Uniswap V4 is the next iteration of Uniswap DEX, which is designed to incorporate bespoke automated market maker (AMM) functionalities within the existing Uniswap framework.
Regarding decentralized exchanges, Uniswap’s name always comes into the conversation. The decentralized exchange operates on the Ethereum Blockchain. The exchange allows users to swap various ERC-20 tokens directly from their Ethereum wallets without going through an intermediary or a centralized exchange.
Uniswap operates based on automated liquidity provision through liquidity pools and smart contracts holding reserves of two tokens. Uniswap is known for pioneering the Automated Market Market (AMM) model.
In the AMM model, trades are executed against liquidity pools rather than order books, which means they are settled instantly at a price determined beforehand through a mathematical formula based on the ratio of the two tokens in the pool.
The Uniswap exchange was created in 2018 by Hayden Adam, a mechanical engineering graduate at Siemens, when he was inspired to work in the crypto space. He developed an interest in Ethereum and decentralized finance (DeFi), which led him to explore the potential of creating a decentralized exchange protocol.
His main objective was to create an exchange that could provide liquidity and facilitate trading with the need for order books, and that is where he got the inspiration to create an AMM model.
The Uniswap has undergone various iterations since its inception. It is recognized as one of the top decentralized crypto exchanges in the market regarding trading volume, number of users on the platform, and liquidity.
Uniswap V1
The Uniswap V1 was launched in November 2018, and it marked a significant advancement in the decentralized crypto exchanges because it was the first time a crypto exchange implemented a Constant Product Market Maker (CPMM) model.
The CPMM model is one particular implementation of an AMM. In the CPMM model, the product of the quantities of two tokens in a liquidity pool remains constant. As one token’s supply increases in the pool, the other token’s supply decreases proportionally to maintain the constant product.
The process of maintaining proportionality is what allows for the determination of token prices based on the ratio of the two token supplies in the pool.
The other salient feature of this version of Uniswap was that it provided the option to exchange ERC-20 tokens with other ether (ETH). Not only that, you could also swap your ERC-20 tokens directly with other ERC-20 tokens.
However, there was a limitation to this process. You cannot directly swap between two ERC-20 tokens, and for any swapping, you have to first swap the ERC-20 tokens with ETH and then swap the ETH for the desired ERC-20 token.
For example, suppose you have some DAI tokens (an ERC-20 stablecoin) and want to exchange them directly for Chainlink (LINK) tokens using Uniswap V1.
Since Uniswap V1 does not support direct swaps between DAI and Chainlink tokens, you would need to follow a two-step process:
- Swap your DAI tokens for ether (ETH).
- Swap the received ETH for Chainlink (LINK) tokens.
Although Uniswap V1 was groundbreaking, it had drawbacks, such as pricing inefficiencies that arbitrageurs could exploit and significant slippage for large-volume transactions.
Despite these limitations, Uniswap V1 laid the foundation for subsequent iterations and was crucial in advancing DeFi.
Uniswap V2
The challenges faced in Uniswap V1 were addressed in the next iteration, called Uniswap V2. The V2 iteration was launched in May 2020, and significant advancements were made.
The key improvement was the inclusion of direct token-to-token swaps within its AMM model, meaning you wouldn’t need to swap any token with ETH first and then swap it again with your desired ERC-20 token.
The other benefit achieved from this process was the reduction in slippage, which then enhanced the capital efficiency for users.
Slippage refers to the difference between the expected price of a trade and the actual price at which the trade is executed. Slippage occurs because the price of tokens in liquidity pools is determined by a constant mathematical formula based on the ratio of token reserves.
When executing a trade, especially for large orders, buying or selling can cause the price to shift due to changes in the pool’s reserves.
Another improvement made in the Uniswap V2 iteration was the introduction of Flash Swaps. This groundbreaking feature allowed users to withdraw funds from liquidity pools without requiring them to submit any capital upfront.
Instead, users could utilize these funds for other purposes within the transaction if they returned the withdrawn amount plus a fee. The innovation opened up opportunities for arbitrage and yield farming without the need for significant initial investment.
