This is going to be a very precise article, explaining Uniswap V1, V2, and the newest update V3 to my subscribers, so that they can understand how it works.
It is very technical but very powerful, so I’m going to spend a decent amount of time, ensuring that you can understand it. In this article, we’re going to explain what in the world Uniswap is what the crazy developers did to improve it in the recent version 3 and at the end, I’m going to give you my thoughts on what could cause This token, to triple in price, let’s first go over Uniswap V1. Uniswap V1 allows traders on the Ethereum network to use a new system of trading called an automated market maker to allow traders to trade with a pool of money.
At any point in time with very low fees and they could theoretically trade for an infinite amount of coins. So how does all this trading happen? Well, Uniswap was created using smart contracts, which are pieces of code that work on the blockchain and allow people to do cool things that they can’t do with the bitcoin network, for example, in V1 you could give Uniswap 200 and they might give You one Ethereum after that, you might give them 200 again and this time they’d give you 0.8 Ethereum. This is because, since you bought Ethereum, the price of Ethereum went up and the pool charged you more for it.
The money in the pool is deposited by other investors. So basically, investors come along, they deposit their money, and then you get to trade with their money now, version one had many different liquidity pools, but all of the pools had to contain at least one Ethereum.
For example, you could have a USDC and Ethereum pool and a basic attention token in the Ethereum pool among hundreds of other pools. However, if you wanted to trade USDC that you had for the basic attention token that someone else had you’d have to interact with each pool meaning extra work.
Next, let’s go-to unit swap V2, so version 2 fixed this problem by creating pools that don’t need Ethereum. Now we can create any pool that we want, including a USDC and basic attention token pool that allows us to swap tokens with one click now, Uniswap became famous for this. They grew literally exponentially for a while and then even became the most popular app on Ethereum, because of that now Uniswap is probably one of the most forked projects in the blockchain because the code is so useful.
Finally, it’s time to start explaining Uniswap V3, have you ever seen, one of those SpaceX rockets that goes up, and then comes back down and it lands the same way It went up. I’m fairly certain that the same math used in those rockets is also used in Uniswap V3. That’s how complex it starts to get now, short of explaining rocket science Bear with me, as I explain what took me about 12 hours, 44 breaks, and about 7 Uniswap experts to teach me.
First off Uniswap V3 was launched around march of 2021 on both the Ethereum main net, as well as the optimism main net, which, if you don’t know what optimism is, it’s a secondary network used to scale Ethereum now, just like V2 had one big update. The big update in V3 is called concentrated liquidity. Liquidity – if you don’t already know basically means money that you provide to someone else so that they can use it for something.
In this case, it’s trading, let’s go over concentrated liquidity. Now the benefit of concentrated liquidity is that you can make your money work even harder for you simply by giving it some rules. Let me explain normally when you want to be an investor and put your money into a Uniswappair like USDC or Ethereum, you lend your assets to the pool.
Now the pool lets other traders, trade, your assets back and forth, basically collecting very small fees from those traders so that they can pay you. This way, traders are happy to trade and you’re happy to lend your money. Now, when you provide liquidity, it evenly spreads your money for traders to use between the prices of zero dollars and infinity dollars.
This means if Ethereum goes to a hundred thousand dollars or even plops down to fifty the money that you provided is fairly allocated across all price ranges for traders. V3 changes this, Instead of letting your assets be spread thin across all price ranges, you can now select where you want to deploy your concentrated liquidity, so, instead of giving it to some USDC and then some Ethereum and then basically collecting fees here and there you can say, here’s some USDC And some Ethereum, but only let it be used between the prices of three thousand and four thousand dollars. The benefit to this is that your capital is essentially multiplied and we’ll get into that later, when the price falls out of both of those ranges, two major things happen, number one you stop earning fees now.
This is quite simple, as you only provided your assets to collect fees in those ranges, number two, your liquidity or the money that you provided will be turned into one single asset. For example, let’s say that Ethereum is crashing. It crashes from three thousand five hundred dollars to one thousand dollars now all of your capital used to be in Ethereum and USDC.
