How to Use Uniswap V3: Ultimate Guide
The third and latest version of Uniswap launched in May 2021. With every version, there are new updates. Uniswap V3 is the most user-friendly and efficient of all the versions. It can be difficult to understand the new changes of each version, and how to use them.
Uniswap is a decentralized exchange (DEX) market operating on the popular Ethereum blockchain. It’s used to trade fungible ERC20 tokens. The Ethereum blockchain creates these tokens. New aspects of Uniswap have crypto enthusiasts excited, for good reason. This version highlights all the best aspects of crypto. From better decentralization, higher security, and more liquidity.
If you are unsure of what Uniswap is and how it works in crypto trading, don’t worry! This guide has all the information you need, explained in simple terms. We did a deep dive into the history of the market, from its first launch.
What Is Uniswap V3 and How Is It Different Than V1 and V2?
Uniswap V3 is the latest version of Uniswap Protocol, launched in May 2021. Compared to the previous versions, Uniswap V3 is more capital efficient. It is more decentralized and secure. It also has more fee tiers, and advanced data feeds called oracles.
These allow traders to hold their assets with more security. They can also watch their trading pairs with enhanced accuracy. There are many terms that can describe the function of Uniswap. It is a peer-to-peer marketplace that isn’t controlled by a central authority.
This means that traders swap cryptocurrency with each other, without an intermediary. A third party will never interact with their wallets and the tokens they swap. Traders on Uniswap are Liquidity Providers (LP). This is because traders add more tokens to the Uniswap liquidity pool.
They do so by swapping tokens with smart contracts. These contracts define how to create a liquidity pool. When we say pool, you might imagine a big group of assets. In reality, every pool contains two assets. Liquidity pools keep track of LP pricing strategies and asset values.
Uniswap is also an Automated Money Maker, which is a key feature. It allows for decentralization. It’s also a network protocol, as it connects directly to the Ethereum blockchain.
Using Uniswap, you can trade ETH with DAI, USDC, USDT, WBTC, and WITH.
Uniswap launched in November 2018. It was proof of concept that an AMM (automated money maker) DEX could work. It used simpler math equations to help LP transfers. Other DEXs use complicated math equations to match traders together. Several factors would affect how traders could place individual orders.
Uniswap uses math formulas in pricing assets. The formula is the CFMM (Constant Function/Product Market Maker) where x*y = k (the constant). The multiplied value of two assets in a trade equals the constant.
This prevents slippage. Slippage is the difference between the expected and actual price of a sale. This means that a trader could make a swap with a better idea of the value they would receive. In simpler terms, Uniswap made sure that traders could exchange ERC20 tokens conveniently. The liquidity reserve of tokens also increases in value over time.
LPs also received value for trading. They would receive extra ERC20 tokens to trade.
Suggested reading: What does ERC20 Stand For?
They could also choose to burn the tokens. This means taking the tokens out of the blockchain for good. Then, distributing their value across other tokens. Either by trading or burning, LPs could contribute more liquidity with their tokens. Every exchange with this version had a 0.3% fee. This fee went to the liquidity reserve.
The success of the first version proved that Uniswap would change cryptocurrency. Yet, there was still room for improvement. Competition in DEXs was growing. Even though Uniswap led the charge with its proof of concept, it could do better.
ERC20 Token Pools
The second version allowed for ERC20 - ERC20 token pools. It reduced slippage and made swapping tokens much easier. This also meant LPs could swap ERC20 tokens with other crypto coins faster. The USDC/Uniswap DAI pool for example became more efficient.DAI is a stablecoin on the Ethereum blockchain. It keeps a close value to the United States Dollar.
To further solve the lack of ETH bridging, wrapped ERC20 tokens replaced native ETH. Wrapped ERC20 tokens stay pegged to the value of ETH. This keeps them stable in price.
This method of trading is even faster and more convenient. It allows for output tokens to reach the recipient first. Then it enforces the tokens received by the other LP.
Oracle Data Feeds
Oracles are connections to real-world information. It allows for smart contracts to be more specific and secure. Using an oracle, LPs can build terms into their smart contracts. For example, you can search the next week’s weather forecast using an oracle. Then, you can set a term based on the prediction for rain. Most LPs will search for the average price or past price of the asset they swap.