The exchange ensured that when a user initiates a flash swap, the smart contract checks if the user returns the withdrawn amount plus the fee within the same transaction. If the user failed to do so, the entire transaction would be reverted, effectively canceling the flash swap.
Additionally, Uniswap V2 introduced Time Weighted Average Prices (TWAP), which provided a more reliable and secure method for other decentralized applications to utilize price data from Uniswap.
The concept facilitated the integration of Uniswap’s price data into various DeFi protocols and applications, further expanding its utility and impact within the decentralized finance ecosystem.
Uniswap V3
The third iteration of Uniswap, Uniswap V3, was launched in May 2021. The V3 upgrade was designed to address issues regarding capital efficiency and concentrated liquidity.
Capital efficiency is effectively utilizing funds or capital deployed in a decentralized exchange. Concentrated liquidity refers to the ability of liquidity providers to concentrate their assets within specific price ranges within a liquidity pool rather than spreading them evenly across the entire price spectrum.
Uniswap V3’s approach increased efficiency and potential earnings, as liquidity providers could strategically place liquidity where trading activity was expected to be higher.
Another improvement made in the V3 iteration was the introduction of multiple fee tiers. There were three tiers introduced, with different percentages allocated to different tiers.
- Tier 1: 0.05%
- Tier 2: 0.30%
- Tier 1: 1.00%
These percentages indicated the portion of the trading volume collected as fees by Uniswap and distributed to liquidity providers.
For example, if a trade occurs with a 0.30% fee tier, 0.30% of the trade volume will be collected as a fee. These fee tiers allowed users to choose the appropriate fee level based on their risk tolerance and trading preferences.
Another notable upgrade in the V3 version was the introduction of non-fungible tokens (NFTs) to the platform. The new feature allowed liquidity providers to receive NFTs according to their share in the liquidity pool. Liquidity providers who held large shares in the liquidity pool were awarded the NFTs with larger values than others.
Using NFTs to represent ownership stakes in liquidity pools, Uniswap V3 enabled liquidity providers to engage in secondary market activities with their liquidity positions.
They could trade their NFTs representing liquidity positions independently of the underlying assets in the pool, providing flexibility and liquidity to liquidity providers.
Additionally, Uniswap V3 integrated with Ethereum’s Layer 2 solution. The Layer 2 solution is Ethereum’s blockchain response to address blockchain scalability issues. The solution was designed to minimize network congestion, reducing transaction costs.
The V3 upgrade introduced several key features that enhanced the platform’s performance by improving capital efficiency and addressing scalability issues. It also provided liquidity providers more flexibility in transferring ownership to other parties without affecting the underlying assets.
What’s New with Uniswap V4?
So far, there is no timeline for when the Uniswap V4 will officially launch. While Uniswap has released the draft code for Uniswap V4 for public review, there are two major hurdles it has to overcome before it launches the next iteration,
- Ethereum Cancun Upgrade: Uniswap v4 relies on a specific feature called Cancun, which is included in the upcoming Ethereum upgrade. The upgrade, expected in Q1 2024, introduces EIP-1153: Transient storage, which helps reduce network fees and enhances the platform. Until Cancun is live, Uniswap v4 cannot launch.
- Security Audit: Once Cancun is implemented, Uniswap v4 will undergo a thorough security audit before the official launch. This process can take several months, further delaying the release date.
So far, we have yet to find an updated timeline on Uniswap’s website, which was last updated four months ago regarding launching the V4 iteration.
The best information we could gather was that the Cancun upgrade is expected to go live in March of this year, and after that, we expect to see some progress on the Uniswap V4 front.
However, the exchange has provided the potential features and improvements we could see in their draft code and white paper.
1. Hooks and Custom Pools
Uniswap V4 introduces hooks, essentially small programs that can be attached to liquidity pools. These hooks trigger specific actions at different stages of the pool’s life cycle, such as when liquidity is added or removed. These allow developers to customize the pool’s behavior in various ways, including:
- Dynamic fees: Fees can automatically adjust based on market conditions.
- On-chain limit orders: Users can place orders that execute at specific price points in a controlled manner.
