Comparing Uniswap v2 and v3
This chapter retells the whitepaper of Uniswap V3. Again, it’s totally ok if you don’t understand all the concepts. They will be clearer when converted to code.
Exploring Uniswap V3 Innovations Through V2's Limitations
To fully grasp the advancements introduced by Uniswap V3, it's essential to first understand the limitations inherent in Uniswap V2. Uniswap V2 operates as a universal exchange platform utilizing a singular automated market maker (AMM) model. However, not all trading pairs exhibit the same characteristics, primarily due to differences in price volatility. Trading pairs can generally be categorized as follows:
Tokens with Medium to High Price Volatility: This category encompasses the majority of tokens, which are not pegged to any stable asset and thus are more susceptible to market dynamics and fluctuations.
Tokens with Low Volatility: This group primarily consists of pegged tokens, notably stablecoins like USDC/USDT, USDC/DAI, and USDT/DAI, as well as variants of wrapped ETH such as ETH/stETH and ETH/rETH.
These distinct groups necessitate tailored pool configurations. Specifically, pegged tokens demand substantial liquidity to mitigate the impact of large trades on their price stability — the goal being to ensure that the value of stablecoins like USDC and USDT remains consistently close to 1, irrespective of trade volumes. Given that Uniswap V2's generalized AMM algorithm isn't optimally configured for stablecoin exchanges, traders often turned to alternative AMMs, like Curve, for more efficient stablecoin trading.
The Root of the Challenge in Uniswap V2's Design
The underlying issue with Uniswap V2's liquidity distribution stems from its design to allow for trading at any conceivable price, ranging from zero to infinity. On the surface, this might appear advantageous, offering limitless trading opportunities. However, this approach results in capital inefficiency. The historical pricing of an asset typically oscillates within a specific range, which can be either narrow or broad, but seldom if ever, encompasses the entirety of possible prices.
Taking ETH as an example, its historical price has fluctuated between $0.75 and $4,800, as reported by CoinMarketCap. As of June 2022, with ETH priced at $1,800, it's improbable that anyone would consider purchasing 1 ether at $5,000. Consequently, allocating liquidity at such a price level is essentially futile. Providing liquidity for a price range significantly detached from the current market price or beyond likely future prices does not contribute effectively to the liquidity pool's utility or the liquidity provider's potential returns.
However, we all believe in ETH reaching $10,000 one day.
Concentrated Liquidity: Uniswap V3's Solution
With the advent of Uniswap V3, a groundbreaking concept of concentrated liquidity was introduced, empowering liquidity providers (LPs) with the ability to select specific price ranges for their liquidity contributions. This innovation significantly enhances capital efficiency by concentrating liquidity within narrower price bands. This adaptation makes Uniswap more adaptable, capable of accommodating pools tailored for trading pairs of varying volatility levels, thus refining the versatility of V2.
In essence, the structure of a Uniswap V3 trading pair can be visualized as a composite of numerous smaller Uniswap V2 pairs. The key differentiation between V2 and V3 lies in V3's ability to host multiple distinct price ranges within a single trading pair. Each of these delineated price segments possesses its own set of finite reserves. The comprehensive price spectrum from zero to infinity is divided into these discrete segments, each endowed with tailored liquidity provisions.
Crucially, within these condensed price intervals, the operational dynamics mirror those of Uniswap V2. This characteristic is pivotal, illustrating how a V3 trading pair essentially functions as a conglomerate of miniature V2 pairs, ingeniously segmented yet seamlessly integrated.
Dune Analytics Dashboard Uniswap V2/V3 Comparison
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