- Uniswap V2 was launched in May 2020 as an improvement to Uniswap V1. Uniswap V2 introduced many new features and optimizations, which makes Uniswap V2 one of the largest cryptocurrency spot exchanges in the world within 1 year.
- Uniswap V2 works using model of x*y = k with x and y each quantity of asset X and asset Y. This means that for two exchangeable assets there will be a constant k as product of its quantity’s multiplication.
- For example if price of x relative to y is increased, then the reduction in quantity of X will be counterbalanced by corresponding increase in quantity of Y in order to keep the K constant.
- Uniswap V2 also provide Infinite liquidity with price range, which means that liquidity in V2 is distributed evenly along an x*y price curve, with assets reserved for all prices between 0 and infinity.
- Uniswap V3 was launched in May 2021 and introduces concentrated liquidity and multiple fee tiers.
- Concentrated liquidity means that Uniswap V3 gives individual LP granular control over what price range their capital is allocated to, which then individual positions are aggregated together into a single pool, forming one combined curve for users to trade against.
- Multiple fee tiers means that the fees per pair is flexible and divided to three tiers which are 0.05%, 0.3%, and 1.00%. This allows liquidity pools to be appropriately compensated for taking on varying degrees of risk.
- Another feature of uniswap v3 is slicing the price range of AMM into granular ticks. This allows investors to specify which ticks they want to trade in. This keep the formula of x*y=k from V2, but now the user can choose what price range they provide. Liquidity in Uniswap V3 is represented by the formula below, in which L2=k.
- As seen in the graph below, in uniswap V2 there is no point where the reserves are zero. While in V3 you can take two points and only provide when the price is between those points.
Uniswap V3 vs Uniswap V2
There are some differences between Uniswap V2 and Uniswap V3 which are:
- LP token in V2 is represented by fungible token, while LP token in V3 is represented by non-fungible token. This means that liquidity in V2 is simpler to provide than V3.
- In V3, users can choose what price ranges they want to provide. This means that when the exchange price is outside the price range, tokens provided will not be used in exchanges.
Advantage and Disadvantage
Advantages of V3 over V2 are:
- Since there is concentrated liquidity in V3, LPs can provide the same liquidity depth as V2 within specified price ranges while putting far less capital at risk.
- As its LP token is in NFT form, it can be freely traded in OpenSea or any other NFT exchanges.
While the disadvantages are:
- V3 is not composable for yield farming purposes.
- For investors, there are needs to consistently rebalance (i.e. adjust price range) in which you provide liquidity. In short, it requires active capital / liquidity management
- More pronounced impermanent loss as there are price ranges in which the assets will not be earning fees at all
- Autorebalancing results in volatility drag (i.e. forces users to crystallize impermanent loss). They increase investors gamma exposure, which means that it increase asset’s volatility in the direction of risk exposure, versus passive i.e. V2.
- Autorebalancing exposes investors to path dependency, increased gas cost, and operational risk. It is also more complicated to use.
When Should You Consider Using Uniswap V3?
- For stablecoin pairs e.g. USDT - USDC.
- For anchored pairs e.g stMATIC - MATIC.
- LP-ing for a volatile pair should be avoided e.g ETH against gaming tokens, etc.
- Uniswap V3 is a more capital efficient alternatives to Uniswap V2, but is only advisable for pairs that tend to be stable in its price movements.
- Autorebalancing strategies for V3 require a high level of fees to be profitable. Therefore one should turn on rebalancing only during periods of high volumes.