Uniswap V3 has now been live for almost two months and has improved the capital efficiency of the largest decentralized exchange (DEX) in the crypto space by a factor of 4,000. For this reason, let’s take a closer look at how investors can benefit from it.
The Uniswap team released the long-awaited V3 Mainnet in early May. The upgrade included some massive improvements for the decentralized exchange (DEX) and, among other things, ensured that liquidity providers can make even more money.
What is Uniswap V3?
Uniswap has developed rapidly in recent years. The introduction of the V2 upgrade ensured that liquidity pools consisting of several ERC-20 tokens could be formed for the first time.
During the rest of 2020 and early 2021, this led to activity in the DeFi space going through the roof. In the meantime, the trading volume for some trading pairs has even exceeded that of centralized crypto exchanges.
Uniswap V2 is definitely a marvel of technology, but it does not make optimal use of the liquidity of the liquidity providers. This is because the liquidity in Uniswap V2 Liquidity Pools is evenly distributed along the entire price range of a token. Since most tokens trade within a certain price range, this means that a large part of the liquidity is only used very rarely or not at all.
Why is the upgrade so special?
Uniswap V3 solves precisely this problem. By introducing concentrated liquidity, V3 enables liquidity providers to only provide liquidity for a certain price range.
An example
Let’s say you want to trade the USDC / USDT stablecoin pair. On V2, we can hypothesize that the vast majority of trading in this pair will be within the $ 0.98 to $ 1.02 price range. Within a V2 pool, this ensures that a large part of the liquidity pool’s capital is never used, as it is distributed along the entire price range.
The great advantage of V3 is that liquidity providers can choose for which price range they provide liquidity. In the case of the example above, V3 liquidity providers can target the price range above directly. This allows you to use your liquidity as efficiently as possible without a large part of your capital lying idle. So it is possible that V3 can offer better conditions for traders with less liquidity and that liquidity providers earn more.
This is how you become a liquidity provider
Since Uniswap V3 is dependent on concentrated liquidity, you have to determine yourself for which rate range you want to provide liquidity.
1. First of all you have to go for it Uniswap select an appropriate liquidity pool.
2. Next, you select the desired fee level (0.05 percent, 0.3 percent or 1 percent) for the use of the liquidity pool.
Which fees are incurred which liquidity pool can be found in the official Uniswap V3 user guide read up.
3. Then, in the next step, you choose the price range for which you want to provide liquidity.
Depending on which fee level you have previously selected, you now have the option of adjusting the rates in either 0.10 percent, 0.60 percent or 2.00 percent steps. Manually entered values are automatically adjusted to the nearest step. Then you only have to specify how much capital you want to provide and finally confirm the transaction in MetaMask – and you are a liquidity provider on Uniswap V3.
Conclusion
Uniswap V3 is a highly efficient DEX that is currently superior to all other decentralized exchanges in terms of capital efficiency. However, the operation is still a bit complicated and not particularly accessible, especially for inexperienced DeFi investors.
If the price of a token moves outside the specified range, the position is concentrated in one of the two tokens and you no longer earn trading fees. You can only earn money again when the rate returns to the set range or you set a new rate range yourself.
The narrower you set a price range, the more capital-efficient you provide liquidity and the more trading fees you earn. The big disadvantage of this is that a narrower range means that you have to actively manage your position in order not to fly out of the price range. This can be a problem, especially for small investors. This is because an Ethereum transaction is used to adjust the price range must be carried out. When the Ethereum network is heavily used, managing a liquidity pool position can be extremely time-consuming.
Disclaimer
This article was already published by BTC-ECHO in June 2021. It has now been checked and updated.