Now it is only in the form of Ethereum in version 2, you would always have at least a little bit of both tokens, but version 3 changes that. Now you might even think this is beneficial because by supplying between the ranges of three thousand dollars and Four thousand dollars: you are effectively placing a three thousand dollar Ethereum limit, sell order, and a four thousand dollar limit buy order. Now, in simple terms, this means, if you supply liquidity between three thousand dollars and four thousand dollars, you’re, basically saying if the price of Ethereum goes above Four thousand dollars spend all my money buying it, but if the price goes below three thousand dollars sell All of my Ethereum and, of course, there’s going to be a little bit of impermanent loss, but that’s for another article.
Next up, we have the concentration multiplier. So let’s go over an example of why this matters, you and I both supply liquidity to an Ethereum and USDC liquidity pool now, for this example, let’s assume Ethereum is one thousand seven hundred and fifty dollars, you do it in the way that it was done in version two, where the liquidity is spread Evenly across all price ranges, and you invested ten thousand dollars, I, on the other hand, use the special rocket science math and supply my liquidity. I decide to supply an equal amount of ten thousand dollars to the pool, but only when the price of Ethereum ranges from fifteen hundred to twenty-five hundred dollars.
Now, let’s get into the important question: what fees do we both collect? Well, it depends on the volume that Ethereum is trading at, but let’s assume that you collect four percent a year, four hundred dollars. I on the other hand, who deploy my capital in a specific range, will earn eight and a third times that much so three thousand three hundred and thirty-two dollars, Even though we invested the same amount.
I know what you’re thinking this isn’t to say that it comes without risks because there is a case when I could get wrecked within permanent loss anyways. As long as the price does stay in that range, I will earn a much better return than you, an even better way of thinking about It is like this.
I could simply supply one thousand and two hundred dollars, keeping all the other eight thousand eight hundred safe, and earn the same amount in fees as you. This concentrated liquidity is especially useful for situations like stable coin pools, where there are two assets that hardly ever change in price with each other. For example, the pool that holds dye and USDC hardly ever gets out of the range from a dollar and a penny to 99 cents, so you can imagine how powerful this is. The capital multiplier here isn’t 8.33.
Like the last example, it is 200x now, if you’re like me, you might be asking what’s the highest capital multiplier, I could get well, I’m glad you asked because I have the answer and the answer is 4000 times now. This only happens when you provide liquidity inside a very narrow range of 0.1 percent.
Next up, I want to cover something called active liquidity, so we already covered active liquidity, but I didn’t call it that. So if you supply liquidity to the ranges of 25 dollars to 35 dollars and two tokens and the price of the token drops out of those ranges, what happens? Well, your liquidity will instantly turn into one token. The token that is dumping, at least whenever it hits the 25 price point after that if the price keeps dropping, and your liquidity is technically inactive, you’re, not earning any fees or even changing due to impermanent loss.
The next thing that I wanted to talk about is how Uniswap uses NFTs, so this brings us to the part of the article where I will now explain how Uniswap gives NFTs. If you know what an NFT is, you know that it’s simply a token that isn’t fungible well in the past, one USDC and Ethereum lp token were exactly equal to another USDC Ethereum lp token, by the way, if you’re not sure what an lp token is, it Is what is given to liquidity providers or investors so that they can prove that they provided money to a specific pool and using that lp token, you can redeem it for your portion of the pool at any time? Another cool thing is, that you can trade them, and in the past, there was only one type of lp token per pool. However, now, since we have price ranges, we actually must create NFTs that have specific data attached to them.
For example, I could have the NFT USDC Ethereum lp token, with the data of the price range from two thousand dollars to three thousand dollars. Another really big thing that I have not seen many other people mention about Uniswap version Three is their licensing.
This means you can’t copy or fork the code for two years and basically, since a ton of other exchanges on other networks are quite literally using Uniswap with different branding. They are not going to appreciate this. This licensing protects their code for a while, so it’ll be interesting to see how it plays out for them.
Finally, one thing worth mentioning before we get into my thoughts on this is that there were a few fixes that made Uniswap, even cheaper, meaning fewer gas fees, which is always a nice upgrade to have. As we end this complicated article I’d like to thank you for bearing with me through this crazy explanation. One last thing I’d like to share is my thoughts on v4.
Now I have no idea what these amazing developers will come up with in a future version, but something I’d personally like to see is in the form of passive income for Uniswap token holders. I was thinking something like a very small portion of all fees on uniswap that goes back into buying the Uniswap token, essentially meaning it is an asset-producing token that continually buys itself. This should mean that the price should appreciate and would be really cool to see such a large-scale platform actually try this.
Thanks for reading.