Uniswap version 3.0 is live, an upgrade widely expected to make the automated market maker much more attractive for the cryptocurrency traders and funds with the deepest pockets.
The decentralized exchange, which appeared on Ethereum in late 2018, is currently the fourth-largest decentralized finance (DeFi) application on that blockchain, as ranked by DeFi Pulse, with $7 billion in assets staked. According to its own stats, Uniswap’s v2 accrued $1.6 billion in trade volume over the last 24 hours.
The company behind the Uniswap protocol announced version 3 was coming in late March and now the automated market maker (AMM) is rolling it out in the middle of a crypto bull run that has pushed ether (ETH) to all-time highs. ETH is the second-largest cryptocurrency by market cap and the native token of Ethereum, where DeFi was born and much of the action still takes place.
“Uniswap v3 is a big step forward for the protocol,” Peter Johnson of Jump Capital wrote via email. “The increased flexibility it provides market makers on how they provide liquidity into the protocol makes liquidity provisioning more attractive, and should make trading on Uniswap more efficient for traders.” Jump Capital is the venture arm launched by the principals behind Jump Trading, the influential high-frequency and algorithmic trading firm founded in 1999.
The chief innovation in this new version is what the company is calling “concentrated liquidity.”
Concentrated liquidity makes the basic functionality of an AMM more efficient for all users. A basic AMM allows market participants to deposit two tokens into any given liquidity pool. Each pool then offers a price for both tokens. That price is determined simply by the ratio of the two tokens.
When traders buy or sell tokens from AMM pools, they pay a very small fee for each trade. That fee is then shared out among all the pool’s depositors on a pro rata basis.
For example, if there’s 100 DAI in a pool with 100 USDC, then 1 DAI is worth 1 USDC and vice versa. These markets depend on arbitrageurs to trade them back in line with the market when this simple system goes out of whack.
This approach leaves a lot of liquidity effectively unusable, though, because if someone tried to buy 70 USDC from our pool above, it would knock the average price for the trade way above the market price. So no one would ever make that large of a trade there.
Concentrated liquidity allows people lending funds to a pool, known as liquidity providers (LP), to define a band in which their deposits will trade. They might deposit 100 USDC and 100 DAI, but with the caveat their USDC will never trade for less than 0.99 DAI and never more than 1.01 DAI.
In that case, someone could buy 100 USDC and pay right around 1 DAI each.
This enhancement is why most people in DeFi agree the new version of Uniswap will lure more “whale,” or large-scale, investors.
It’s also a clever solution to the problem of “impermanent loss,” a persistent bugbear for liquidity providers to AMMs. In a classic AMM, a liquidity provider can lose money over shorter periods of time when one token in a pool of two gains too much against the other.
Bancor and THORChain provide insurance against impermanent loss. With Uniswap v3, however, a liquidity provider can simply not allow deposits to be traded in ranges where an impermanent loss would occur.
The new version also allows depositors to define different fees for trading, which should make it more attractive to provide liquidity to less-frequently traded tokens.
The Uniswap protocol is governed by the UNI governance token. UNI is trading at $42.88 as of this writing, up from $4.74 on Jan. 1.