The growth flywheel in the DeFi field, explaining the four major innovation mechanisms of Uniswap V4 in detail

Author: Daniel Li

On June 13, Uniswap released the Uniswap V4 version code draft, which caused a strong shock in the industry and became a hot news in the past few weeks. As the largest decentralized trading platform at present, Uniswap has long occupied more than 50% of the transactions on the chain, and its transaction volume is more than three times that of the second largest competitor. The launch of Uniswap V4 will further strengthen its position as the largest DEX in DeFi.

In the two articles "Our Vision for Uniswap v4" and "Uniswap v4 Core Whitepaper" (white paper) released by Uniswap, Uniswap Labs introduced in detail Hooks that can realize AMM customization, Singleton that changes account framework and order logic, and can greatly reduce Gas Flash accounting and Native ETH for fees. These innovative features will bring greater freedom, better liquidity, lower handling fees and more choices to DEX. At the same time, it injects a catalyst into DEX, which has been weak in the competition between DEX and CEX for a long time, and accelerates the pace of DEX to catch up with CEX, which will have a profound impact on the future development of DeFi.

Uniswap leads the development of the entire DeFi industry with innovation

The upgrade of Uniswap V4 has attracted the attention of many institutions. On the one hand, the U.S. Securities and Exchange Commission (SEC) sued Binance, the world’s largest CEX, which made industry institutions start to worry about the future development of CEX. The DEX that is modernized and audit-resistant has undoubtedly won more favor. In addition, the most important point is that Uniswap, as an industry leader, leads the development direction of DEX with each version it launches, and is imitated by successors, which also drives the prosperity and development of the entire DeFi. Let's review each historical version of Uniswap below.

Uniswap V1 is the first official version, launched in November 2018. It provides transactions between ERC-20 tokens and ETH, and introduces an automatic market maker model for the first time, which automatically adjusts token prices and liquidity, thereby making token transactions faster, easier and less costly. This approach also provided inspiration for many subsequent decentralized exchanges and laid the foundation for the development of the entire DeFi ecosystem. During the same period, SushiSwap, Curve Finance, and Bancor all borrowed from Uniswap V1.

Launched in May 2020, Uniswap V2 further provides trading support between ERC-20 tokens, and introduces a liquidity mining mechanism to increase the liquidity of trading pairs by rewarding liquidity providers. With the liquidity empowerment of V2, projects that emerged during the same period include Yearn.finance, AAVE, Compound, and Chainlink.

Launching in May 2021, Uniswap V3 introduces centralized liquidity and price limit order (PLC) functionality. Centralized liquidity allows market makers to manage funds more effectively, increasing their profits and efficiency. PLC allows users to set the upper limit and lower limit of the transaction price according to their own needs, so as to control the transaction more finely. During the same period, both Concentrated Liquidity and BarnBridge achieved higher efficiency and benefits by using the centralized liquidity and PLC functions of Uniswap V3.

Uniswap V4 is an upcoming new version. Although the specific launch time has not yet been announced, according to the information released by the project party, this Uniswap V4 version will be different from the previous V1-V3. It will no longer be a technological innovation from 0 to 1, but Carry out a comprehensive subversion from the infrastructure of DeFi. For example, V4 will provide a token pool that can be created and managed independently, an AMM that can add new functions through "hooks", and a large contract framework to replace the previous Factory/Pool model, etc. These innovations will further strengthen Uniswap's characteristics as a decentralized trading platform and bring new changes and opportunities to the entire DeFi ecosystem.

Uniswap V4: Four innovative mechanisms to create the real infrastructure of DeFi

As an important participant and leader in the DeFi industry, Unsiwap has played a vital role in promoting the progress and improvement of the industry. This time, Uniswap V4 will introduce innovative mechanisms such as Hooks, Singleton and Flash accounting to create a truly suitable DeFi The efficient, flexible, and low-cost infrastructure provides users with a better trading experience and more opportunities. Let's introduce these new functions of Uniswap V4 in detail

Hooks

One of the key innovations of Uniswap v4 is the introduction of "hooks". Hooks are also translated as "hooks", which are essentially an external contract created and defined by developers for transaction logic. Through Hooks, developers can call external contracts to perform specified operations at specific points in the life cycle of the liquidity pool (such as adding, adjusting, deleting, exchanging, etc.), such as creating limit orders before trading, and adjusting after the liquidity pool position changes Transaction fee levels, etc.

