Comparison between Uniswap V2&V3 and improved liquidity mining strategies

1.Introduction

DeFi (Decentralized Finance) boomed in 2020 and has attracted tens of billions dollars nowadays. Dex (Decentralized Exchange) and AMM (Automated Marketing Maker) have been welcomed by the majority of blockchain users. One of reprensentative mechanisms is CFMM (Constant Function Market Makers) designed by Uniswap, which has become the most popular decentralized exchanges and conducted billions of dollars volume everyday. Followers like SushiSwap, PancakeSwap, QuickSwap, etc, also adopted CFMM mechanism.

2. Analysis of Uniswap V2 eco-system

Before discussing the behavioral characteristics of liquidity mining participants in Uniswap V3, we first conduct a framework analysis of Uniswap V2 and other Dexes that use the CFMM mechanism.

2.1. Arbitrage traders

Based on the definition of arbitrage traders, their key motivation to trade is whether there is a large enough price difference between the Dex and other exchanges. When the price difference exceeds the sum of two platforms’ trading fee together with the blockchain transaction fee, arbitrage traders tend to carry out arbitrage trades. For example, assuming the transaction fee of Uniswap V2 is 0.3% and Binance is 0.1%, and the current price of ETH/USDT in Uniswap is 2000 USDT, while the Binance selling price is 2020. Assuming that the transaction gas fee for Dex is estimated to be $10, so the net profit ratio of the arbitrage trader is:

2.2. Active traders

The trading motivations of active traders are more complicated, which are related to market sentiment and personal preferences. On average, the active traders will contribute a greater proportion of the trading volume in the bull market. When the market goes down, the enthusiasm for trading of active traders will decline. The trend traders can’t make money in the spot market and may leave or turn to derivatives, while the increases of utility traders will be slow down due to the market sentiment.

3. Comparison and Analysis of Uniswap V3 and V2 Ecosystem

According to the white paper Uniswap V3 Core, we found that for centralized liquidity AMM, compared with the CFMM used in the V2 version, the core is to provide LP with a range order liquidity market-making strategy. If LP sets the price corresponding to the range order from 0 to positive infinity, then Uniswap V3 will produce an effect equivalent to V2.

3.1. Arbitrage LP:

One of the differences is that the price range design of the range order has also become an important factor affecting the ratio of impermanent loss to fee income during the oberservation process. If the range order is too small, the price will no longer bring new fees to LP after the price exists the position’s price range. Thus when the price exists the range for the last time during the observation, LP fees collected are less than impermanent loss which means the LP will bear permanent loss. As there will be no fee collected and the price has exists the price range. The loss will continue to expand with the price going further out of the price range, and the comprehensive income will be negative, which can lead to the following inferences:

3.2. Passive Trading LP

The second difference of V3 is that LP’s motivation is not limited to obtaining profits between collected fees and impermanent loss. LPs could also use range order to act as market makers with minus trading fee, which is similar to the market makers in tradition exchanges. For this type of passive trading LP, they could select a tiny price range and withdraw the liquidity after the price passes the range. The whole process works like “limit order”. Passive trading LPs will not compare the fees and impermanent loss. Instead they value the order fulfillment ratio.

4. Uniswap V3 liquidity mining management — R3 system

Combining Corollary 1 and Corollary 2 in Chapter 2, and Inspiration 1 and Inspiration 2 in Chapter 3, we designed the R3 system, a liquidity mining management system for Uniswap V3. Compared with the V2 model, which simply puts the two tokens of LP in the AMM with the same value, the flexibility and features brought by V3 provide LPs with more opportunities to earn. LPs in V3 obtain new entry opportunities and far-reaching opportunities through the optimization of liquidity mining strategies, like super-unexpected returns.

  1. Limit order (Deploy just above or below the current price, working for rebalancing or trending strategy)
  2. Full order (Full range cover and symmetrical deployment like V2, designed for long-term asset allocation)
  3. Concentrated order (Bounding current position within an arbitrary price range, earning fees with capital efficiency)

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iZUMi Finance

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