Uniswap v3 Charms The Market

Uniswap v3: New Horizons

Uniswap V3 is unlocking greater capital efficiency for liquidity providers and better pricing for traders. It does so through a new primitive described as “concentrated liquidity”. With Uniswap V2, the liquidity added by LPs was maintained in a 50-50 ratio by the protocol’s market making equation (XYK, or constant product market maker). The XYK price curve provides inventory from just above $0, to just below infinity. As a result, liquidity density was low and LP fees weren’t too impressive either (though still attractive). Since it’s highly unlikely that the price of ETH would either go to $10 or soar towards infinity in a brief amount of time, providing liquidity at these extremes can be considered a waste.

The concentrated liquidity enabled by V3 improves upon this by allowing LPs to set custom ranges. For example, let’s say there is an LP who thinks ETH won’t go above $5k or below $2k. With UniV3, they can now provide liquidity at only the range between $2k-5k. Again, this is in contrast to UniV2, which previously would have spread that liquidity across a semi-infinite range. This model also does away with the fixed 50-50 allocation in a pool, which further opens the door to positional flexibility.

If you’re familiar with how professional market makers provide liquidity on an orderbook, you can think of this as analogous to having a large block of asks (i.e. maker sell orders) stacked up from current price till the upper bound, and bids (i.e. maker buy orders) stacked down from current price till the lower bound.

While Uniswap v3 hasn’t seen explosive trading volumes since it launched in May, by no means has it been disappointing. In recent weeks, UniV3 has consistently had days that facilitated over a billion dollars in volume.

LP flexibility wasn’t the only thing that