providers, changes were made to increase exposure to preferred assets and to reduce their risk taken. V3 liquidity pools can sell one asset for another by adding liquidity to a price range above or below the market price as needed. 

Another new feature in V3 is that liquidity providers receive non-fungible tokens (NFTs) that represent their Uniswap V3 liquidity positions. In Uniswap V1 and V2, users receive fungible ERC-20 tokens representing their liquidity position in the pool. The reason for issuing NFTs is explained in the V3 mainnet post:

“The pool interface now supports the creation of Uniswap v3 positions with multiple fee tiers and concentrated liquidity ranges. Each position is represented as an NFT and comes with a unique piece of on-chain generative art.”

Road Map

Where Uniswap V1 was launched in November 2018 as a proof of concept for AMMs and V2 set the stage for growth, V3 aimed to target a Layer 1 Ethereum mainnet and was launched on May 5, 2021. The upgrade executed a Layer 2 deployment on Optimism (an Ethereum layer that addresses scalability) in order to introduce concentrated liquidity and multiple fee tiers. 

Concentrated liquidity gives individual liquidity pools control over what price ranges their capital is distributed to. This upgrade allows individual positions to be merged together into a single pool, forming one combined curve for users to trade against. Multiple fee tiers allow liquidity pools to be compensated for taking on varying degrees of risk. Liquidity pools will provide up to 4000x capital efficiency relative to Uniswap V2, allowing higher earnings.

The capital efficiency upgrades also allow low slippage trade execution, increase liquidity pools’ exposure to more assets, and reduce downside risk. In V3 liquidity pools, the user can sell one asset for another by adding liquidity to a price range above or below the market price. In doing so, the liquidity pool construct will be customized to individualized price curves that reflect the user’s profit. 

In May 2021, a community-driven effort forced the Uniswap protocol to hold a community vote over whether V3 should be deployed utilizing Ethereum layer 2 scaling solution Arbitrum. Two days after the vote began, the poll passed with 41.72 million UNI (-13.59%) in favor and only 309.34 UNI against. 

Arbitrum went live for developers in June 2021, giving them access to Arbitrum’s increased transaction throughput than Ethereum and lower gas fees. 

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