In-depth analysis of the innovation and subversion of Uniswap V4

Author: Lian Zhu, CEO of Aperture Finance

Japanese designer Kenya Hara once explained his design philosophy in this way: "In this world, we only use two things, one is a stick and the other is a bowl." "Bowl" generally refers to all carriers that carry other things, such as bookshelves and refrigerators; while "sticks" are tools that act on other things, such as screwdrivers and levers.

**If Uniswap V3 is more like a bowl, carrying liquidity to empower DeFi, then V4 is more like a stick, relying on functionality to promote industry changes and subvert the existing situation of DeFi. **As a DeFi practitioner, based on the current information on the product form and user experience of Uniswap, it is not difficult to imagine that a storm is already brewing, and the launch of V4 in half a year will surely set off a bloody storm.

Looking back at the history of this "unicorn", Uniswap V1 (version one) was born in November 2018 as the first decentralized exchange on Ethereum, providing ERC-20 tokens and ETH exchange between. Projects started during the same period or borrowed or integrated include SushiSwap, 1inch, Curve Finance, Balancer and Synthetix. Uniswap V2 (version 2) was born in May 2020, further providing swap between ERC-20 tokens. With its liquidity empowerment, projects that emerged during the same period include Yearn.finance, AAVE, Compound and Chainlink. Uniswap V3 (version 3) was launched in May 2021, introducing centralized liquidity. Projects that became famous for providing position management include Visor Finance (later merged into Gamma) and Instadapp, among others.

** From V1 to V3 is a breakthrough in technology, but in essence it is the same. The project party has built a huge ecosystem relying on Uniswap. However, from V3 to V4, technology is no longer a breakthrough from zero to one, but it is a subversion of the market. **The following is a brief analysis from the perspective of liquidity and product form.

Uniswap V3 is an integrated liquidity pool, that is, the liquidity for a certain currency pair is relatively concentrated. The liquidity pool of Uni V3 is defined by two parameters, namely "currency pair" and fee rate. For example, looking at ETH-USDC, there are 4 liquidity pools in V3, corresponding to 4 levels of fee rates. These 4 pools provide liquidity for all transactions between ETH and USDC. With Uniswap V4, this situation has changed. **Its subversion and innovation is that everyone can customize the pool and realize various additional functions through "Hooks". **So for the ETH-USDC currency pair, theoretically, there can be countless pools. For example, market maker Zhang San provides an "ETH-USDC-Zhang San pool", and market maker Li Si provides a "ETH-USDC-Li Si pool" . Zhang Sanchi has the function of Zhang Sanchi, and Li Sichi has the selling point of Li Sichi. There can be countless pools that provide liquidity for transactions between ETH and USDC, and the fragmentation of liquidity can be imagined.

Take hot pot as an example. The liquidity pool of Uniswap V3 is like a big pot. Everyone has the same taste. There is no need to choose and there is no choice, but the pot is big enough and the water is deep enough. The water here is the liquidity of funds. Uniswap V4 allows everyone to customize the small pot and provide a variety of special flavors to attract diners. The "taste" here is analogous to the functions added through hooks, such as chain price caps and automatic reinvestment. There are many flavors, and everyone can choose what they like. But there are too many pots, and there is still so much water, so some small pots may not be deep enough to boil the meat.

Uniswap V4 provides unprecedented openness. While realizing the blooming of a hundred flowers, it opens a Pandora's box, which may have consequences including:

**1) Separation of liquidity. **From the perspective of the stock market, there is only so much liquidity. If there are more pools, the average liquidity will be less. More liquidity in one pool, less liquidity in the other. In extreme cases, if the liquidity is evenly distributed in countless small pools, a large transaction cannot be completed in one pool. Therefore, in an environment of multiple liquidity pools, the role of liquidity aggregators like 0x or 1inch will be doubled.

**2) Reduced the difficulty of entry for competitors. ** Some complex rebalancing functions (such as triggering rebalancing according to market conditions), if implemented on V3, need to complete real-time inquiry through off-chain infrastructure and send transactions to the chain. The common method is to use Gelato service, Or build your own off-chain infrastructure (Aperture Finance takes the latter). On Uni V4, with the hook, the project party can natively realize the conditional trigger rebalancing function without relying on a third party or building additionally, which greatly simplifies development and reduces operating costs.

**3) Liquidity management projects or market makers may adopt more aggressive incentives to compete. **The functions that can be added through hooking in Uniswap V4 are unlimited, including custom profit distribution or subsidies. If a bank provides currency exchange services that not only allow users to exchange at an ideal exchange rate, but also provide free handling fees and even subsidies, then this bank will definitely explode, and other banks may have to follow suit. The project party can choose to subsidize various expenses, or even pay back money to attract users to join their own pool. This will cause liquidity to erode and divide among project parties, and the degree of involution can be imagined.

**4) The process of survival of the fittest will be accelerated. **The original liquidity of Uniswap V2 or V3 may be gradually withdrawn and transferred to V4. DeFi projects relying on V2 or V3 may be struggling due to the loss of liquidity, while the competition in the liquidity pool of V4 will continue to intensify (take over the above point), accelerate the downfall of the project party, and eventually emerge as a dominant player.

**5) A test of brand recognition. **From the perspective of user experience, the previous currency exchange experience was to directly select the currency and amount, but after V4, users still need to select a pool. The user experience of choosing a liquidity pool is still unknown, but once it involves choosing between similar pools, in addition to functions and benefits, brand recognition is particularly important. This poses a difficult problem for the project party on how to maintain the brand image and stand out from the competition.

The rain is coming, and the project owners of the DeFi-related tracks still need to make early plans. In half a year, whether Uniswap V4 is a "bowl" or a "stick", let us wait and see!

About the author: Lian Zhu, Web3 entrepreneur, translator. Co-founder and CEO of Aperture Finance. Formerly a senior product manager for Amazon Kindle, Netflix and AWS. EMBA from Haas School of Business, University of California, Berkeley, Master of Simultaneous Interpreting from Monterey Institute of International Studies. A member of the North American Writers Association and the American Translators Association (ATA), his translated works include "Rebirth" ([US] Stephen King's works) and "Diary of a Wimpy Kid" series and more than 30 kinds.