Uniswap from V0 to V4: Shaping the Future of DEX (Part 2)

Uniswap V4 (2023) — More flexible and efficient

Uniswap V4 marks an important development in the field of AMM, introducing “hooks”, which offer optimal performance and higher customizability compared to previous versions. The improvements in this release not only help reduce transaction fees, increase capital efficiency, but also open up new opportunities for participants in the DeFi ecosystem.

Improve performance and reduce transaction costs

One of the most important changes to Uniswap V4 was the introduction of the Singleton model, in which all liquidity pools coexist in a single smart contract instead of each pool being an individual contract as in Uniswap V3.

Benefits of Singleton:

• Significantly reduces the cost of implementing a new pool, making it easier to expand the trading market.
• Optimization of multi-hop swaps, which reduces gas fees when trading between different tokens.

In addition, Uniswap V4 uses Flash Accounting, a method that helps reduce the number of internal transactions, making asset transfers based only on the final net balance instead of moving piecemeal after each transaction.

Optimization of transaction accounting:

• Reduced asset handling fees when trading.
• Limit unnecessary data recording, take advantage of Transient Storage (EIP-1153) to reduce temporary storage costs.

In addition, Uniswap V4 supports native ETH without Wrapped ETH (WETH), which eliminates unnecessary wrapping costs, providing a cheaper and faster trading experience for users.

Expand Customization with Hooks

Uniswap V4 introduces Hooks, a mechanism that allows external contracts to interfere with the trading process of the pool at certain points. This makes it possible for developers to further customize the Uniswap protocol according to their own needs.

Application of Hooks:

• Create Dynamic Fees instead of fixed fees as in V3.
• Integrate custom oracle types, improve price accuracy.
• Supports advanced liquidity management strategies, which optimize profitability for LPs.
• Establish auction mechanisms to improve the distribution of value in the system.

Hooks also pave the way for setting up advanced order types, including Limit Orders, TWAP, and Stop-Loss, making it possible for users to execute complex trading strategies without the need for external protocols.

Oracle Model and Fee Structure Improvements

A big problem of Uniswap V3 is oracle price is built directly into the protocol, which makes it easy for other DeFi protocols to use price data but increases transaction costs for Uniswap users.

• In Uniswap V4, oracle is no longer a core part, but is implemented through hooks, making it possible for developers to customize pricing data in their own way.
• This opens up anti-manipulation oracle models, such as Winsorized Price Oracle or Volatility Oracle, which help provide more accurate price data without increasing gas costs for users.

Uniswap V4 also introduces a Dynamic Fees model, where fees can change based on market conditions instead of staying the same at fixed rates such as 0.05%, 0.30% and 1.00% like V3.

• For example, if the price on a centralized exchange (CEX) moves too far relative to Uniswap, the system may increase trading fees to prevent arbitrage trades that are not favorable to LPs.
• If the market stabilizes, fees can drop, helping to optimize benefits for both users and LPs.

This model makes LPs pay more deservedly when providing liquidity in highly volatile markets.

MEV Auctions and Value Optimization for LPs

Another important improvement of Uniswap V4 is the implementation of an auction mechanism to prevent value losses from MEV (Maximal Extractable Value).

Ex Ante Auction: Allows the auction of the right to execute the first transaction in a block, limiting front-running.

Ex Post Auction (Auction after price fluctuation):

• Help optimize profit from arbitrage before the next block is recorded.
• However, this approach needs off-chain infrastructure to ensure transparency.

In addition, Uniswap V4 supports Diamond Hook, a method that allows block producers to hold arbitrage auctions and split profits between LPs and block producers.

Application of Zero-Knowledge (ZK) Technology in AMM

Uniswap V4 also opens up the opportunity to integrate Zero-Knowledge (ZK) technologies into the AMM model, which improves both performance and security.

• ZK Coprocessors help smart contracts securely retrieve off-chain data, minimizing gas costs.
• Applications like zKamms allow swap calculations and liquidity management to take place off-chain, then simply verify the results on the blockchain.

These improvements make Uniswap a more powerful platform, opening up more opportunities for integrated DeFi protocols in an efficient and low-cost way.

Challenges of Uniswap V4 and UniSwapX Solutions

Uniswap V4 allows the creation of liquidity pools with a variety of features, such as dynamic fees, auctions, advanced order types (TWAP, limit order). However, this leads to a major consequence: liquidity is fragmented among different pools, making it more difficult to find the optimal trading path.