With the function of adding plug-ins through Hooks, Uniswap V4 has become a customizable liquidity pool platform. This customizable feature is unattainable for centralized exchanges. Developers can paint freely and develop various new functions on this basis to meet various transaction scenarios and make liquidity more deeply bound to the development of the project itself. In addition, this customizable feature can also stimulate the imagination and creativity of developers and communities, further increasing the network effect of Uniswap V4, making it the underlying infrastructure of the entire DeFi ecosystem.

Currently Uniswap V4 shows the following hook samples:

• Time Weighted Average Market Maker (TWAMM)

When a traditional AMM market maker executes a large transaction, the price in the pool will change during the transaction, so there will be a huge slippage, which will bring inconvenience to the transaction. TWAMM splits large transactions into multiple small transactions, and each small transaction is completed within a period of time, thereby reducing price fluctuations, reducing slippage, improving transaction smoothness, and providing users with better transactions. experience.

• Dynamic fee

Dynamic fees can be calculated based on factors such as the number of assets in the liquidity pool, trading volume, and volatility. When market volatility is low, transaction fees are reduced, providing a more competitive trading environment. When the market volatility is high, transaction fees will increase accordingly, thereby protecting the stability and security of the liquidity pool.

• On-chain Limit Orders

On-chain limit orders are implemented by introducing a new contract type called Limit Order Contract, which allows users to automatically execute preset trading orders under specific price conditions. Through the chain price limit list, users can trade more flexibly to meet specific trading needs.

• Borrowing of idle liquidity

In traditional AMM exchanges, liquidity providers can only deposit assets into the liquidity pool to obtain benefits such as transaction fees and mining rewards. However, if the liquidity exceeds a certain range, these liquidity may not be able to maximize returns and become idle assets. In Uniswap V4, through the introduction of the Idle Liquidity Transfer Contract (Idle Liquidity Transfer Contract), excess liquidity can be deposited into the lending agreement, which improves the efficiency of capital utilization and increases the source of income.

• Customized on-chain oracle

Custom on-chain oracles are implemented by introducing a new contract type called Aggregator Contract. The aggregation oracle contract can select different oracle service providers, data sources and calculation formulas according to the user's configuration, so as to realize customized oracle service.

• Internalized MEV profit distribution back to LP

In traditional AMM exchanges, MEV profits are usually obtained by miners or other participants, while liquidity providers can only obtain income from transaction fees and mining rewards. By distributing internalized MEV profits back to LPs, liquidity providers can directly obtain income from MEV profits, thereby increasing their income sources and income levels.

Singleton

Singleton is a new contract structure of Uniswap V4. In the previous version, each liquidity pool corresponds to a contract. When adding a new liquidity pool, a new contract needs to be deployed, which not only increases the deployment cost of developers, but also requires transactions to span multiple contracts. This leads to an increase in Gas fees and transaction times. In the Singleton architecture, all liquidity pools are stored in one contract. This design greatly reduces the cost of creating a liquidity pool and Gas fees, and improves transaction efficiency.

The main advantages of the Singleton architecture are as follows:

• Cost reduction: Since all liquidity pools are stored in the same contract, developers do not need to deploy separate contracts for each liquidity pool, thereby reducing development and maintenance costs.
• Improve efficiency: The Singleton architecture realizes multi-hop transactions, and users only need to call the contract once to complete all exchanges, which greatly improves transaction efficiency and reduces Gas costs.
• Scalability: The Singleton architecture can easily add new functions and features, leaving more possibilities for future innovation, making Uniswap V4 more scalable and flexible.
• Simplified liquidity position management: In the Singleton architecture, liquidity positions are no longer encapsulated by tokenization, but address is used for position management, which can manage liquidity position data more simply and efficiently

Flash Accounting

Flash Accounting, called "Flash Accounting", is a new accounting method introduced on top of the singleton contract structure. In the previous version, each transaction needs to calculate the balance of all related positions, which will take up a lot of Gas and lead to high transaction costs. The Flash Accounting system can calculate transaction fees only based on the net balance (that is, the amount of change in the balance), thereby reducing Gas consumption.

Specifically, the FlashAccounting system takes advantage of the fact that all liquidity pools in Uniswap V4 are managed by one contract. When a user makes a transaction, the Flash Accounting system will query the net balance of the current pool (that is, the difference between buying and selling volume), and then calculate the transaction fee based on the user's net balance in the transaction. Since only the net balance is calculated, the Flash Accounting system can avoid calculating the balance of all related positions, thereby reducing the Gas required for calculation.

In addition to reducing Gas consumption, the FlashAccounting system can also improve cross-pool routing efficiency and further reduce transaction costs across multiple pools. This feature becomes very useful when combined with pegged contracts, enabling more complex integrations and innovations that can greatly increase the number of pools.

