Providing liquidity in Uniswap V3. Seeking Profitable Uniswap V3 Pools
Opportunity to earn while having moderate risks under control.
1. What is a decentralized exchange (DEX) liquidity pool?
A Decentralized Exchange (DEX) employs a liquidity pool mechanism facilitated by smart contracts. Users can engage with these smart contracts without the need for pre-registration or obtaining anyone’s permission, a concept known as “permissionless.” This ensures that your funds are exclusively under your control, and no entity has the authority to hinder your transactions or block your access in any manner.
Consider a liquidity pool as a container initially funded by its creator, say with 1 ETH and 2500 USDT. Now, anyone can engage in an ETH-USDT exchange, such as sending 0.1 ETH to the pool and receiving 250 USDT in return. In the realm of blockchain, a liquidity pool is a predefined smart contract capable of holding a pair of assets and autonomously executing exchanges between them. This means you can swap one token for another at any time, provided the relevant pool has the required liquidity.
Additionally, the liquidity pool features an exchange fee that is automatically collected with each transaction and then distributed proportionally among the liquidity providers.
2. Uniswap V3 liquidity pools
Uniswap V3 represents the third iteration of the protocol for the widely-used decentralized exchange available at https://app.uniswap.org. It stands out from its predecessors in a fundamental way.
The primary distinction of the third version lies in its capacity to offer concentrated liquidity. Unlike the earlier versions, where liquidity covered the entire price spectrum, often resulting in underutilized liquidity during narrow trading ranges, Uniswap V3 allows liquidity providers to specify their own price bounds.
This innovation ensures that capital is employed with maximum efficiency, addressing the challenge of liquidity providers having to lock substantial amounts of liquidity while earning relatively low fees, making it a more attractive proposition in terms of the risk/profit ratio.
3. From theory to practice
Let’s attempt to estimate the returns derived from supplying liquidity in a relatively secure pair, WBTC-WETH, concerning mutual volatility, using the calculator found at https://imxflow.com/univ3lp. This pair consists of two assets highly correlated with each other, making a significant drop in one asset relative to the other improbable. This popularity contributes to higher fees for liquidity providers. However, it’s essential to note that increased competition results in diminished earnings for each liquidity provider.
In the provided illustration, we observe that liquidity in the WBTC-WETH pair is focused within the 19.63–12.44 range (expressed in USD for convenience, but originally represented by the token ratio). Liquidity providers optimize their earnings by narrowing the liquidity range, anticipating a prolonged price stability within that range. Throughout this period, as the price stays within the specified range, liquidity providers receive commissions (here, 0.3% for each swap), distributed proportionally among all providers whose liquidity range encompasses the current price.
In this instance, the primary liquidity is centered around a 36.62% volatility (delta), indicating that liquidity providers anticipate that the joint volatility of these assets will not surpass this threshold.
However, upon reviewing the asset price chart, it becomes evident that the blue line is notably distant from the upper price boundary (in this case, functioning as the lower price boundary due to the inverted chart). Considering the recent month’s price movement, where the price has not dropped to such low levels, it seems reasonable to refine the liquidity provision range for this asset pair. Let’s determine the optimal liquidity range based on the price trends observed over the last month.
Establishing price boundaries slightly above the monthly high and low results in a volatility delta of 18.45%. This adjustment has led to a doubling of the daily return from 0.04% to 0.08%. Furthermore, by encompassing all days when the price fell within our specified range throughout the month, the overall monthly return has surged by 2.5 times.
Now, the question arises: what if we attempt to further narrow the range? Let’s explore in an effort to identify the most lucrative price boundaries.
In 13 trading days, the price has settled within 7.5% volatility and the daily return is 6 times higher than the initial one. But, what if we try to find an even more profitable strategy?
During a 10-day period characterized by volatility not exceeding 3%, the daily income experienced an extraordinary surge, increasing nearly 12 times and reaching 0.47% of the deposit per day. Remarkably, this occurred in a widely-used pool featuring a 0.3% fee.
Now, let’s shift our focus to altcoin pools and those with a 1% fee. The profitability of a pool is contingent on factors such as the total liquidity, the pool’s commission percentage, and the daily trading volume.
In the WETH-MUBI pair, the liquidity in the pool is $7,126,678, coupled with an average daily trading volume of $5,837,412 and a pool fee of 1%. This configuration results in an average daily return of nearly 4%, taking into account a volatility of 35.6%. It’s important to note that the 35.6% volatility is relative to ETH, not USD. Considering that altcoins often align with the movement of the underlying asset (ETH), the actual volatility of altcoins against USD may be higher. Consequently, this setup yields about 4% per day, accommodating altcoin fluctuations of 40–50%.
