What Does v3 AMM & Concentrated Liquidity Mean For Binance Smart Chain.
Last updated
Last updated
Brief Introduction On AMMs: The idea behind AMM was first published by Vitalik Buterin in 2017 here but the production was pioneered the Uniswap team and thus Uniswap v1 was launched as a proof of concept for AMMs and since then as been more of less the global standards for AMMs on Ethereum Networks & across other EVM- Compatible platforms with over $10 billion dollars total value locked.
Basically AMMs mean Automated Market Makers which means unlike order-books on centralized exchanges where a centralized team manages the markets and order books - on AMMs, anyone can pool assets into shared market making strategies. On centralized exchanges, the trading of assets requires proper matching of buy/sell orders between the traders. The order remains unexecuted if the sell order does not match the existing buy orders, affecting the liquidity. This model had it's own limitations and challenges as it does not provide a full decentralized system for buying and selling of tokens unlike the privileges & decentralized nature where liquidity providers add liquidity to the pools that help to make a market hence making exchanges fully decentralized.
v1 In Summary: In this model, the ratio of the trading asset pairs should be constant such that the liquidity providers should add liquidity in such a way that constant "K" experiences no change. An average of 0.3% trading fee is incurred to reward the liquidity providers.. The uniswap v1 was first launched in 2018 and its model of operations were quite simple. The primary objective was to provide an interface for seamless exchange of ERC20 tokens on Ethereum.
The features of the v1 protocol would allow LPs join liquidity pools to collect fees on ETH-ERC20 pairs, trade ETH for any ERC20 without wrapping, trade any ERC20 for any ERC20 in a single transaction. It was the first proof of concept for AMMs and has so far grown to become the standard allowing trades and transfer to a different address in a single transaction.
Introduction of v2 AMMs: This came into the market around middle of 2020 with new features, advanced optimization and would go as far as setting the standard for AMM adoption across the industry. Anyone can become a liquidity provider (LP) for a pool by depositing an equivalent value of each underlying token in return for pool tokens. These tokens track pro-rata LP shares of the total reserves, and can be redeemed for the underlying assets at any time. Each Uniswap smart contract, or pair, manages a liquidity pool made up of reserves of two ERC-20 tokens.
Uniswap v2 eliminated the ETH bridging problem by letting in the concept of ERC20-ERC20 pools. Another significant difference is the usage of wrapped ETH in the core contracts instead of native ETH. With Uniswap v2, if two ERC20 tokens are not paired directly, and do not have a common pair between them, they can still be swapped as long as a path between them exists. Router contracts can be used to optimize between direct and multi-step swaps.
In the next documentation, we shall be sharing with you how this model practically works in the market right now. see current market situation for a full illustration walk through.
Since its launch most recently, V3 now represents more than 40% of all DEX volum with a market cap of over $10B. Lets look at some of its key features:
Concentrated Liquidity
With v3 AMM, instead of providing liquidity across a price range from zero to infinity, LPs now have the option to choose certain price ranges where they want their capital to be active. This allows Liquidity Providers (LPs) to concentrate their capital on smaller price intervals. Rising and falling asset prices may exit bounds set by LPs. When this happens, the position's liquidity is no longer active and no longer earns fees. This offers traders deeper liquidity and allows LPs to earn more with less capital investment.
To simply define concentrated liquidity further, it basically means liquidity that is allocated within a custom price range. As illustrated in the image below:
In earlier versions, liquidity was distributed uniformly along the price curve between 0 and infinity. The previously uniform distribution allowed trading across the entire price interval (0, ∞) without any loss of liquidity. However, in many pools, the majority of the liquidity was never used.
LPs can significantly increase their exposure to preferred assets and reduce their downside risk and they can also one asset for another by adding liquidity to a price range entirely above or below the market price, approximating a fee-earning limit order that executes along a smooth curve.
Flexible Fees
In addition to this new feature, there is also an option to choose multiple fee tiers depending on the LPs market making strategy. This new feature makes this model the most flexible and efficient AMM ever designed. It provides capital efficiency & a fee structure that is very flexible + low slippage on trade executions thus surpassing centralized exchanges & stable coin based AMMs.
The flexible fees options available are three separate fee tiers per pair — 0.05%, 0.30%, and 1.00%
In Summary:
At launch, capital efficiency gains will max out at 4000x for LPs providing liquidity within a single 0.10% price range. The v3 pool factory is technically capable of supporting ranges as granular as 0.02%, translating to a maximum 20,000x capital efficiency gains relative to v2. However, more granular pools can increase swap gas costs and might be more useful on Layer 2.
It is also must be mentioned here that in v3, LP positions will be represented by non-fungible tokens (NFTs).
Many of these features are not yet available on the Binance Smart Chain network hence the market use-case and high demand for a platform like TigerSwap that would make all these possible and usher in an advanced + unique v3 AMM on the Binance Smart Chain Network.
