What is the prospect of the wildly growing Uniswap V3?

The biggest advantage of Uniswap V3 is higher capital efficiency, but if there is a large amount of arbitrage, liquidity providers will still face significant impermanent losses.

Original title: "IOSG Weekly Brief | The Barbaric Growth of Uniswap V3"

The most anticipated upgrade of top-tier AMM is finally here! On May 4, the Uniswap V3 contract was officially launched on the Ethereum mainnet. After a full argument, we finally have some views on the advantages of Uniswap V3.

The biggest advantage of Uniswap V3 is higher capital efficiency. Under the same amount of funds, V3 has lower slippage than V2. Therefore, V3 can mobilize more stock funds than V2. In order to verify the capital efficiency of Uniswap V3, we compared the total lock-up turnover rate with Uniswap V2 and Sushiswap.

Image source: IOSG Ventures

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Overall, Uniswap V3 does have higher capital efficiency in a short period of time. As shown, the TVL turnover rate of V3 is higher than that of V2 and Sushiswap. At the peak, the TVL turnover rate of V3 is much larger than that of V2. Every $1 TVL in V3 can generate $0.7 in daily trading volume, while the same funds in V2 can only generate $0.2 in daily trading volume. In addition, the data after the launch of V3 shows that Uniswap will generate a transaction volume of $5 for every $1 added to the pledged fund pool, while Sushiswap can only generate a transaction volume of $1.3 under the same circumstances.

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As we all know, one of the problems of V2 is the impermanent loss faced by liquidity providers, and V3 also has this problem. But the size of the loss in V3 depends on the behavior of the liquidity provider. That said, in V2, LPs are fairly static relative to arbitrage, while in V3 both parties are able to actively manage their positions.

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So there are two possible situations. The first situation is that liquidity providers have better prices, which will drive arbitrageurs out of the market. This requires mature LPs to constantly adjust their price ranges to correctly map market price changes before arbitrageurs move. However, although this can ensure that LPs will not suffer losses, it will also reduce the potential transaction volume of the agreement, because automatic transactions account for a large proportion of Uniswap v2 and Sushiswap.

The second case is for less established LPs. Assuming that price discovery still exists in centralized exchanges like Binance, liquidity providers whose price adjustment range is too narrow and move too slowly will be defeated by arbitrageurs. A price range that is too narrow means a greater depth of liquidity, because the greater the price volatility, the higher the risk of loss.

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For example, if the price of ETH is $3,500, LP can set a price range of $3,490-$3,510. If the external price of ETH rises to $3600. A rational LP would immediately adjust its price range to around $3,600. Otherwise, she would be exposing the sell exposure to arbitrageurs due to the price difference. Conversely, if the price drops to $3300, unless the LP adjusts her price downwards, there will be no liquidity provided and no transaction fees.

Although it is too early to judge, as a rule of thumb, we can look at the trading volume of the top 10 arbitrageurs in Uniswap V3 and V2. The more professional LP's market making, the less arbitrage activities, and the less losses of liquidity providers. The opposite is true if there is a large amount of arbitrage.

As shown in the table below, the total trading volume of the largest arbitrageurs on Uniswap V3 accounted for 12% of the total volume since V3 went live! That means over $670 million was generated from this address alone (identified as Wintermute by Nansen.ai). In addition, the top 5 arbitrage bots accounted for about 22% of the total trading volume, much larger than the level of V2. In the V2 version, the top 5 arbitrageurs accounted for barely 5% of the total trading volume. It also speaks to the heavy losses that LP suffered in the early days of V3.

Image source: IOSG Ventures

Image source: IOSG Ventures

In the case of a huge amount of arbitrage transactions in the early stage of V3 launch, Uniswap introduced Visor Finance, an active-zce liquidity management tool, to manage multiple positions, automatically balance liquidity according to market prices, reinvest fees, rewards, etc. So, there are currently two paths. In the first case above, mature LPs are completely specialized; in the second case, less professional LPs rely on tools such as Visor to actively manage liquidity.

We expect arbitrage participation to gradually decrease over time in V3 for the following reasons:

Risk control: LP can better grasp risks after learning from the past

Innovative Design: Active Liquidity Management Tool Visor

Deploying Layer 2: Frequent adjustments at low cost

In addition, the Uniswap ecology should not be underestimated. Take the Grants program as an example, which devoted a lot of resources to creating key developer tools, adding high-quality data, and launching key services in the Uniswap ecosystem.

Some ecological projects of Uniswap Grantee

For complete project details, please click the link: https://www.notion.so/3430a00270ea4d79be5c70d4ca99680a?v=cb2ce86b52194b759428b458f9717749

Uniswap V3 is off to a good start. Although there are areas for continuous improvement, we remain optimistic about the future development of V3. Eventually we will see more professional market makers become liquidity providers, crowding out arbitrageurs with better pricing. The savage growth of V3 has just begun, will it become the final match point of the DEX competition? let us wait and see.

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