Uniswap V4: What we Know about the Next Iteration of the DeFi DEX
Uniswap, the top decentralized exchange, is rumored to be developing Uni V4, the next version of their protocol. Though nothing has been confirmed, let’s look at Uniswap’s history, the potential features of this next-generation DEX, and how its release will impact UNI token holders.
Uniswap was released in 2018 at the Ethereum Foundation’s annual Devcon conference. Initially, it was a proof of concept allowing anyone to transact between two different Ethereum-based tokens. There were two primary roles: the liquidity provider and the trader. The liquidity provider supplied two tokens in a 1:1 price ratio and received a transaction fee whenever a trader executed an exchange.
Uniswap V2 was released in March 2020. Its main features were oracle-based pricing to prevent manipulation or price-related exploits and flash swaps for arbitrage trading. In September 2020, the UNI token was airdropped to all prior users of the platform, and the governance of Uniswap was handed over to the newly-created Uniswap DAO. The UNI airdrop catalyzed the popularity of airdrops we see today and cemented the protocol as decentralization-oriented. Additionally, liquidity providers were actively rewarded in UNI tokens, helping to increase the total value locked on the dApp significantly.
Uni V3, released in March 2021, provided two main innovations focused on capital efficiency. The first was concentrated liquidity, which allows liquidity providers to specify a range of prices within which their liquidity will be utilized. This can be upwards of 4000x more capital efficient than the previous approach and earn LPs significantly greater fees. Additionally, it became possible to charge varying fees on different trading pairs, so a less volatile stablecoin pair would earn a lower return than a riskier, more volatile crypto pair.
This code license expires in April 2023, which would open the floodgates for protocols like SushiSwap, QuickSwap, and other Uniswap forks to once again directly compete with the protocol. Moreover, the V3 model has not been kind to liquidity providers. Data from the past two years has shown that actively managed positions, on average, fare no better than simply holding the underlying assets. In some cases, liquidity providing performs even worse.
One way that Uniswap V4 could fix this issue is by creating some sort of dynamic fee model based on a measure of asset volatility. This model would provide a greater reward for liquidity providers on pairs with higher impermanent loss dynamically instead of requiring LPs to speculate on which pairs will be volatile at any given time.
The Uniswap team has recently been pushing for the adoption of EIP1153. This upgrade to Ethereum would lead to lower transaction costs on Ethereum, an obvious benefit for the Ethereum-based Uniswap dApp. However, it has been deemed not significant enough to be included in the next couple of Ethereum upgrades.
One of the biggest issues with DeFi is the complex and challenging user experience. Uni V4 may simultaneously release with an improved user interface. This could include some sort of NFT aggregation, a built-in wallet, and possibly a mobile app. These features would help cement Uniswap as the best decentralized exchange for novice and advanced DeFi users.
Another possible feature of Uni V4 is a batched auction system. Minimal extractable value, better known as MEV, is a side effect of public blockchains that results in inefficiencies for traders. When a user makes a trade, it goes into the blockchain mempool while waiting for confirmation. An Ethereum validator could see this trade and execute a sandwich attack, in which they buy the token a user is exchanging, then the user’s order occurs, and the validator sells all the tokens they just bought. This is possible since validators have the final say over the ordering of transactions. To mitigate this issue, Uniswap could create a more privacy-oriented solution that has already been adopted by Cowswap: coincidence of wants. In this model, users sign a transaction, either buy or sell, then get paired in a quasi-peer-to-peer manner with someone else on the other side of a trade over a specific period. Though not as immediate as a traditional exchange, this approach eliminates MEV and gives users a more efficient trade.
When V4 is released, the UNI token will likely see a short-term increase derived from hype. Over the long term, UNI is effectively tied to the governance power it provides since Uniswap has yet to give transaction fees to UNI holders due to regulatory concerns. If V4 increases Uniswap TVL or provides new parameters for token holders to vote on, then the token will likely increase in value. It’s also possible that Uniswap will find a solution that allows the token to derive some sort of value from exchange transaction volumes, such as a buyback and burn or a split token model.
Though everything covered today about Uniswap V4 is pure speculation, it draws from market trends, real data, and the history of the protocol. With a potential release before or after the V3 license expiration, we will know soon enough how Uniswap plans to remain competitive, innovative, and keep its status as the top DEX.
By Lincoln Murr