Basic of Concentrate Liquidity
Basic of Uniswap v3
The goal of Uniswap V3 is to improve the capital utilization of LP. V3 “concentrated” the whole selling/buying process into a selected range, which greatly increased the liquidity depth with fewer assets. Uniswap V3 allows users to provide liquidity in a certain price range, trading fees will only be generated when the trading token price is within the selected range, which brings users higher earning chances with higher risks.
For details, you can check:
Constant product model VS. concentrated liquidity model
How efficient it can be, let’s compare the real-time data (18 Feb - 11 Feb 2023). The TVL of Uni V3 is 2.97B, and Uni V2 is 1.18B (Uni V3 has 197% more TVL than V2). If we compare the trading volume, we will find Uni V3 contributes 84.2% of the total volume of Uniswap, while only 15.8% from V2. This means the utilization rate of V3 liquidity is 212% of Uni V2. Furthermore, if we look at the transaction quantities, we will find that the transaction numbers of V3 are only 53.8% of V2, which implies V3 10-times the trading volume per unit gas fee.
Uniswap V2/V3 Comparison (dune.com)
Uniswap: TVL and Stats - DefiLlama
Data of Uniswap V3
The average last 7 days (18 Feb - 11 Feb 2023) trading volume is 8.39B (with more than 1.51B contributed from stable coin pairs) of Uni V3 against 1.59B of Curve, while the TVL is 2.97B against 5.82B.
Uniswap v3 Volume and Fees Collected (dune.com)
Barriers in Uniswap v3 Liquidity Providing
However, most LPs are actually losing money during the past year on V3, according to Impermanent Loss in Uniswap v3. There are three main problems making it hard to earn profits on V3:
More significant exposure to price volatility. Zero trading fee when the price is out of range. LPs only receive trading fees when the market price is within their selected price ranges, no trading fee will be generated when the market price is out of LPs’ selected range. It might sound unnatural but true that LPs are not earning fees from trading all the time. Choosing the right price range is challenging for most LPs. A narrow price range brings high efficiency but with a high risk of being out of range which may greatly reduce the average profit rate time-weighted, while a wide range reduces the risk but with less earning potential. At high-volatility markets, more fees are distributed to the ones who choose a better price range.
Multiplied Impermanent Loss. More impermanent loss (IL). Take the X/USDT trading pair as an example, when X’s price goes down, the net market is selling X to LPs, so the LPs are actually buying X. In the V2 model, LPs loss is proportional to the square root of the ratio between X’s new price / old price, the LPs will never fully convert their position into X. However, in the V3 model, since the liquidity is “concentrated”, you will buy more X than V2 model and when the price drops out of the range, all your asset has been swapped into X, then you will be faced with linear lose curve, which is sharper than square root curve. The same thing happens in the other direction. Due to the full conversion, LPs will never benefit from the price rises out of range, since all assets have already been converted into USDT when they reach the upper limit of the selected price range.
More Complex users experience. To manage LP positions in Uniswap, one must perform several manual steps, such as setting tick ranges, swapping assets, and depositing them. When closing a position, one must collect fees, close the position, and manually swap collected tokens if a single token is desired. These manual steps across multiple interfaces add extra difficulty for users, which will reduce efficiency and may result in decreased TVL and trading volume.
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