Title: State of Uniswap Q3 2022

Author: Kentrell Key, Messari

Compiler: Guo Qianwen, ChainCatcher

Key Points

• Despite the decline in protocol prices, liquidity continues to be attracted. Investors are seeking opportunities to profit from core assets, with the market share of assets held in Uniswap pools doubling year-on-year.
• Several important milestones have been achieved through governance, including the establishment of the Uniswap Foundation and the creation of a fee pool (0.01%) on Optimism.
• The number of DEXs on Ethereum scaling solutions continues to grow, but Uniswap remains the market leader. For three consecutive quarters, Uniswap has dominated, with its market share steadily increasing to 65% of total trading volume.

Uniswap Overview

Uniswap is a decentralized automated market-making protocol that facilitates token trading on the Ethereum network and its scaling solutions (i.e., Optimism, Arbitrum, and Polygon).

The protocol is recognized as a pioneer in DEXs. In its V2 version, it adopted a constant product pricing curve of X*Y=K with pooled liquidity; in V3, it introduced concentrated liquidity and tiered transaction fees. Since then, many other decentralized exchanges in the industry have adopted constant product pricing curves; however, its model of concentrated liquidity and fee tiers remains relatively unique, making it a distinctive feature of Uniswap.

Performance Analysis

In the third quarter, despite a 32% increase in swap transactions, total trading volume decreased by 30%. The decline was primarily concentrated on Uniswap on Ethereum. Trading volume on Optimism increased by 67%, while Arbitrum and Polygon saw approximately a 7% increase. Following the announcement of a 1 million OP token airdrop for the Uniswap Grants Program (UGP) on September 7, trading volume on Optimism may soon rise again. At the time of writing this report, the official allocation of OP tokens had not yet been announced, but a UGP proposal released in May detailed that 80% of the tokens would be used to incentivize liquidity on Uniswap V3 Optimism.

In the third quarter, the total value of liquidity supplied on Uniswap remained stable, with the total market capitalization of cryptocurrencies increasing by 5%. Over the past year, the share of liquidity on Uniswap in the total cryptocurrency market capitalization has nearly doubled, reaching a market share of 0.4% by the end of the third quarter. This net growth in market share highlights Uniswap's ability to attract liquidity, especially as the overall prices of cryptocurrencies have declined alongside trading volume and fees.

In the third quarter, excluding liquidity mining rewards, Uniswap pools on Polygon and Optimism provided the highest asset returns for liquidity providers. Despite a 67% increase in trading volume on Optimism, overall yields decreased by 24%. This was due to a 23% increase in average daily liquidity, with trading volume shares increasing by 15% through lower 1 basis point pools (0.01%) and 5 basis point pools (0.05%).

In the third quarter, Uniswap's yields on Polygon and Arbitrum increased by 64% and 58%, respectively. Polygon's strong performance was due to a 6% increase in trading volume, while liquidity decreased by 38%; Arbitrum's performance was attributed to a 7% increase in trading volume and a 7% decrease in liquidity.

Despite the decrease in liquidity on Arbitrum, it achieved results similar to Optimism. This is because Uniswap on Arbitrum has not yet adopted the 1 basis point fee tier. Therefore, it requires less trading volume to achieve the same yield as other Uniswap instances. Additionally, one of the largest trading pairs by volume on Arbitrum is ETH/GMX, which uses 30 basis point pools (0.30%) and 100 basis point pools (1.00%). These pools accounted for only 13% of trading volume in the third quarter but generated 43% of LP (liquidity provider) fees.

Uniswap's 1 basis point fee tier is designed to attract stablecoin liquidity to the protocol. After deploying the 1 basis point pool on Polygon in April, Uniswap deployed it on Optimism in July, attracting an average daily liquidity of $2.6 million.

Compared to the second quarter, the 1 basis point pool on Polygon yielded higher returns due to a 33% decrease in daily liquidity, while trading volume remained stable. The 1 basis point pool on Ethereum also had stable trading volume, with daily liquidity increasing by 34% (i.e., $364 million), but yields decreased.

Capital efficiency is difficult to achieve and measure. Uniswap V3 uses multiple fee tiers to concentrate liquidity within a custom price range, leading to diverse pricing curves and making it challenging to calculate Uniswap's liquidity utilization.

