Empirical Study of the Ability of Unsiwap V3 to Handle Unexpected Price Shocks

What is it about?

Financial markets have evolved over centuries, and exchanges have converged to rely on the order book mechanism for market making. Latency on the blockchain, however, has prevented decentralized exchanges (DEXes) from utilizing the order book mechanism and instead gave rise to the development of market designs that are better suited to a blockchain. Although the first widely popularized DEX, Uniswap V2, stood out through its astonishing simplicity, a recent design overhaul introduced with Uniswap V3 has introduced increasing levels of complexity aiming to increase capital efficiency. In this work, we empirically study the ability of Unsiwap V3 to handle unexpected price shocks. Our analysis finds that the prices on Uniswap V3 were inaccurate during the recent abrupt price drops of two stablecoins: UST and USDT. We identify the lack of agility required of Unsiwap V3 liquidity providers as the root cause of these worrying price inaccuracies. Additionally, we outline that there are too few incentives for liquidity providers to enter liquidity pools, given the elevated volatility in such market conditions.

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Photo by m. on Unsplash

Photo by m. on Unsplash

Why is it important?

Uniswap V3 is the largest decentralized exchange by volume. Our findings show that Uniswap V3 currently cannot handle unexpected price shocks. We believe that the platform's success is tied to its future ability to follow the external price.

Perspectives