Native ETH

Native ETH in Uniswap V4 refers to the direct transaction between Ethereum native token (ETH) and other tokens during the transaction process. In the previous version, if you want to trade between ETH and other tokens, you must first convert ETH to WETH tokens. This process requires multiple transactions and Gas fees, resulting in high transaction costs and low efficiency.

In Uniswap V4, the concept of Native ETH is introduced, which allows transactions between ETH and other tokens to be carried out directly without converting to WETH first. This can significantly reduce transaction costs and time. At the same time, Native ETH can also improve liquidity, attract more liquidity providers into the Uniswap V4 ecosystem, and provide traders with better liquidity and prices.

In terms of specific implementation, Uniswap V4 adds an ETH pool to the core contract, which is only used for direct transactions between ETH and other tokens. When a user trades between ETH and other tokens, the system will automatically compare the transaction volume with the ETH volume in the pool, and then calculate the amount of other tokens corresponding to the transaction volume based on the ratio. In this way, users can directly trade between ETH and other tokens in Uniswap V4 without going through a cumbersome conversion process. Therefore, the introduction of Native ETH makes Uniswap V4 more convenient and efficient, provides users with a better trading experience, and further strengthens Uniswap's liquidity and competitiveness.

Uniswap V4 may become an opportunity to solve the DEX dilemma

In the digital asset trading market, CEX and DEX are the two main exchange models. Due to the long-term problems of DEX with insufficient liquidity, poor user experience, high transaction fees and costs, CEX has long occupied the majority of the digital asset trading market. With the rapid development of DeFi, the development dilemma of DEX has also attracted more and more attention. In this case, the release of Uniswap V4 may become an opportunity to solve the dilemma of DEX. Through innovative solutions, Uniswap V4 plans to improve the situation of DEX from four aspects. Once successful, it will lead more institutions to join in and jointly promote the complete resolution of the DEX dilemma.

Improve liquidity: Liquidity is one of the core issues of DEX. Uniswap V4 improves the customizability and liquidity of DEX by introducing the Hook function and the combination of internalized MEV profit distribution back to LP and other hooks. The Hook function allows anyone to use custom contracts to deploy liquidity pools, making Uniswap's liquidity more composable and scalable, and the internalized MEV profit distribution back to LPs can encourage more LPs to participate in Uniswap liquidity provided to improve liquidity.

Improve user experience: Uniswap V4 introduces the TWAMM algorithm and price limit trading function, which improves the efficiency of price discovery and the user's trading experience. The TWAMM algorithm can calculate the price based on the time-weighted average, thus reflecting a more accurate market price. The price limit transaction function allows users to set the upper and lower limits of the price to better control transaction risks. These functions can improve user experience and attract more users to participate in DEX transactions. In addition, deploying liquidity pools through Hook custom contracts can meet different needs of users and greatly improve user experience.

Reduce transaction fees: transaction fees are one of the most important reference indicators for users to choose an exchange. Uniswap V4 reduces transaction costs through mechanisms such as internalized MEV profit distribution back to LP, hook combination and lightning bookkeeping. Internalized distribution of MEV profits back to LPs can increase LPs' income, thereby reducing users' transaction costs, and lightning bookkeeping can reduce the cost of frequent transactions, providing users with lower transaction costs and higher efficiency.

Improve cost efficiency: The Singleton architecture of Uniswap V4 can set all LP contracts into a single contract, which not only reduces the gas cost of creating LP and multi-hop trade (cross-pool routing transactions), but also greatly improves deployment contract efficiency. Coupled with lightning bookkeeping to reduce the cost of frequent transactions, Uniswap V4 helps users achieve maximum benefit or value at minimum cost, and also provides a better foundation for the sustainable development of DEX.

Summarize

Uniswap is one of the important founders in the DeFi industry, and has been continuously introducing new innovative mechanisms to drive the development of the entire industry. As the master among them, Uniswap V4 is undoubtedly a major innovation in the DeFi industry and even the entire encryption industry. Uniswap V4 endows users with greater freedom, higher liquidity, lower fees, and more complete and convenient services. These advantages make Uniswap V4 a more competitive trading platform and promote the development of the entire DEX industry. progress and refinement.

Although there is still a large gap between DEX and CEX in terms of user experience, fees, and security, this gap is gradually narrowing as the Uniswap version is continuously updated and improved. It is believed that in the near future, Uniswap V4 will occupy a more important position in the competition between DEX and CEX, become the flywheel of liquidity growth in the DeFi industry, and lead the development direction of the entire industry.