To standardize performance, utilization is calculated as the total trading volume of a V3 pool on a given day divided by the total liquidity supplied across all V3 pools. Compared to the second quarter, Uniswap V3's utilization increased by an average of 23% across the three Ethereum (L2) scaling solutions. Polygon led with a 37% increase, followed by Optimism with a 19% increase, and Arbitrum with a 12% increase. On Ethereum, V3's utilization decreased from 51% to 34%, with trading volume declining by $44 billion and average daily liquidity supply increasing by $64 million.

In the third quarter, LP fees on Arbitrum increased by 37%; Optimism's fees remained stable after a 176% increase in the second quarter. Overall, LP fee distribution this quarter was reasonable, with LPs on Arbitrum and Polygon receiving around 37% of the fees, while Optimism's LPs received 25% of the fees.

In the third quarter, the three main stable ETH pairs (USDC-ETH, DAI-ETH, and USDT-ETH) on Uniswap L2 saw their liquidity more than double by the end of the quarter, accounting for 59% of total trading volume. Overall, 47% of trading volume came from Polygon, representing 49% of total trading volume on Uniswap Polygon.

Towards Multi-Chain Development

In the third quarter, Uniswap continued its multi-chain development, attracting 65% of trading volume on L2 chains. Additionally, Uniswap V3 was deployed on the Celo blockchain in July. Two months later, the voting results showed that 99.99% of voters agreed to deploy V3 on zkSync and Aurora. If the proposal passes, Aurora will allocate $5 million for liquidity mining activities and long-term protocol development to incentivize Uniswap users.

Uniswap Foundation

The Uniswap community is also optimizing its internal governance structure. The governance department of Uniswap passed a $74 million proposal to create the Uniswap Foundation (UF). UF is an independent entity dedicated to supporting the decentralized and sustainable development of the Uniswap protocol and its ecosystem. The results showed that 99.8% of on-chain votes supported the proposal, with over 50% of the affirmative votes coming from a16z, Variant Fund, ConsenSys, Compound's Robert Leshner, Gauntlet, and Uniswap Grants Committee member John Palmer.

Of the $74 million, $14 million will be used to cover the operational costs of a 12-person team for three years. The remaining $60 million will be used to expand the Uniswap Grants Program (UGP). The Uniswap Foundation also obtained 2.5 million UNI tokens through the Franchiser smart contract for governance participation. The Franchiser smart contract allows the Uniswap DAO to revoke these tokens at any time and restricts their use in governance.

By the end of this quarter, the Uniswap Foundation completed its first batch of 14 grants, totaling $1.8 million. Of this, approximately $1.6 million was allocated to GFX Labs for the creation of Uniswap Diamond. Uniswap Diamond aims to enhance Uniswap's market share in user experience and data, making it superior to other leading centralized exchanges. It will create an open-source API and SDK to access real-time and historical data, providing a professional trading interface with functionalities akin to centralized exchanges, such as LP tools, market orders, and limit orders.

Fee Conversion

For a long time, fee conversion has been one of the most discussed topics within the Uniswap community. Currently, all trading fees are distributed based on LP contributions to liquidity reserves. Fee conversion refers to the ability to transfer a portion of fees to the Uniswap DAO treasury as protocol fees.

In August, a 120-day pilot program for fee conversion was conducted on Snapshot, with 99.99% of voters supporting the pilot. According to the proposal, the pilot will be tested on the following three trading pairs, with 10% of each LP fee going to the Uniswap DAO treasury:

• DAI-ETH: LP fee is 0.5%
• ETH-USDT: LP fee is 3%
• USDC-ETH: LP fee is 0%

The proposal aims to quantify how LPs would redeploy their liquidity supply in the face of fee conversion. If the pilot passes the final stage of governance and is recognized by the Uniswap community, the next significant decision for Uniswap governance will be how to utilize the protocol fees. "Fee conversion" does not mean that protocol fees will be paid to UNI token holders, but rather aims to provide token holders with new tools to promote protocol development and fulfill its mission.

In Q3 2022, these three trading pairs accounted for 4.34% of total trading volume. Based on the proposed 10% fee allocation, these trading pairs would generate over $850,000 in revenue for the Uniswap DAO treasury.

Conclusion

Despite the sluggish trading volume and revenue performance on Ethereum, the Uniswap protocol performed well this quarter. The increase in swap trading volume, market share, and deployments on L2 solutions has boosted the sentiment within the Uniswap community. Meanwhile, with the establishment of the Uniswap Foundation and the upcoming fee conversion feature, this leading decentralized exchange appears to have a bright future ahead.