Suggested reading: A Fundamental Look at Decentralized Oracle Technology
How Does Uniswap V3 Work?
Uniswap V3 is the most user-friendly version, due to concentrated liquidity. As this version’s foundational concept, it caused many improvements. Such as the following.
Concentrated Liquidity Pools
It makes pricing in trading more flexible. In previous versions, Uniswap could accept any price between one to infinity. This allowed for a huge range of trades to add to liquidity pools and Uniswap's liquidity reserve. This was inefficient, as most trades were in the $0.99 to $1.01 USDC/Uniswap DAI pool.
This meant all other trades and their fees were going unnoticed. In V3, an LP can choose a custom price range. Most people choose a similar price range to trade, like $0.99 to $1.01. The capital becoming liquidity will concentrate on it. With custom price ranges came new fee tiers. LPs could now earn a higher trading fee from higher price ranges. The fee is proportional to the liquidity contribution they make.
There are three fee tiers per pair. They are 0.05%, 0.3%, and 1.0%. Keep in mind, that V1 had only a 0.3% fee. V2 allowed for governance to turn on a 5-point fee. V3 governance can turn on fees per token pool. The fees also correlate to the risk traders are taking. A new feature called range limit orders shows how specific the price range can be. A range limit order allows an LP to contribute one single token. To do so, they can input a price range of $1.001 to $1.002.
Active liquidity is also a key concept. It keeps track of LP assets with better security. Market prices of assets in token pools update in real-time. If the price of assets in a liquidity pool no longer suits their price range, Uniswap removes them. The liquidity shifts towards one out of the two assets. Then, the LP can decide if they want to update the price range of the assets. The LP can also hold onto them until the market price moves back into the wanted price range.
Uniswap V3 Swap
Let’s look at how the swap feature actually works in V3. Flash swaps are still used, so you can trade without any delay. Check out the interface to see how simple swapping is. You can input the amount of ETH and other cryptocurrencies to swap. You can also set a slippage tolerance and transaction deadline. Then, connect your Web3 wallet. The assets will swap when you set the deadline.
How do you determine how much to swap? Imagine that a curve exists between the two assets you trade. It is between the prices of one to infinity. You can now set a price range on that curve to contribute liquidity. You’ll also get a fee for your contribution. With the use of active liquidity, you can measure the market price of assets. This allows you to swap for a profit with more efficiency.
Instead of receiving LP tokens, you will receive non-fungible tokens (NFTs). These will represent your position as an LP in the liquidity pool.
Remember how V2 allowed LPs to add terms contingent on real-world data to smart contracts? This version's oracles are even more advanced. They are TWAP (time-weighted average price) oracles.
You can find the TWAP of any on-chain call for the last nine days. On-chain calls are swaps on the blockchain. You can be far more accurate in checking prices. The gas cost to keep an oracle running is also about 50% less. Finally, Uniswap V3 is under a license. Previous versions were open-source. This business source license protects the ecosystem around DEX. Outside parties will not be able to use the V3 code for commercial purposes.
Is Uniswap Safe?
Uniswap has always been safe, but V3 upped security. It has the same security level as the Ethereum blockchain. It is safer than ever to use and incredibly easy. There are a couple of disadvantages. Uniswap, like any other DEX, has high gas fees. LPs using Uniswap contribute to the Ethereum blockchain’s gas needs. You also risk losing crypto when staking it in volatile price ranges. Remember that their market prices are updated in token pools. You might invest in a high-interest pool for a profit, but market prices could drop fast. Your interest in those assets wouldn't return until the market price restores.
These are risks that come with any cryptocurrency marketplace. It’s important to remember Uniswap’s better features. Because it’s decentralized, there are no servers to hack into. Uniswap stores trader funds. They are also exchanged between wallets. There is no intermediary, and no risk of a third party gaining access. It also leaves all assets in the hands of the LPs. Uniswap won’t take custody of any crypto.
Suggested reading: CeFi vs DeFi
There is no doubt that Uniswap has numerous benefits for those looking to take advantage of decentralized finance. However, if you managed to get this far in the article and still seem confused about what Uniswap is, you're not alone.
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