- Time-weighted average market maker (TWAMM): Large orders can be spread out over time to reduce their impact on the price.
Overall, hooks bring significant flexibility to Uniswap V4, allowing developers to create unique, specialized liquidity pools for diverse financial needs.
2. Singleton
In Uniswap V3, each liquidity pool had a separate contract, making creating new pools costly and swapping between them inefficient. Uniswap V4 introduces a revolutionary singleton design.
The singleton design essentially merges all the pools into one shared contract, therefore simplifying the swapping process and also introducing further benefits:
- Massive gas savings: Swaps no longer require transferring tokens between separate contracts, drastically reducing transaction costs. Estimates suggest pool creation costs could plummet by a whopping 99%.
- Enhanced efficiency: Swapping and other operations become smoother and faster thanks to the streamlined architecture.
- Reduced complexity: Developers and users enjoy a more accessible and user-friendly platform.
These changes promise a significant leap forward regarding cost-effectiveness and usability for the Uniswap platform.
3. Flash accounting
The singleton design has another use case as it assists with a new architectural feature called flash accounting. Unlike previous versions where every operation, like token swaps or liquidity addition, ended with token transfers, Uniswap V4 delays external transfers until the end. It streamlines the pool operations and also lowers operating costs.
The singleton and flash accounting mechanisms enhance efficiency and cost-effectiveness when routing across multiple pools. With the anticipated increase in liquidity pools due to the introduction of hooks, this optimization becomes particularly valuable.
4. Native ETH trading pairs
Uniswap V4 is reintroducing native ETH trading pairs. Previously, Uniswap V2 and V3 required users to wrap their ETH into WETH before trading, adding extra gas costs.
With the introduction of singleton and flash accounting in Uniswap V4, both WETH and ETH pairs can be traded directly. The change benefits users by reducing gas costs, as native ETH transfers require approximately half the gas compared to ERC-20 transfers.
Challenges with Uniswap V4
So far, in the previous section, we have discussed how the new upgrades can improve the next iteration of Uniswap. The upgrades include customization through hooks for innovative pool creation and improved transaction routing efficiency.
Additionally, they help achieve gas cost reductions, increased earnings for liquidity providers, and advanced trading strategies like TWAMM and dynamic fees.
However, there are some potential challenges associated with the new iteration that must be addressed:
Fee Governance
Uniswap V4 introduces two distinct governance fee mechanisms: swap and withdrawal fees, each governed differently.
As with Uniswap V3, Uniswap governance, including the Uniswap DAO and UNI token holders, can impose a capped percentage of the swap fee on specific pools.
Additionally, in Uniswap V4, governance may impose a capped percentage of the withdrawal fee if hooks activate withdrawal fees for a pool.
The governance mechanism adds a layer of complexity as they must consider when and how to activate withdrawal fees for pools and determine appropriate fee percentages.
It may pose challenges regarding decision-making, coordination, and transparency within the Uniswap ecosystem. Additionally, governance entities may require more resources and effort to manage and oversee these fee mechanisms effectively.
License Restrictions
Uniswap V4 is set to be released under the Business Source License 1.1, which imposes restrictions on the commercial or production use of the Uniswap V4 source code for up to four years.
After this period, it transitions to a General Public License (GPL) in perpetuity. Some community members have criticized this approach, arguing that it deviates from the principles of open-source software.
Closing Thoughts
The cryptocurrency market is known for being dynamic, and with growing adoption, we will see new sets of use cases and innovations being made in the crypto space. Similarly, the decentralized exchanges will introduce new features in this ever-evolving space to remain relevant and attract a larger customer base.
Uniswap V4 is a testament to this fact in the sense that this will be its fourth iteration in six years since its launch in 2018, which means that it knows that to stay ahead in the game, it must constantly evolve and improve its platform.
It is important to mention here that investing in cryptocurrency is risky, and you should conduct your research and do your due diligence before starting your trading journey. similarly, choosing the right exchange, whether DEX or CEX, requires conducting research and implementing due diligence.
A better approach would be to look at what types of service you want from your crypto exchange, whether or not they allow services in your jurisdiction, and whether your goals align with what the exchange offers.
