By @ndhung1104 and @RochelleSophie_

There’s been a lot of talk around how efficient Uniswap v3 is:

However, according to Bancor’s Head of research, v3 comes at a price.

In this article we work to evaluate whether Uniswap V3 is sacrificing retail LPs for a better capital efficiency.

V2 has a higher TVL and more active users.

With regards to TVL and active users, V2 comes out ahead with 18k daily users and 4B$ in TVL in comparison to just 8.45k daily users and 2.5B$ TVL in V3.

But V3 has 4x the volume with half the TVL on V2.

V3 has 6.79B$ in daily volume which nearly quadruples the transaction volume on V2.

At first glance, capital efficiency on V3 is the real deal. It generated 4x more volume than V2 with only half the TVL required.

Despite the capital efficiency, why do people still keep their liquidity in V2? With the volume / TVL ratio of 2.79 in V3 and only 0.71 in V2, you should earn at least 3.8 times more if you migrate to V3 right?

Well, the true story is not so simple.

V3 and Capital Efficiency

To understand how v3 works, let’s take a look at their unique mechanic: concentrated liquidity.

“In Uniswap v3, LPs can concentrate their capital within custom price ranges, providing greater amounts of liquidity at desired prices. In doing so, LPs construct individualized price curves that reflect their own preferences.

LPs can combine any number of distinct concentrated positions within a single pool. For example, an LP in the ETH/DAI pool may choose to allocate $100 to the price ranges $1,000-$2,000 and an additional $50 to the ranges $1,500-$1,750.”

Source: https://uniswap.org/blog/uniswap-v3/

Moreover, “Swap fees are not automatically reinvested as they were in previous versions of Uniswap. Instead, they are collected separately from the pool and must be manually redeemed when the owner wishes to collect their fees.”

Source: https://docs.uniswap.org/protocol/concepts/V3-overview/fees

On V3 not only do you have to actively monitor and adjust your position to get the best yield, you also have to manually claim the rewards if you want to compound them. On v2, the only thing you need to do is deposit your funds into the LP pool.

Note: you can use this Uniswap v3 Fee calculator to understand more on how different ranges affect your yield on V3.

This effectively gives an edge to a small group of people who:

• Have a working strategy and are hedging to battle against the high impermanent loss on concentrated position.
• Have capital that is large enough to outweigh the high gas fee on each rebalancing position / claiming reward on Ethereum.

Indeed this small group of people will see their capital efficiency increase by 4000x compared to others.

What happens if I just provide liquidity to Uniswap V3 the same way I would on V2?

To evaluate the impact of not adjusting your position on V3, let’s use this Uniswap calculator and look at the USDC / ETH pool with a 0.3% swap fee.

The widest liquidity concentration in the last 30 days is around 20% - 30% with most of the day being only around 5%. Let’s use 20% as an example.

There is a 10x difference between a user who actively adjusts their position inside the 20% range and a normal user who just provides liquidity in the 0 - infinity range (v2).

The fees you earn in a pool are distributed based on the ratio of your liquidity over total liquidity.

The top 10 LPs on V3 hold such a high concentration of the total liquidity that their effective liquidity will increase 10x compare to those who provides liquidity without a range on v2.

Meanwhile retail users will earn 90% less fees if they don’t adjust their range accordingly.

Retail investors will earn 4x more in rewards on V2 than on V3.

Rewards for retail users:

• With the v2 pool, the fee/liquidity ratio is 184,461 / 218,728,477 = 0.000843.
• The same ratio on v3 is 703,170 / 332,460,000 = 0.00211. However since you don’t provide liquidity in a tight range / actively manage your position, your actual ratio will be divided by 10 or 0.00021.

V2 gives out 0.000843 / 0.00021, i.e. 4x more rewards than a v3 pool.

Moreover, on some days, liquidity is only concentrated around the 10% range:

In this case v2 gives out 8x more reward than v3.

Therefore, while v2 makes everyone receive the same reward per dollar deposited, v3 allows some small group of people to receive more rewards at the detriment of others receiving less.

Will retail users be able to enter V3 LPs in the future?

While layer 2 might solve the gas problem on Ethereum, it won’t remove the technical barrier (the complexity of adjusting the range to maximize the profit). Unless someone can propose an optimized strategy that no one else can beat, there will always be a winner and a loser in this game.

Somehow in the end, the liquidity provider’s job on a decentralized exchange is handled by a centralized group of people.