Uniswap V3 claims to increase capital utilization by 4,000 times, does it really deliver?

With a lower total locked position than V2, V3 does have a significantly higher capital utilization compared to V2, about 4 times that of V2.

Written by Wootrade

Uniswap V3, which launched on May 5 in Ether, is arguably one of the most exciting DeFi updates, bar none.

According to the latest news, if voted on by the community V3 will be deployed to the Ethernet scaling network Arbitrum, bringing faster transactions while reducing transaction fees. So what exactly are the specific innovations in V3?

The first chapter of Uniswap V3’s technical white paper summarizes its core technical features – “Concentrated Liquidity”. In other words, based on V2, V3 focuses on solving the problem of low utilization of AMM funds.

The formula below is its core formula, which is to calculate liquidity L by using the relative value (the relative value of funds Y and price P), liquidity is the amount of funds per unit “price change”. With a certain trading volume, if the liquidity is good, the price change will be small, while if the liquidity is not enough, the price fluctuation will be large.

Uniswap V3 claims to increase capital utilization by 4,000 times, does it really deliver?

I’m sure many of you will raise an eyebrow at the sight of such a complex formula, but never mind, let’s start with its curve.

Traders familiar with the Uniswap product should know that at the heart of its ‘automated market making’ is a mathematical model with a fixed product: x*y=k, with k being a constant. That is, the total liquidity of any exchange pool needs to satisfy the formula on this curve, and the x and y assets put in by the liquidity provider will be evenly distributed across price points for market making. It’s like eBay, if you want to sell something, just list it (trade it). That’s how Boris Wertz, one of the project’s early investors, described the simplicity of Uniswap.

But in reality, most of the time the token price will only be concentrated in a small range, and the rest of the money is idle, leading to the pain point of low capital utilization, which is the ceiling that almost all DeFi AMM projects want to break.

According to the data available at press time, Uniswap V2 has a total lock volume of $6.88 billion, but only $950 million in 24-hour trading volume, or only 13.8%. This is a very low number and means that very little liquidity is being centralized.

Uniswap V3 claims to increase capital utilization by 4,000 times, does it really deliver?

The daily trading volume has increased rapidly since the launch of V3, and this chart shows the daily trading volume in the last 7 days compared to V2

In order to focus on solving this pain point, Uniswap has updated V3, and it is expected to increase the capital utilization by 4000 times. We can verify this by looking at the data and calculating the daily trading volume and lock volume for the last 7 days, we can see that the capital efficiency is not as high as the official statement. Where capital efficiency = volume of transactions / volume of locked positions.

According to the above table, we can conclude that the capital utilization rate of V3 is significantly higher than that of V2, which is about 4 times higher than that of V2, even though the total locked position is lower than that of V2.

What are the ways that V3 uses to improve the capital utilization rate?

  1. “Interval market making” – allows liquidity to be provided within a specific price range.
Uniswap V3 claims to increase capital utilization by 4,000 times, does it really deliver?

LPs allow market making within a specific price range

Imagine a mechanism that divides the overall liquidity provision curve into small “containers”, officially called “price ticks”, each with a small price range, and each a small automated market maker.

You may be thinking, how is this a bit like creating an order book? Yes, for example, in the USDC/ETH pair price between $1700-1800 provides liquidity and these funds will be traded in multiple bands.

Compared to the V2 “evenly distributed” liquidity that is the same at all price points, V3’s liquidity is composed of a series of liquidity in different intervals, thus alleviating some of the idle, underutilized funds, and the chart below graphically shows how liquidity is distributed.

Uniswap V3 claims to increase capital utilization by 4,000 times, does it really deliver?
币世界-Uniswap V3 称资金利用率可提升 4000 倍,真的实现了吗?

Liquidity in V2 vs. liquidity in V3 range in the white paper

Of course, some analysts have pointed out the drawbacks of this kind of market making, which is that tying assets to a certain price range is not friendly to the average liquidity provider with low trading volumes. Secondly, when the price range is not set properly, the market making revenue will be affected, unlike the professional DeFi people and professional market makers who benefit more from the superiority of their strategies. In Uniswap V2, however, each LP is allocated a proportional share of the liquidity pool’s revenue.

Uniswap also expressed its hope for the future in a community post: that in the future there will be a role for “Uniswap strategy consolidators” who can aggregate the funds of smaller traders and share the proceeds with them to balance costs.

This leads us to the second innovative idea of the V3 version – NFT. 2.

  1. Uniswap LP token NFT-ization.

What would you associate with the V3 version if every Uniswap LP position was unique? Yes, non-homogeneous token NFT.

Because each LP sets a different price range, it can use NFT to represent its own separate position, and this idea is implemented in V3 by replacing the homogenized ERC-20 LP tokens with NFT.

Uniswap V3 claims to increase capital utilization by 4,000 times, does it really deliver?
Uniswap V3 claims to increase capital utilization by 4,000 times, does it really deliver?

Some users are selling NFTs representing Uniswap V3 positions on the trading platform OpenSea

Turning financial strategies into NFT is creating a “money” that is smarter than digital currencies, because it is a completely automated mode of operation for transactions, or financial instruments, eliminating the tedious intermediate consumption of matching, negotiating and signing transactions between people, making it easier to reach transactions easily, and making it easier for ordinary people to participate and cooperate more efficiently.

However, there is a small negative impact, because of its uniqueness, these NFT tokens are not interchangeable, but of course there are still external contractual agreements to convert them into homogenized tokens.

In addition to these 2 key innovations, V3 has 2 other major updates for fees and price queries: 3.

  1. the use of a fee tier system (0.05%, 0.3% and 1%) instead of V2’s single 0.3% fee, which is set up to allow liquidity providers to choose an acceptable level of risk in advance and be more reasonably compensated – definitely making trading more user-friendly.
  2. Adopting an optimized price entry mechanism, which makes price inquiries faster and less costly by keeping records of past price inquiries.

These are the core competencies of the V3 version, how good is it? Only hands-on transactions to know.

I believe that in the future, V3 will also create more opportunities for peripheral infrastructure and derivatives, attracting more capital and talent to the market and creating a positive spiral effect.

As written in the Uniswap V3 whitepaper.

What is not needed for the core contract of Uniswap V2 should be turned into peripherals (applications).

The release of Uniswap V3 will bring investment opportunities in various tracks around its peripheral functions. In the short term future, as market makers gradually realize the increased capital efficiency of V3, the market making capital of V3 will become more and more huge, and we can foresee that the track of active market making strategies based on Uniswap V3 will be a hundred and one, thus giving rise to more investment opportunities.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/uniswap-v3-claims-to-increase-capital-utilization-by-4000-times-does-it-really-deliver/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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