Since the outbreak in 2020, decentralized finance (DeFi) has shown its vigorous vitality with its characteristics of decentralization, non-censorship, and fairness. In the world of DeFi, endless new ideas, new concepts and new applications emerge every day, and many major breakthroughs have been made so far. It can even be said that DeFi has promoted the realization of inclusive finance.
Among many applications, the decentralized exchange (DEX) based on the AMM model is undoubtedly one of the most influential DeFi innovations. According to Messari’s research report, the transaction volume on DEX in the second quarter of 2021 reached 405 billion US dollars, which was 117 times that of the same period last year. Compared with the first quarter, the growth rate was 83%.
DEX has become the most important infrastructure in the DeFi world, but innovations and breakthroughs based on AMM are still continuing. Earlier, the V3 version launched by Uniswap opened a new chapter for the development of DEX.
A brief review of AMM
Before we dive into V3, let’s quickly review a few key basic points of AMM.
The core of AMM is the constant product formula x*y=k, where k is a constant, the number of token A is x, and the number of token B is y. It does not rely on the traditional order book model, the price of the token is determined by this formula. Liquidity providers inject their own funds into the fund pool for execution and completion of transactions on the platform, and to earn passive income by providing liquidity.
Although AMM is undoubtedly a breakthrough and innovation from 0 to 1, there are still some problems and limitations in this mechanism. One thing that has always been criticized is the low utilization of funds.
Anyone familiar with DEX knows that Uniswap V2 AMM is the mechanism adopted by most DEX at present, and all liquidity is evenly distributed in the range of (0, ∞) along the price curve of x*y=k. However, in reality, most transactions in a certain period of time will only be completed in a certain price range, which means that a large number of locked assets have not been used in the actual transaction process.
In some specific scenarios, such as the trading of stable currency pairs, even more than 99% of the liquidity will never be used. A large number of market-making assets are in idle state, and the utilization rate of funds is very low. Even Curve, which specializes in stable currency transactions, still faces this problem after improving the AMM formula.
The V3 version launched by Uniswap solves these problems well. Through some innovative functions such as interval market making, range orders, multi-level rates, etc., aggregate liquidity is realized, and liquidity providers (Liquidity Provider, LP) can also adopt more diverse and more complex market-making strategy combinations to obtain higher returns .
Simply put, with Uniswap V3, you can get higher returns with less funds.
As an LP, how to make the most of V3
Now, each LP can choose a custom price range in Uniswap V3 to add liquidity, thus having its own personalized price curve. In this way, you can earn more commission rewards within a limited price range with less funds, and maximize the use of funds. Coupled with functions such as multi-level rates, LPs will have more flexibility and strategy combinations in market making.
But, how do you do it? Let’s take a simple and intuitive look at what needs Uniswap V3 can meet through different scenarios and how to profit from it.
1. Provide liquidity for stablecoin pairs
Stable currency pairs are often the first choice for many LPs, because price fluctuations are generally small and impermanence losses are negligible.
Take USDT/ DAI as an example, most of the time the price only fluctuates between 0.99-1.01. Now you can put all your funds into this range to provide liquidity, instead of being evenly distributed between (0, ∞) as before. In this way, you can earn more commission rewards, because most transactions will only occur within this price range.
Uniswap official information shows that if LP provides liquidity within the 0.10% price range, the utilization rate of funds will increase by up to 4,000 times compared with before.
In addition, Uniswap offers three levels of rates of 0.05%, 0.30%, and 1.00%. Through different levels of fees, you can get more benefits when you take more risks, and vice versa.
For example, in a stable currency pair, LP does not need to bear any impermanent losses, then the fund pool with a low fee rate is more competitive, and a 0.05% fee rate should be selected to provide liquidity.
2. Provide liquidity for other currency pairs
When providing liquidity for other currency pairs, the logic behind it is similar, and a rational LP will provide liquidity within a reasonable price range.
You can choose to set your own price range relatively small. If the transaction price is within the set range, you can get more commission rewards. However, the requirements for LP are relatively high, because if you want to continue to receive commission rewards, you need to continuously analyze data, formulate reasonable strategies, and constantly adjust the price range. Another point to consider is that, because Uniswap V3-based Ethernet Square , often change the price range may be required to pay a large amount of gas costs, affecting the overall profitability.
