Uniswap v3 hopes to reinvent its DEX, others see a different path for DeFi

The v3 upgrade seeks to maximize capital efficiency, but it may worsen many impermanent loss-related issues that plague DeFi.

Uniswap decentralized exchange and its governance token, UNI, have been defying all expectations in recent months, with the world’s largest DEX recently recording cumulative transaction totals exceeding the $10-billion threshold. What’s more, it is estimated that Uniswap’s 24-hour trade volume currently lies somewhere around the $2.3-billion range.

Uniswap CEO Hayden Adams has been tweeting about the milestone recently and has even released an accompanying chart showcasing a 25.7% weekly increase in Uniswap’s weekly trade volumes. It’s worth noting that if the platform is able to keep up its current in/outflow pace, it will be able to process a whopping $500 billion worth of transactions within the next 12 months.

Uniswap’s increasing popularity seems to stem from the fact that it allows investors looking to dabble in various decentralized finance projects and other obscure cryptocurrencies fairly easily, which may not be available via popular centralized exchanges like Binance or Coinbase.

As a result, Uniswap’s native token offering, too, has been on the receiving end of some serious monetary traction. For example, since the beginning of the year, the value of the token has increased from $5 to around the $40 mark, thereby showcasing an 8x surge within a matter of just four months.

Even the DeFi market seems to be on a roll at the moment, with data showing that around $67 billion is currently locked into various DeFi platforms. In fact, this number was even higher just a week ago. However, due to the recent marketwide correction — which saw around $300 billion in cumulative crypto value being wiped out from the market almost overnight — the figure has scaled back down once again.

Will Uniswap v3 be a gamechanger?

According to a release from April 21, Uniswap has taken yet another step toward launching the latest iteration of its platform called v3 across all of Ethereum’s test networks, with the mainnet launch set for May 5. More specifically, v3 core and periphery smart contracts have been deployed on Ethereum testnets Ropsten, Rinkeby, Kovan and Goerli.

In terms of what this latest overhaul entails, Uniswap will now make use of the concept of “capital efficiency,” thus potentially complicating the passive income aspect of its liquidity provision for many casual DeFi investors. Providing his take on the upgrade, Brandon Iles, co-founder of rebasing cryptocurrency protocol Ampleforth, told Cointelegraph:

“I think v3’s design is a natural progression philosophically from where they are. It will be interesting to watch how (or whether) other platforms respond in turn. I expect this is the point where Uniswap and other AMMs start to diverge. This means more diversity in the space, and that’s a good thing.”

Other upgrades include a multiple fee tier system that enables liquidity providers to be compensated for taking on varying degrees of risk. Additionally, there are now three separate fee tiers per pair according to their expected pair volatility — 0.05%, 0.30% and 1.00% — which, on paper, helps offer better protection against impermanent loss for liquidity providers.

Lastly, v3 also makes tangible upgrades to Uniswap’s existing automated market maker bonding curves, which aggregate individual positions into a single pool to form one combined curve for users to trade against.

Not everyone is sold on v3

While many seem to be praising Uniswap v3, Sergej Kunz, co-founder of DEX aggregator 1inch, told Cointelegraph that in comparison to v2 and most other automated market makers, the new version has become a specialized instrument that caters more to sophisticated market makers rather than amateur liquidity providers, adding:

“The other side of higher capital efficiency is the complexity of liquidity provision and management. Since Flashbots service launched AMMs became the target for sandwich attacks, Uniswap v3 design is still vulnerable to this issue.”

When asked about UNI’s meteoric growth — something that has seen the token enter the top 10 rankings by market capitalization — Kunz opined that even though UNI’s ascent looks really good, such governance tokens don’t really have any intrinsic value other than providing owners the option to participate in certain governance-related matters.

He also highlighted that Uniswap’s core contributing teams are releasing new features and updates through the use of “business licenses.” Kunz said: “To be honest, such an approach is not aligned with the spirit of decentralized finance.”

Is the current DeFi wave set to grow?

Despite high Ethereum network gas fees — with Uniswap exchanges currently costing users around $21 per transaction — most DEXs have continued to attract high trading volumes. In this regard, Fernando Martinelli, CEO of Balancer — a protocol for programmable liquidity — told Cointelegraph:

“Growing numbers of users are being onboarded to DeFi, and this is particularly driving growth in the AMM space. AMMs act as the crucial underlying layer of liquidity for DeFi products and services, and the market seems to be understanding this more lately. This growth benefits the ecosystem as a whole, including Uniswap.”

He also pointed out that as Balancer looks to launch v2 of its native protocol with an all-new set of features, these options will be considerably different from those being offered by Uniswap v3. “Both will benefit DeFi users with improved capital efficiency. Uniswap v3 has gone in a very different direction than Balancer v2, which is good for the space as a whole,” he added.

While many had been looking forward to Uniswap v3, it seems as though the upgrade may have potentially underdelivered. For example, even though founder Adams had promised to silence the critics by rolling out an update that would make the platform’s AMM impermanent loss-protected and super-efficient, v3 seems to actually worsen impermanent loss.

This is because the mechanism hinges largely on the concept of “concentrated liquidity,” which basically affords liquidity providers the power to choose the price ranges in which they are comfortable committing liquidity — as opposed to covering the entire zero-to-infinity range.

Another potent drawback with v3 is that it no longer has pool tokens. Instead, the protocol now makes use of nonfungible tokens to represent a user’s particular position, thus landing a blow to “composability” that would instantly render concepts like Aave’s Uniswap markets or Maker’s pool token vaults unusable.

While v3 does make it hard for users to avoid slippage issues and utilize pool tokens, it seems quite likely that the platform’s developers will take these pain points into consideration when looking to tweak the system in the future, thus making it easier for newer entrants to explore the DeFi landscape much more easily.