Why Uniswap?
Did you know what the top 3 DEXs by TVL look like?
- Uniswap V3 — $6.4 billion
- Uniswap V2 — $3.2 billion
- Camelot — $1.8 billion
But why is that? What makes Uniswap so valued?
In 2016, Vitalik pushed the idea on Reddit about creating DEXs on Ethereum.
The idea was quickly picked up by EtherDelta and IDEX. They tried to implement Buterin’s idea, but these projects were still similar to traditional CEXs and were far from the original concept. Just look at this guide from 2016 for EtherDelta.
Uniswap V1
By November 2018, a man named Hayden Adams revolutionized the DeFi sector by introducing the automatic market maker (AMM).
Key features of the first version:
- You can only swap ETH/ERC20, for example, USDT/ETH, ETH/USDC, and you can’t swap USDC for USDT directly.
- The algorithm type CPMM (constant product market maker) in their AMM pools works by a simple formula: Token A * Token B = K, where K is a constant.
How this algorithm works in practice:
- A liquidity provider deposits 50,000 USDC and 10 ETH into the pool, resulting in the formula: 50,000*10=500,000 => ETH price = 5000 USDC
- A trader comes who wants to exchange 5000 USDC for ETH
- Since the liquidity provider must maintain the constant 500,000, the formula for this swap becomes 55,000*~9.09 = 500,000
- The trader ends up getting ~0.91 ETH for 5000 USDC
- The price for 1 ETH jumps to 6050 (55000/9.09)
A unified fee structure: Uniswap v1 charges a 0.3% fee on all trades, which is distributed among liquidity providers. This fee is hard-coded into the protocol and cannot be adjusted.
Uniswap V2
The first version was a big success, and in May 2020, V2 was launched, introducing several important improvements aimed at increasing liquidity, reducing impermanent loss, and providing more flexibility for traders and liquidity providers.
V2 features:
- Support for ERC20/ERC20 swaps, which was a significant enhancement over the first version — now it’s possible to swap USDC/USDT, USDC/BTC, etc.
- A protocol usage fee: Uniswap V2 introduces a 0.05% fee for ETH/ERC20 swaps and 0.3% for ERC20/ERC20.
- Introduction of Flash swaps: These are not accessible via the interface, so this option is more for developers and software. Not the same as a Flash Loan
- Improved price oracles: Roughly speaking, it’s a price parser for trading pairs, which provides accurate and reliable price transmission and enhances the overall stability and efficiency of the protocol.
Uniswap V3
Another major iteration of the protocol, launched in May 2021, introduced a number of innovative improvements to provide greater control over liquidity provision and trading.
Let’s start with what V3 liquidity pools are and how they differ from V2.
In V2, there’s an AMM (automatic market maker), in V3, there’s a CLMM (concentrated liquidity market maker).
The fundamental difference is that in the V3 version, stakers independently choose the price range in which their assets will participate in the exchange process.
What are the advantages of this setup?
- For liquidity providers — higher APY because their assets are used only within a specific price range.
- For protocols and users — much more liquidity and reduced probability of large slippage during exchanges.
A good comparison is with a sandwich:
Imagine you have a huge piece of bread that you need to spread butter on.
In a V2 sandwich, stakers’ funds are spread in a thin, even layer across the entire surface. But there’s a problem: the funds distributed at the edge of the bread aren’t used because we don’t eat the sandwich all at once, only in parts.
In a V3 sandwich, funds are mainly concentrated in the range of current prices and are adjusted with any movement of quotes. If represented on a graph, it would look like a parabola, where 0 is the maximum concentration of funds, decreasing evenly with the price difference.
The result is clear: studies show that Uniswap V3 has higher liquidity for pairs like ETH/USDT and ETH/BTC than Binance and Coinbase combined.
Here’s the stats and comparison of V2/V3 on Dune: [LINK]
To calculate the approximate APY, you can refer to the yield calculator for a V3 pool here
For example: the ETH/USDC pair, with a price range within +-3%, gives a yearly APR (without compounding) of 327%.
Yes, it’s not as simple as depositing money into a V2 pool and forgetting about it. You need to constantly monitor prices and adjust your position. According to a study, the average yield for V3 providers was 22.8–324% higher than for V2 providers, depending on the pool and fee level.
It’s not all straightforward. There’s a complex concept known as “impermanent loss (IL).” In short — it’s the decrease in the value of the liquidity position compared to the hypothetical situation where a user holds them in a wallet, not contributing to the pool.
According to another report, half of the liquidity providers (in a bull market) earned significantly less than if they had simply held the tokens, not contributing to the pool.
What can we conclude?
In a bull market — it’s more profitable to hold tokens.
In a bear market and during consolidation periods (especially in sideways markets) — providing liquidity surprises with high yields.
Uniswap V3 major features — summary:
- Concentrated liquidity
- Multiple fee tiers
- Ability to place limit orders
Once again, let me remind you, we are still early. In Q4 of this year, Uniswap will introduce V4, which should pleasantly surprise us.
Stay tuned.
