Today we are thrilled to present a detailed overview of Uniswap v3, the most flexible and capital efficient AMM ever designed! — Uniswap

One of the biggest issues facing Liquidity Providers (LPs) is that before V3, LP’s had to provide liquidity over any range of prices for a basket of assets. This could lead to high impermanent loss. In a nutshell, a user can end up holding on to an asset that is declining relative to its paired asset and therefore the user would have been better off holding on to both tokens rather than providing liquidity in the given trading pair. Although the LP is earning trading fees, if the relative performance of each asset diverges significantly, even the trading fees do not make up for implied loss vs holding the asset.

However, Uniswap has been at the forefront of solving this issue with a new paradigm of Uniswap V3 which allows LPs to provide concentrated liquidity across various ticks and ranges. As mentioned in Uniswap’s whitepaper

“To implement custom liquidity provision, the space of possible prices is demarcated by discrete ticks. Liquidity providers can provide liquidity in a range between any two ticks (which need not be adjacent).”

The general idea behind concentrated liquidity, is that instead of providing liquidity on the entire price range of (0, ∞), providers can choose one or multiple intervals of price for one of the assets over which to provide liquidity. In a way this gives the LP complete autonomy on how their liquidity is traded and if it does not meet the LP’s range, then their assets are not traded. Users will input their min & max prices in terms of one of the tokens as a base that they want their liquidity traded. Although IL can still exist, the user is free to choose which range they are okay with owning either asset. In most cases users should choose a pair of assets in which they do not mind holding either token. For example if you are indifferent between holding ETH & WBTC, or ETH & UNI, then you should provide liquidity in these pools.

Some basic axioms regarding providing concentrated liquidity:

  1. Trading fees depend on asset types i.e. 0.3% general trading fees, 1% for exotic pairs, 0.05% stable pairs
  2. The more concentrated your liquidity range, the higher returns you can expect
  3. There are fees to join and exit a pool

Tools that Exist today

A. Uniswap V3 Flipside Crypto Tool

Uniswap V3 Fee Calculator

My favorite tool is https://uniswapv3.flipsidecrypto.com/

This tool is an all encompassing tool that allows a potential liquidity provider to input her:

  1. Pool she is interested in providing liquidity
  2. Total $ amount of investment
  3. Move active price assumptions (where price is currently at and where you estimate it will go — if outside of the range = $0 return)
  4. Liquidity Bounds — choose your range (if outside of range = $0 return, if in range = earning trading fees)
  5. Swap Dates

Given the LP input, this tool then calculates the potential returns that can be generated in a 24 hour time period. In order to help the LP make decisions, this tool also provides information on the swap curve, existing liquidity positions, Prices Last 5 Days, and the 5 Day Swap Volume.

The Prices Last 5 Days is very helpful in understanding what range your liquidity bound has been “in the money” so to speak or “out the money” over the past few days. Simply put, if your liquidity bound is in range, you are earning trading fees, but if you are out of bounds you no longer are earning fees and depending on what side of the liquidity bound you are — you will have 100% of one asset in your pair.

Because this tool is easy to use and gives a great indication of what you can expect, Uniswap V3’s network can grow significantly.

B. Correlation does not imply Causation

Yes, yes correlation does not imply causation, but when you are deciding which liquidity pairs you want to provide liquidity for, the more correlated the assets:

  1. The less chance you have of being out of range
  2. You can have a tighter range which means getting a higher return

For example as of today 8/1/21 BTC/ETH has a correlation of 0.80, which is relatively high still. A correlation of 1 would imply that if ETH moves up by 10%, BTC also moves up by 10%.

Depending on your strategy if your goal is to stay in range as much as possible to earn trading fees, you want to choose pairs that have high correlation. With pairs that do not have a high correlation, you may need to set max and min bounds, as well as end up holding an asset that falls relative to the stronger asset.

C. Muad’Dib aka Dune Analytics

Muad’Dib is wise in the ways of the desert. Muad’Dib creates his own water... That is a powerful base on which to build your life— Dune

An underrated tool for understanding overall metrics regarding Uniswap V3 is Dune Analytics. There are many Uniswap V3 dashboards but among my favorites are the following:

  1. Uniswap v3 Volume and Fees Collected by @gammastrategies

Shows aggregate data regarding Uniswap V3 trading pairs, and fees. You can see fee tiers, 7 day volume, Top 15 pair volumes (concentration of LP positions), # of trades per trading pair, and much more.

