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How Uniswap V3 Works

This page explains the key concepts behind Uniswap V3, a decentralized exchange (DEX) that lets you trade tokens (cryptocurrencies) directly on the blockchain without needing a traditional middleman.

Overview​

Uniswap V3 is like a digital marketplace where you can swap one cryptocurrency for another. Instead of buyers and sellers, it uses "liquidity pools" where people provide tokens to enable trading and earn fees.

Key Benefits​

  • Better Prices: Concentrated liquidity means trades have less impact on price.
  • Earn Fees: Provide liquidity and earn a share of trading fees.
  • Permissionless: Anyone can add tokens or create new markets.
  • Secure: Runs on Ethereum's blockchain with battle-tested smart contracts.

Core Concepts​

1. Liquidity Pools​

A pool is like a shared pot of two tokens (e.g., ETH and USDC). People who add tokens to these pools are called "liquidity providers" (LPs).

2. Concentrated Liquidity​

Unlike traditional AMMs, Uniswap V3 lets LPs choose specific price ranges to provide liquidity, making capital more efficient.

3. Swaps​

When you trade one token for another, the protocol automatically finds the best price across all available pools.

4. Fees​

  • TradingFees: A small percentage (e.g., 0.3%) is charged on each trade and distributed to LPs.
  • GasFees: Paid to the Ethereum network to process transactions.

User Stories​

For Traders​

  • "I want to swap ETH for USDC with the lowest fees."
  • "I need to know how much USDC I'll get for 1 ETH before I trade."

For Liquidity Providers​

  • "I want to earn fees by providing liquidity to the ETH/USDC pool."
  • "I'd like to provide liquidity only when the price is between $1,800 and $2,200 per ETH."

Architecture Overview​

flowchart TD
    User[User with Wallet] -->|Connect| dApp[Uniswap Interface]
    dApp -->|Read/Write| Contracts[Uniswap Smart Contracts]
    Contracts -->|Interact| Pools[Liquidity Pools]
    Pools -->|Hold| Tokens[Token Pairs e.g., ETH/USDC]
    dApp -->|Price Data| Oracles[Price Oracles]

Key Components​

  1. Swap Router: Handles token swaps and finds the best trading routes.
  2. Factory: Creates and manages liquidity pools.
  3. Quoter: Provides price quotes for trades.
  4. Non-Fungible Position Manager: Manages liquidity positions as NFTs.

Economic Model​

Value Flow​

  • Traders pay fees for swapping tokens.
  • Liquidity Providers earn fees by supplying tokens to pools.
  • Protocol: Takes a small fee (if enabled by governance).

Fee Tiers​

Uniswap V3 offers multiple fee tiers to suit different trading pairs:

  • 0.05%: For stablecoin pairs (e.g., USDC/USDT)
  • 0.30%: For most common pairs (e.g., ETH/USDC)
  • 1.00%: For exotic or less liquid pairs

Next Steps​