For those monitoring an altcoin and possessing the ability to accurately predict its future volatility and increased trading volumes, there’s an opportunity to narrow the liquidity range further to enhance returns.
In this instance, by strategically adding liquidity within a narrow range amidst escalating trading volumes, a noteworthy yield of 17.45% per day was achieved over a span of 3 days. This significant return can be attributed to the relatively low pool liquidity of around $426k, combined with substantial daily trading volumes averaging $3.6m. The utilization of available liquidity multiple times generated substantial fees for the liquidity providers.
It’s important to acknowledge that such lucrative situations are typically short-lived, and prices tend to swiftly move out of narrow ranges. However, liquidity can be shifted to a new range, allowing for continuous profit generation. This represents one viable strategy to optimize profits.
Nevertheless, it’s crucial to emphasize that these calculations do not guarantee earnings. To validate the practical feasibility of such profitability, let’s examine the actual positions within Uniswap and their returns in the WETH-PNDC 1% pool.
Real positions validate our calculations. As an illustration, position ID 656599 yielded a 46% return on commissions within an incomplete 24-hour period (0.94 days). For more comprehensive statistics, hover over the PNL numbers
The initial deposit stood at $22,189, and the generated fees amounted to $10,122 for the liquidity provider within a single day! Furthermore, the liquidity amount increased to $23,388 due to the token price growth. Consequently, the total income reached an impressive 51%.
This table serves as a reliable tool to verify the precision of calculated parameters against the actual earnings of liquidity providers in this specific pool.
For tracking the performance of various pools, they can be added to the Watchlist.
On the example above we can see how easy it is to track the trading volumes of a pool and changes in its liquidity.
Pool data is updated every time the page is loaded, or we can update this block separately by clicking the Reload button and get the most recent data for the current time.
When placing large amounts of liquidity, an important parameter for profitability is the liquidity density (liquidity density) in a particular range. We can estimate the liquidity density using a dynamic chart that simulates fee calculations for different deposit sizes. The narrower the range or the less liquid the asset, the more steep the decrease in liquidity density with increasing deposit size. It is important to keep this point in mind when analyzing the pool.
In the example below, the wide range of liquidity has sufficient density and the decrease in fees with increasing deposit size is insignificant.
We can experiment with narrowing the range and observe how the liquidity density rapidly diminishes with an increasing deposit size. As a result, the fees decrease by almost 2 times.
Another crucial factor to consider when identifying profitable pools is the occurrence of time spikes in pool activity. While some tokens enjoy global popularity with uniform trading activity over time, others may be more regionally popular, such as in the USA or Asian countries. If you’re closely monitoring a pool’s trading activity, it’s beneficial to take note of when the most active trading periods align with your local time.
Examining the PNDC-WETH 1% pool as an illustration, we observe that heightened trading volume commonly occurs between 18 to 22 hours in our local time (please note that the time on the bottom scale may vary for different time zones)
4. Seeking Profitable Uniswap V3 Pools
Discovering the most lucrative Uniswap pools involves examining certain indicators. One approach is to analyze unusual spikes in trading volumes within a pool. For instance, if the current trading volume for the day is three times higher than the average volume over the past two days, it may signal a potentially profitable pool.
Identifying interesting token pairs with increased interest is facilitated by trading volume, but determining the most profitable pools requires a comprehensive approach.
What if we could leverage data from all pools and simulate fee calculations in each? To pinpoint the most profitable pools, it’s advisable to exclude stablecoin pools and those with 0.01% and 0.05% commissions. Despite sizable trading volumes in such pools, the abundance of liquidity providers coupled with low commissions limits potential profits.
Our selection parameters include:
⦁ Exclusion of Stablecoins
⦁ Elimination of pools with 0.01% and 0.05% commissions
⦁ Total Value Locked (TVL) greater than $100,000, with a test deposit of $10,000
⦁ Data from all pools’ trades for three days, including the present day
⦁ Automatic selection of the price range as the minimum and maximum prices observed over the past three days
Additionally, an optional parameter is introduced: Pool lifetime (to filter out newly created assets that might exhibit temporary high profitability). Users can choose a pool lifetime of one month or more.
This comprehensive approach yields a selection of the most profitable pools across the entire Uniswap exchange at the present moment. The data is dynamically updated in real-time upon page reload or block refresh.