You can also provide liquidity in multiple price ranges so that you can profit from multiple pricing opportunities.
For example, you can provide liquidity for the following price ranges of ETH /USDT at the same time :
Provide a range of USD 20,000 to USD 3,000 -5,000;
Provide a range of USD 5,000 to USD 2,500-3,500;
Provide a range of 1,000 USD to 5,500-8,000 USD.
If you are a professional LP, these can allow you to create more complex market-making strategies. In addition, remember to use flexible rates to hedge against impermanence losses.
When providing liquidity for trading pairs other than stablecoins, such as ETH/USDT, the risk of impermanent loss is slightly higher, and a 0.30% handling fee can be set. As for other long-tail assets, such as the animal currency that exploded some time ago, the price fluctuates greatly and needs to bear greater risks, so a fee rate of 1.00% is more appropriate.
3. What if I am an unprofessional or lazy LP
If you are conservative, or don’t want to spend time and energy to monitor price fluctuations at all times, you can actually set your price range relatively large, or even set the range to (0, ∞), just like in V2.
Many people always think that V3 is designed for professionals and only professionals can use it. Although there is some truth to this, it is true that professional LP can better reflect and utilize the value of V3, but this is still a misunderstanding. Because V3 is perfectly backward compatible with V2, you can still experience all the functions of V2 in V3, so if it is a non-professional LP, then use V3 as V2, and there is no problem at all.
4. Realize profit-taking or bargain hunting by providing liquidity
Uniswap V3 supports a range order function similar to a limit order. You can provide a single token liquidity in a price range higher or lower than the current market price. When the market price enters the specified range, the provided asset will be sold along a smooth price curve and become another asset. You can use this function to carry out bottom hunting or take profit, and at the same time get commission rewards.
Let’s take ETH/USDT as an example.
Assuming that the spot price of ETH is 4,000 USDT, if you want to provide liquidity in the range of 4,500-5,000 USDT, you only need to deposit ETH. If the price of ETH rises to 4,500 USDT, the ETH you provide will be gradually converted to USDT. The proportion of USDT in your assets will continue to rise until the spot price reaches 5,000 USDT and all assets are converted to USDT.
If your initial purpose of making a market is to sell all ETH at a price of between US$4,500 and US$5,000 for profit settlement, then providing liquidity in V3 actually accomplishes your goal well.
The price range can be further reduced to 4,500.00-4,500.01 USDT. This can almost be regarded as a limit order to sell ETH at a price of approximately 4,500 USDT. As long as the market price is higher than 4,500.01 USDT, all the ETH you provide will be sold and converted into USDT.
In this way, you can almost sell tokens at the price you want, and at the same time get rewards, which is more advantageous than grid trading.
But it should be noted that if you want to sell ETH at a price of 4,500-5,000 USDT through a range order to make a profit, after the range order is fully filled, you must withdraw the liquidity as soon as possible before the ETH price drops to 5,000 USDT. Otherwise, once the price drops below $5,000 again, the range order will automatically “buy on dips” again and repurchase the already sold ETH.
On the contrary, if you want to buy ETH at 3,000-3,500 USDT to buy bottoms, you only need to deposit USDT to provide liquidity in that range. When the price of ETH drops to 3,500, USDT will gradually buy into ETH.
As a trader, Uniswap V3 aggregates liquidity so that it can have a better depth in the price range where most transactions occur, thereby reducing slippage. Especially compared to stablecoins, Uniswap can even provide better depth than Curve, which is very suitable for large transactions, because slippage will be significantly reduced, which undoubtedly provides traders with a better trading experience.
Even as a project party, you can also benefit from Uniswap V3.
The range order function is also very friendly to ITO. If a project wants to go to CEX, the process may be very long and the cost will be high. Now through Uniswap V3, project parties can deposit a single token asset to provide liquidity within the price range at which they wish to sell their tokens. Low cost, convenient and friendly.
All the innovations mentioned above will give Uniswap V3 unstoppable vitality. It may not only change the development direction of DEX, it may also change the pattern of DeFi.
Uniswap’s V3 AMM provides more flexibility and choices for different users, paving the way for the further popularization of DeFi. There are many combinations of these different functions, and we are looking forward to seeing more strategies and ideas from everyone.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/an-article-to-understand-how-to-maximize-profits-with-uniswap-v3/
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