2. Uniswap v3 — Last 2 Days Trading Pair and LP Position Discovery by Gamma Strategies

More granular data on 2 day view, as well as hourly information. New LPs added over shorter time period, Net new liquidity, total fees over 2 days, most fees by trading pair and more.

For an overall portfolio view, Dune Analytics is great for understanding how well the Uniswap V3 pool is doing on an aggregate level and helps an LP decide which pairs are worth going into and what they can expect.

This is another plus for Uniswap V3’s network effect as it helps people see how quickly and lucrative concentrated liquidity can be and can drive people to using the tool.

D. Zapper.fi

Zapper is an awesome tool not only for Uniswap V3 but for all your existing holdings and LP positions across your wallets. An added bonus is that you can also view your NFT tab which displays your LP token pairs as an NFT. This was a really cool and interesting design decision by Uniswap. When you provide liquidity an NFT is created with your trading pair, which is Uniswap just going above and beyond.

Zapper.fi is a great dashboard, with friendly UI and helps you keep track of all your existing positions.

E. Nansen.ai

Last but not least, there is also Nansen.ai which helps users track certain wallets and understand user (and whale) behavior. Although Nansen is a paid service, they do also publish public data regarding the overall Uniswap V3 landscape. Tools like this are really for super and advanced users who want to see what others are doing and maybe even allow for copying certain strategies (if you know which wallets to look for).

Tools that Should Exist

A. Monitoring Tools

Because Uniswap runs 24/7 without stopping, the only way to know if your trading pair is out of bounds is if you are constantly checking your Uniswap V3 dashboard. Having some kind of notification system or monitoring system would be a great end user experience — so they could know when they are no longer earning trading fees. This could also help users understand when to reroll profits or enter new LP positions.

Another aspect of monitoring is for super users with multiple LP positions. The great thing about Uniswap V3 is that you can have the exact same LP position across different Liquidity Bounds. However, tracking this is pretty manual at this point.

B. The Yearn Finance of Concentrated Liquidity

In order to really grow the network Uniswap V3’s concentrated liquidity needs to be simplified for the most basic defi user.

This might be an unpopular opinion but I do not think Uniswap V3 concentrated liquidity will reach mainstream until there is an automated and simplified LP tool that dynamically adjusts a user’s ranges. According to Nansen’s report:

58% of addresses own only 1 liquidity position. In fact, less than 10% of addresses that provide liquidity on V3 own more than 5 NFT positions.

As Elon mentioned in his recent talk,

“The simplest solution is almost always the best” — Occam’s Razor

Defi itself is a somewhat complex space, and my thesis is that mostly power-users, Crypto funds, and advanced users are benefitting from Concentrated Liquidity but the majority of people are ignoring it. It is something you have to actively monitor, need to understand trading pairs, and need to understand price movements. From the many conversations I have had with people in the space only 5% of the people (this is more anecdotal) I talk to are currently using Uniswap V3. I enjoy using it, but a lot of new people to Defi do not understand how to use it and shy away from it. There is also a recurring fear of impermanent loss.

However, if you are in a pair of assets in which you don’t mind holding either token, then you realize you are basically buying one asset at the cheapest price, while your other token is at its best performing price, so you are actually buying at an optimal price point over a given range.

Most users just want to earn a return, whether it is through staking, farming or even basic LP’ing without putting in a lot of effort.

I think a tool like Yearn Finance and Vault strategies can be a great onboarding tool for new & average Defi users to grow the network. For example if Uniswap V3 had Strategy managers that would manage your liquidity (via a smart contract) and take a percent of the return (i.e. 20% fee on upside), I think quite a few people would be okay with doing this. Strategy managers could also share their return performance which can easily be verified because it is all on-chain data.

Actively managing your Uniswap V3 LP positions and earning a healthy return takes up a lot of time and effort. You can have a passive strategy for you LP position, and just ignore it over time, but chances are that you are leaving money on the table. The more time you spend on understanding your LP positions the better the chance that you will outperform the market.

Conclusion

Overall Uniswap V3’s concentrated liquidity option is a game changing tool and a new paradigm shift in how LPs can have more flexibility, autonomy, and control over their assets. There are many tools that exist today that can help users understand their LP positions and what returns they can expect. There are also a few tools that can and should be built to make providing concentrated liquidity easier and effortless for new and basic defi users.

Crescat scientia; vita excolatur ◎ Crypto mad scientist ◎ Analytics @ Flexport ◎ MS Computer Science @penn ◎ Econ @Uchicago . https://medium.com/@alisheikh