We’ve compiled around 100 pools ranked by profitability. Our primary focus lies on the daily return and the associated volatility, a critical metric for comparing pools in terms of yield. A higher volatility delta is advantageous, providing more room for price fluctuation. When two pools exhibit identical profitability, the one with a higher volatility (e.g., 20% compared to 5%) is more appealing, as the price is less likely to surpass a broader range.
However, it’s crucial to recognize that this is an indirect indicator. Making well-informed decisions requires a more in-depth investigation into the token, considering factors such as its historical volatility, overall profitability, trading volumes, and other relevant parameters.
5. Risks
Concentrated liquidity introduces an elevated risk of Impermanent Loss (IL). Impermanent Loss occurs when the token prices change, prompting a rebalancing of your liquidity. For instance, consider providing liquidity in the pair ETH-ALT, where ALT represents an altcoin. Assuming the underlying asset (ETH) remains relatively stable, monitoring the altcoin’s price is crucial. If the altcoin’s price surpasses the upper limit of your specified range, your entire deposit converts into ETH. In the event that the altcoin’s price continues to rise, you miss out on potential profits compared to holding the altcoin in your wallet. Conversely, if the altcoin’s price falls below your lower limit, your deposit converts into altcoins, and its value decreases with the declining altcoin price.
Even when the altcoin’s price remains within the upper and lower boundaries, there’s a scenario where the total assets in the pool may be less than your original deposit, as if you had kept the tokens in your wallet. This scenario is termed Impermanent Loss, as the losses incurred become impermanent once the prices return to their original values.
An essential point to note is that in liquidity pools, you don’t earn USD but rather commissions expressed in tokens of the two pool assets. Even during a market downturn, when both tokens decrease in value, the overall value of your deposit decreases. However, you continue accumulating more tokens through earned commissions. As the market rebounds, the value of your deposit returns and increases, driven by the commissions earned.
6. Comparison of Calculators
The calculations presented in this article are performed using the calculator at https://imxflow.com/univ3lp. While there are several similar calculators available, they are less accurate and lack essential data. Notably, none of them offer a comparison of actual positions with Uniswap, including crucial parameters like volatility delta, received fees, PNL (profit and loss), etc. Additionally, other calculators lack dynamic calculations for liquidity density, hourly transaction statistics, a list for monitoring pool volumes, tracking volume spikes, and the emulation of calculations for all possible Uniswap pools to identify the most profitable ones.
Methodological Differences in Fee Calculations: Calculating fees involves considering Total Value Locked (TVL), pool trading volume, and price range. Most calculators rely on average TVL and average trading volume data for a 7-day period, extrapolating calculations based on this information. To show monthly revenue, they often multiply by 28 (Metacrypt) or 30 (Poolfish) days, which deviates from reality.
In contrast, only the https://imxflow.com/univ3lp calculator factors in days when the price falls within the chosen range, calculating the average TVL and volume exclusively from data on these days. Monthly income calculations also only consider days when the price was within the specified range. This meticulous approach enhances the accuracy of calculations.
From the above examples, it’s evident that the IMXFLOW calculator distinguishes itself by displaying the number of days within the specified price range. It exclusively factors in volumes and Total Value Locked (TVL) from these specific days, resulting in a more precise fee calculation.
Uniswap V3 pools allocate prices using ticks, varying across pools with different assets and fee percentages. Metacrypt and Poolfish calculators use linear price changes in arbitrary values (sequential numbers like 1–2–3–4–5, rather than actual values like 1–3–6–9–12). In contrast, the https://imxflow.com/univ3lp calculator accurately reflects price changes over ticks specific to each pool.
This precision is crucial when calculating and creating future positions using the “Create position” button. The calculated price aligns exactly with the appropriate pool ticks, ensuring that creating a position with inappropriate prices is prevented. Uniswap adjusts the price to the nearest tick if it deviates. Without accurate calculations, your token balance may shift, and the parameters of your position calculation will change.
To utilize the calculator, visit https://imxflow.com/univ3lp and try calculating positions from test pools like WETH-IMX. Registration grants you one hour of full access for testing on any available Uniswap tokens. Subsequently, you can purchase one of the accounts — $29.99 for a month, $24.99x3 for three months, and $19.99x12 for a year. Payment is made in ETH by connecting your wallet and sending ETH; your account activates automatically after payment.
For any inquiries, feel free to reach out on Discord: https://discord.gg/F8sNJzedkd
