Uniswap V4 Will Approach the Functionality of Centralized Exchanges

UNISWAP V4

TL;DR
Uniswap v4 will be the next major upgrade of the most used decentralized exchange (DEX). The upgrade aims for a user experience closer to centralized exchanges – combined with the obvious benefit of not relying on a central custodian. Uniswap has given developers a sneak peek into the code of Uniswap v4. It’s main feature is called hooks and they will allow for limit orders, as an example.

Uniswap founder Hayden Adams wrote an article about Uniswap v4 in which he releases the draft code of v4 and talked about its goal. Which is ‘that v4 can be built in public, with open feedback and meaningful community contribution.’ Adams expects this to be a months-long process.

A Step Back: What Is Uniswap?

Uniswap is a DEX built on Ethereum and launched in 2018. It pioneered a mechanism known as an Automated Market Maker (AMM) to facilitate trades. This means that instead of matching individual buyers and sellers like a traditional exchange, Uniswap has pools of different cryptocurrencies that people can trade against. These pools are funded by other users who earn fees on trades as a reward for providing liquidity. 

To give you an idea: there are hundreds of thousands of liquidity providers on Uniswap, and millions of traders. The trading volume of Uniswap is in the same ballpark as that of listed centralized exchange Coinbase.

Uniswap has been updated two times already. The transition from v2 to v3 was a big one and was released in the spring of 2021. V3 added concentrated liquidity, which allowed liquidity providers (LPs) to take positions in a certain price range for a trading pair. This increased the efficiency with which LPs can deploy (and risk) their capital. It allowed them to deploy refined strategies as opposed to just dumping their coins in a pool and hoping for the best. (More on that in the article about Trader Joe’s Liquidity Book, which uses a similar design.) Uniswap v3 also enshrined oracles, which allowed builders to integrate real-time, on-chain pricing data.

Hooks and Singleton Contracts

The mentioned integration of real-time on-chain pricing data came at the expense of some increased costs for swappers. Now Uniswap v4 allows anyone to make these tradeoff decisions through the introduction of “hooks.” Hooks are contracts that run at various points of a pool action’s lifecycle.

Hooks

In software, a hook is a place where a developer can insert their own code into an existing system. The hooks are essentially pieces of code that run at certain points in a transaction’s lifecycle, offering further potential for customization and complex operations.

In Uniswap V4, hooks allow developers to customize how the Uniswap protocol behaves in specific situations. They will make it possible to add a new feature or change how something works without developers having to fork the entire code base.

Hooks can for example be used for dynamic fees. Unlike in Uniswap v3, where the pool creator was limited to a few fixed fee tiers, in Uniswap v4, the pool creator can choose any fee as a static fee or attach a dynamic fee hook. This allows for a greater range of fee implementations, such as an oracle that tracks on-chain volatility and adjusts the fee accordingly. 

Additionally, Uniswap v4 introduces the concept of a limit order hook. This feature allows the creation of limit orders at specific ticks, an improvement over the v3 model that required liquidity provision at narrow ranges for similar functionality. 

Singleton Contracts

In previous versions of Uniswap, each liquidity pool had its own separate smart contract. But in Uniswap v4, there’s only one contract that manages all the pools. View it as having one master control panel which can control all the lights in a house, instead of having to use separate switches for each room. This change makes transactions more efficient and will lower gas fees. It will also improve the interaction between multiple pools.

Uniswap v4 singleton contracts

TWAMM

Another significant feature made possible by Uniswap v4 is the Time-Weighted Average Market Maker (TWAMM). In simple terms, it divides large orders into smaller portions and thus allows users to spread out their trades over time, instead of executing them all at once. This can help traders to get a better average price and reduce slippage.

Pro’s and Cons of Uniswap V4

Pro’s

The basic system of Uniswap v4 is leaner, with fewer inherent features, focusing on maximal efficiency, and cost-effectiveness. As an example: previously, in v3, features like oracles and fees were embedded into the system. This led to complexity and increased costs for swappers. In Uniswap v4, these elements are optional and can be implemented as Hooks. 

In true open-source fashion, by releasing v4 as a draft code, Uniswap outsources the final stage of idea generation and debugging to the community, thereby virtually guaranteeing that a flawless v4 can go live in a few months’ time. In an interview with Bankless, founder Hayden Adams says he wants to promote innovation within the ecosystem by providing incentives for building within Uniswap. He expects so-called shelling points to form around the best designs (focal points that people tend to use in the absence of communication).

Cons: License for the Code

On the other hand, there is a point of criticism on Uniswap v4, namely the use of a Business Source License (BSL). Not everyone in the open-source Ethereum community is pleased. This license means the code is publicly available and can be copied, modified, or redistributed, but it cannot be used for commercial or production purposes for up to four years. People fear that the BSL could stifle innovation and create legal challenges. For example, anyone who’s looked at BSL code even once and then later codes something similar could risk a copyright claim.

And then there are of course the trade-offs that come with any design decision. For example, singleton contracts introduce complexity and will require thorough security measures. Why?  A single contract now handles a larger variety of tasks and manages all pools, which may increase the risk surface for potential attacks. 

Will the Transition From V3 to V4 Be Smooth?

The migration from and to previous Uniswap versions went smoothly. The migration from v3 to v4 might be slower and more complex, according to Hayden Adams. The switch to v4 involves intricate factors such as the concept of a Singleton contract.

A feature of v4 that could help migration speed up is Native Pools. V4 reintroduces the native ETH pools, which were prevalent in v1 but were replaced with wrapped ETH in v2 for coding simplicity. Native pools could offer significant gas savings for transactions buying or selling ETH.

Conclusion

The introduction of hooks into Uniswap v4 will enable better integration with on-chain protocols and will foster innovation.

Uniswap v4 will be part of the ongoing effort to make decentralized exchanges more accessible and affordable, by optimizing gas costs and implementing other improvements.

While, with features like limit orders, Uniswap v4 will make strides towards matching centralized exchanges in terms of user-friendliness, it will not reach the same level of cost efficiency. Centralized exchanges essentially operate on a spreadsheet model and don’t have to incur blockchain transaction costs. But… you don’t own your coins on these, an ever so slight inconvenience…

Uniswap V4 Will Approach the Functionality of Centralized Exchanges - - 2024

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