Aggregation function of liquidity will bring the LP which change | Uniswap V3 new features a parsing series

As the absolute leader in the DEX market, the release of Uniswap V3 received wide attention as soon as it was released. The new version focuses on improving market making and improving the efficient use of funds by liquidity providers (LP). So, for LPs who are already familiar with V2 mode, what changes will V3 bring to them?

A more concentrated price curve

We know that in the Uniswap V2 version, all the liquidity provided by LP is evenly distributed along a curve defined by x*y=k. Regardless of the size of the pool of capital, the curve fully represents all possible prices and provides unlimited liquidity to the market. However, the even distribution of funds also greatly reduces the efficiency of LP market making. Especially when it comes to stablecoin trading pairs, about 99 percent of the liquidity in the pool is never used efficiently. Moreover, the inefficient trading Curve also gives SWAP, such as Curve, which focuses on stable currency, space to survive and develop.

The new version finally solves this problem.

In the V3 version, LPs will be able to actively choose the range of market making based on their expectations of price movements. The mathematical formula can be expressed as follows:

x*y=k(price :P=x/y, P∈[price floor, price ceiling])

As you can see,The new liquidity provision method still follows the original simple price curve, and the change is only reflected in the limited value range of price P. Equivalent to the original price curve, artificially cut one of the line segment. The new market making method enables LP's funds to be fully aggregated within the selected curve range. If the subsequent price trend is in line with LP's expectation, LP will therefore get more commission income. Especially for stablecoin trading pairs, assuming that the relative price of the two currencies fluctuates no more than 0.1%, then according to UNISWAP official introduction calculation, under the ideal state, through the concentration of liquidity, LP will earn 4,000 times more fee income with the same capital than the previous version.

(from Uniswap v3 Core)

Say goodbye to 50 per cent market making

Although it is only a small adjustment on the original curve, the V3 version will bring about a big change in LP's market-making habits. LPs will no longer be able to make markets at the familiar 50-50 ratio.

As we know, in the classic V2 version, LP would provide both tokens for market making, and the values of the two currencies must be equal, which has been summarized by many as the 50% market making principle. With the new V3 release, the process is much more complicated.

To better illustrate the changes in the V3 version, let's take the ETH-USDC transaction as an example.

The scene of a

With the spot price of ETH at $2000, LP anticipated that the price of ETH would move sideways in the range of $1900-2100 and decided to make the market in the range of $1900-2100 to earn a fee.

According to the new V3 algorithm, LP will need to pay equivalent ETH and USDC liquidity to the protocol, such as 5 ETH and 10,000 USDC, with a total market value of $20,000.

As you can see, since the spot price is right in the middle of the market-making price range, there is no significant difference between the market-making operation in this scenario in V3 and in the V2 version.

Scenario 2

With ETH spot prices up to $2300, LP still wants to make the market in the $1900-2100 range. Since the spot price is already higher than the upper limit of the price range chosen by LP at this time, LP will have to make all the market in USDC.

Of course, since the spot price is higher than the market-making price range, LP will not be able to receive the commission fee at this time. Only when the ETH price gradually drops to less than $2,100 will the market-making funds of LP be gradually converted from USDC to ETH, and the fee income will start to accumulate.

Scenario 3

With ETH spot prices down to $1700, LP still wants to make the market in the $1900-2100 range. I think the reader can already see at this point that LP needs to provide all the liquidity to the protocol in ETH. Wait until the ETH price rises to $1,900 before the fee income starts to come in.

It can be seen that the currency composition of the market-making funds invested by LP depends on the position of the spot price relative to the market-making price range. If the spot price is outside the market-making price range, LPs must market entirely in a single currency.

If the current price is right within the market making price range, then LP needs to provide two currencies for market making. Specific calculation process is more complex, here but more introduction.

Can we do unilateral market making in V3

At this point, some readers may be wondering, does this mean that we are ready for unilateral market making on V3?

In my opinion, it can not be so simple to understand. Unilateral market making tends to mean that what currency you put in when you make a market will remain in what currency you take out. In the V3 version,While LPs can make markets in a single currency under certain circumstances, the ratio between the two currencies when liquidity is withdrawn will depend entirely on the spot price at the time of withdrawal.

We went on toScenario 2If the ETH price drops to $2000 when the LP withdraws liquidity, the LP will get half of the ETH and half of the USDC. If the price drops to $1,700 at the time of withdrawal, all the money LP gets back will be ETH.

As you may have already sensed, with market making in V3, LP will be exposed to more currency movements. In more familiar terms, the LP's contingent losses have become greater. This topic is important and will be explored in more detail in a future article.

conclusion

It can be seen from the above analysis that making market in V3 is no longer a simple operation like making money without thinking in V2. To become a V3 LP, one first needs to have a clear expectation of the price trend, and at the same time, to adjust the market-making position in time according to the changes in the market. All of this is going to make LP a much more specialized job.

In the next post, we'll talk about Range Orders.

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