1st June 2021
Altonomy’s Discussion of Uniswap V3’s Dealing Strategy
This Altonomy article discusses the factors that influence strategies for making markets on Uniswap V3, including (1) the impact of trading pair volatility on price range selection; (2) the frequency and cost of periodic liquidity reallocation; (3) the impact of untimely liquidity reallocation on returns; and (4) hedging strategies for impermanent losses (IL).
LP is required to consider the following when offering market making:
- Coin price volatility
- Price range to provide liquidity
- Gas costs and frequency of liquidity reallocation
As LP needs to provide liquidity within a certain price range, the volatility of the ratio needs to be taken into account. When expected volatility is higher than actual volatility, the specified price range will become unnecessarily wide, resulting in lower fees charged and less capital efficiency.
Gas cost of reallocating liquidity. The article assumes a simple scenario: once the price reaches either boundary, the position is reallocated. The reallocation operation of liquidity is performed in two steps: deleting the old position and adding a new one. Each step costs 350k Gas, so the cost is 350000 * 2 * 40 * 10−8 = 0. 028 ETH.
Plotting curves with cost deductions (in red) and cost income curves (in blue):
When the price range is wider, there is no need for frequent adjustments. On the other hand, a narrower price range yields more revenue from transaction costs, but the cost of replacement is also higher.
Impermanent losses exist in any automatic market maker (AMM), but in V3 the effect of them is amplified by the concentration of capital in smaller intervals.
USDT as price unit
Agreed tokens as price unit
To summarise, the market making strategy for Uniswap V3 requires some refinement. Parameter adjustments are of paramount importance:
- Select the appropriate price range for injecting liquidity based on the price volatility of the currency pair and the positions of other LPs within that price range
- Manage position reallocation regularly and set the appropriate frequency, taking into account the consumed Gas cost
- Respond fast when prices fall outside the trader’s price range, preferably with the help of automated algorithms instead of manual operations
- If a trader intends to balance a position on both the up and down side, apply a hedge to deal with impermanent losses. Due to the concentration of liquidity, the impermanent losses are much more severe in V3 than in V2. This is particularly vital if the price range is set narrow.
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