Flipside Crypto takes a dive into how Uniswap's v2 compares to its v3.
We have heard a lot of stories about how efficient Uniswap v3 is:
However, according to Mark Richardson, Bancor head of research, v3 comes with a price.
Did Uniswap really sacrifice retail LPs for a better capital efficiency? Let’s find out.
V3 vs. V2 - An overview
Take a look at some of these key Uniswap metrics.
On TVL and active users, V2 comes out ahead with 18K daily users and $4B in TVL in comparison to just 8.45K daily users and $2.5B TVL in V3.
On volume, V3 is the winner here with $6.79B daily volume, nearly quadrupling the transaction volume on V2.
=> At first glance, capital efficiency on V3 is the real deal. It generated 4 times more volume than V2 with only half the TVL required.
Despite the capital efficiency, why do people still keep their liquidity in V2? With the volume / TVL ratio of 2.79 in V3 and only 0.71 in V2, you should earn at least 3.8 times more if you migrate to V3 right?
Well, the true story is not so simple.
V3 and Capital Efficiency
To understand how v3 works, let’s take a look at their unique mechanic: concentrated liquidity:
LPs can combine any number of distinct concentrated positions within a single pool. For example, an LP in the ETH/DAI pool may choose to allocate $100 to the price ranges $1,000-$2,000 and an additional $50 to the ranges $1,500-$1,750.”
“Swap fees are not automatically reinvested as they were in previous versions of Uniswap. Instead, they are collected separately from the pool and must be manually redeemed when the owner wishes to collect their fees.”
Not only do you have to actively monitor and adjust your position to get the best yield, you also have to manually claim the rewards if you want to compound them. On v2, the only thing you need to do is deposit your fund into the LP pool.
This effectively gives an edge to a small group of people who:
Have a working strategy, hedging,... to battle against the high impermanent loss on concentrated position.
Have capital that is large enough to outweigh the high gas fee on each rebalancing position / claiming reward on Ethereum.
Those who have the ability to do so will have their capital efficiency increase 4000x over those who cannot. => Rewards are distributed heavily to a small group of people.
What Happens If I Just Provide Liquidity to Uniswap v3 the Same Way I Do to v2?
The widest liquidity concentration in the last 30 days is around 20%-30% with most of the day being only around 5%. Let’s take 20% as an example.
There is a 10x difference between a user who actively adjusts their position inside the 20% range and a normal user who just provides liquidity in the 0-infinity range (v2).
The fees you earn in a pool are distributed based on the ratio of your liquidity over total liquidity.
=> With the high concentration of top 10 LPs, their effective liquidity will increase 10 times in comparison to those who provide without a range.
=> Retail users will earn 90% less fees if they don’t adjust their range accordingly.
How Much in Fees Can You Earn as a Retail User on v2 vs. v3?
If you’re a retail user:
With the v2 pool, the fee/liquidity ratio is 184,461 / 218,728,477 = 0.000843.
The same ratio on v3 is 703,170 / 332,460,000 = 0.00211. However since you don’t provide liquidity in a tight range / actively manage your position, your actual ratio will be divided by 10 or 0.00021.
Moreover, on some days, liquidity is only concentrated around the 10% range:
=> In this case v2 gives out 8x more reward than v3.
Therefore, while v2 makes everyone receive the same reward per dollar deposited, v3 allows some groups of people to receive more rewards with the cost of others receiving less.
Will Retail Users Be Able to Enter V3 LPs in the Future?
While layer 2 might solve the gas problem on Ethereum, it won’t remove the technical barrier (the complexity of adjusting the range to maximize the profit). Unless someone can propose an optimized strategy that no one else can beat, there will always be a winner and a loser in this game.
Somehow in the end, the liquidity provider job on a decentralized exchange is handled by a centralized group of people.