Try Quests to earn cryptoProviding liquidity has long been a popular method for earning yield in the crypto space. However, the profitability of being a liquidity provider remains uncertain for many users, with impermanent loss being one of the most well-known risks. Beyond impermanent loss, there is another risk known as Loss-Versus-Rebalancing (LVR).
In this research, we will address key issues related to LVR on Uniswap V3, including:
Quantifying LVR on Uniswap V3 by LP position and pool
Assessing the impact of concentrated liquidity price range on Uniswap V3
Comparing LVR between Uniswap V3 and V2
Assessing the total addressable market (TAM) for LVR in Uniswap V3
Key Highlights
- Higher LVR in Uniswap V3: Uniswap V3 incurs a significantly higher LVR compared to Uniswap V2.
- Price Range and LVR Relationship: Liquidity positions with a wider price range consistently experience the highest LVR, followed by moderate and then narrow price ranges.
- Zero LVR Outside Price Range: LVR is zero whenever the token price moves outside the liquidity position's specified price range.
- In Uniswap V3, the LVR percentage for wide price range positions can reach approximately 36% of the total deposited amount after just a month active within the price range. This indicates a potential risk for liquidity providers. In contrast, moderate price range positions incurred around 6% LVR from August 19th to September 1st, while narrow price range positions saw a much smaller LVR of only 1.5%.
- In Uniswap V2, the incurred LVR never exceeds 1%.
Discussion
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Why is the LVR higher in Uniswap V3 compared to Uniswap V2?
The main reason lies in the concentrated liquidity model of Uniswap V3. Unlike Uniswap V2, which uses an infinite price range, Uniswap V3 requires liquidity providers to define a finite price range for their positions. This concentrated liquidity leads to more significant volatility in the token composition within the liquidity pool.
For example, in Uniswap V3, when a token's price moves outside of the specified range, the position can be entirely rebalanced to 0 for that token. In contrast, Uniswap V2's infinite price range prevents such aggressive rebalancing, so tokens rarely reach zero. This aggressive change in token allocation increases the value of the
avariable in the LVR formula,a(p-q), leading to a consistently higher LVR in Uniswap V3 compared to Uniswap V2.