Examples of fragmented liquidity:

• Previously, users only had to trade through a single pool for the ETH/USDC pair.
• In Uniswap V4, various ETH/USDC pools can exist, each with its own fee structure and liquidity strategy.
• This makes it difficult for users to find the pool with the best price and the deepest liquidity.

This problem reduces trading efficiency, making it difficult for users to make transactions that are large in scale or require high speed. To solve this problem, UniSwapX was born.

Instead of letting users find the best liquidity pool on their own, UniSwapX automates transaction routing by delegating the search for the best price to an open network of transaction executors (fillers).

UniSwapX works according to a multi-tiered model, consisting of the main components:

• Swapper (trader): Sends trading orders with off-chain digital signatures via Uniswap API (using Permit2 model, which makes moving assets safer).
• Filler (transaction executor): Develop a strategy to execute trades using any available sources of liquidity.
• Order Reactor: Validate and execute trades based on the strategy of the Fillers.

This process keeps UniSwapX from becoming dependent on a fixed routing mechanism, instead leveraging competition among Fillers to optimize transaction prices.

How UniSwapX works:

• Users simply come up with the desired result (intent-based design) without worrying about how the transaction will be executed.
• Networks of fillers compete with each other to offer the best prices using on-chain liquidity (AMM pools) or their own liquidity.
• Fillers act as smart liquidity providers, using advanced routing algorithms, high computing power, and large capital resources to ensure transactions are executed at the lowest cost.

Essentially, UniSwapX turns a complex trading process into an automated auction between liquidity providers, helping users get the best price without manual manipulation.

UniSwapX's intent-centric model offers many important benefits for both users and liquidity providers:

• Aggregate multiple sources of liquidity → Trading price optimization.
• No gas token required → Supports smooth cross-chain transactions.
• Limit MEV losses → Increase value for users by improving the trading price.
• No fees for failed transactions → Users do not lose gas when the transaction fails.

These benefits make UniSwapX not only an scalable solution for Uniswap V4, but could also become an important infrastructure for the decentralized trading ecosystem of the future.

Although UniSwapX brings many improvements, there are still some major challenges that need to be addressed:

How to make the quotation system (RFQ) completely decentralized?

• Currently, the quotation system still requires a pre-selected list of Fillers, which limits decentralization.
• The solution may be to develop a reputation system to select fillers automatically.

Attracting More Fillers to Participate to Stay Competitive?

• The more Fillers, the higher the liquidity and the better the price.
• To expand the Fillers network, UniSwapX may need stronger incentive mechanisms.

If these challenges can be addressed, UniSwapX has the potential to become a more powerful decentralized trading platform than current AMM models.

The Future of DEX

The development of the decentralized exchange (DEX) is gradually reshaping the way digital assets are traded without intermediaries. Smart ContractsThe current existence of DEXs is considered secure, ensuring that users always keep control of their assets rather than having to trust a third party. The decentralization of AMM also allows anyone to create and trade any asset pair without a license, opening up a more open and transparent financial market.

However, the technical characteristics of the blockchain still have major limitations, hindering the ability to guarantee the best price, fairness, processing speed and availability of transactions on the DEX:

• High gas fees: As network fees increase, transaction costs also increase, reducing the effectiveness of DEX.
• Stale prices: Because the blockchain has a delay in updating data, the transaction price may be outdated compared to the market.
• Fragmented liquidity: When there are too many individual DEXs and AMMs, liquidity is not concentrated but fragmented, reducing trading performance.

These factors significantly affect the trading experience, reducing DEX's scalability compared to centralized exchanges (CEX). What solutions can help overcome these problems?

Layer 2 (L2) and DEX on L2: Large-scale solution

One of the most strategic directions today to improve DEX performance is leveraging layer 2 (L2) such as Arbitrum, Optimism, and ZKSync.

• Reduced gas fees: L2 helps expand the Ethereum network, significantly reducing transaction costs.
• Increased processing speed: Transactions on L2 are much faster than on Ethereum mainnet.
• Improved user experience: The use of DEX on L2 becomes more accessible, especially for general users.

The explosion of L2s not only helped ease the burden on Ethereum, but also created a more efficient environment for DEXs to thrive.

Smart Routing Mechanism: Optimizing Trading Prices

One of the biggest challenges of DEX is the ability to route trades between different liquidity pools to find the best price. To solve this problem, smart routing mechanisms have appeared:

• Batching Order: Combines multiple transactions into one, which reduces fees and optimizes trading prices.
• Request-for-quotes (RFQ): Allows users to get competitive prices from various liquidity providers, making trading more efficient.

These mechanisms help DEX better compete with CEXs, providing higher liquidity and a smoother experience.

Anti-MEV and improved value equity

MEV is one of the most controversial issues in DeFi, as bots can take advantage of processing speed to manipulate prices.

• Order Flow Auction Markets: This is a solution that helps transfer value to users instead of letting MEV bots exploit.
• Anti-front-running strategies: Improvements such as “batch execution” reduce the negative impact of MEV transactions.

Reducing MEV not only protects users, but also makes DEX fairer, attracting more capital flows from traditional financial institutions.

Hooks & zk Coprocessors — The Future of AMM

Uniswap V4 introduces Hooks, which helps customize AMM features to suit each different liquidity model. This opens up more possibilities for flexible AMM design, such as:

• Dynamic Fees: Adjust fees based on market conditions.
• Advanced orders (TWAP, limit order, stop-loss,...): Expand trading patterns, making DEX stronger.
• MEV auction mechanism: Limit negative impact from front-running and sandwich attacks.

ZK Coprocessors (Zero-Knowledge Proofs) technology helps to perform complex calculations while preserving the transparency and security of the blockchain. This makes it possible for DEX to:

• Optimize the transaction routing process without increasing gas costs.
• Improves security when there is no need to disclose all transaction data.

The combination of Hooks and zk Coprocessors will make future AMM stronger, more efficient and more secure.

Money Lego - Build a Comprehensive DEX

In addition to improvements in AMM and routing mechanisms, there are many protocols built on AMM, which extend the functionality of DEX. Some important examples include:

• Liquidity Managers: Help users automatically manage and balance liquidity without manual manipulation.
• Margin Trading & Perpetuals: Use Concentrated Liquidity (CL) positions to create margin trading, perpetual contracts and complex financial products.
• Options & Structured Products: Build financial instruments such as options based on liquidity from AMM.

These protocols are creating a diverse decentralized financial ecosystem, making AMM not only a place to swap tokens but also a platform for more advanced types of transactions.

AMM — A game with no end!

AMM is not merely a decentralized transaction mechanism, but it also reshapes the entire way assets are exchanged on the blockchain. By eliminating intermediaries and traditional order books, AMM makes it possible for users to automatically trade directly on the chain, thereby minimizing the risk of manipulation and enhancing transparency. It is this that has helped the decentralized finance (DeFi) market flourish over the years.

However, the success of AMM does not mean that it has reached a perfect state. The essence of AMM is a never-ending game where every improvement opens up new challenges, forcing the ecosystem to constantly innovate.

Since its early days, AMM has undergone several generations of improvements, each of which solves a different set of problems:

• Uniswap V1 lays the foundation with Constant Product AMM, allowing decentralized trading to operate without the need for an order book.
• Uniswap V2 expands its reach with ERC20/ERC20 Pairing and Flash Swaps, which increases liquidity flexibility.
• Uniswap V3 offers Concentrated Liquidity, which optimizes capital efficiency but poses complex liquidity management problems.

While each version has made significant strides, they cannot radically address AMM's core limitations such as capital efficiency, transaction fees, fairness in trading (MEV), and fragmented liquidity.

Even with Uniswap V4, despite major improvements like Hooks, Singleton Pool, and Flash Accounting, it's not the ultimate solution. Issues that AMM must continue to face include:

• Imperfect capital performance: Despite the presence of Concentrated Liquidity, much of the liquidity has not been used effectively, especially with low-volatility asset pairs.
• MEV and Front-Running: Trading bots can take advantage of blockchain delays to profit from users, causing a loss of value for traders.
• Liquidity is fragmented between different pools: This makes it harder to find the best trading price, and increases the cost of slippage.

These challenges demonstrate that AMM has not yet reached its optimum point, and that further steps are needed to enhance the user experience as well as optimize the decentralized trading ecosystem.

Pioneering projects such as Uniswap, Curve, Balancer or new protocols such as Maverick, Ekubo Protocol, Ambient Finance are constantly testing new mechanisms to improve AMM performance.

As Dan Robinson said at SBC23, DEX design is a limitless game — a never-ending field that requires constant creativity and improvement. Those who stop will be left behind, and those who innovate will lead the game.

The future of AMM is still wide open, but one thing is certain: This game will never stop.