Half of Uniswap V3 Liquidity Providers Underperform Holding: Bancor Study

Key Takeaways

According to a new study, approximately half of Uniswap liquidity providers underperformed a basic buy-and-hold strategy.
In one pool, the number of liquidity providers suffering negative returns was as high as 74%.
The study raises questions about the efficacy of constant function-based decentralized exchanges and concentrated liquidity mechanisms.

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A Bancor-backed study has found that as many as half of Uniswap V3 liquidity providers are suffering negative returns. 

Study Investigates Uniswap Liquidity Provision

Liquidity providers on decentralized exchanges may be getting a bad deal despite high yield rates.  

A new study conducted in collaboration between Topaze Blue and Bancor has found that approximately half of the liquidity providers on Uniswap V3 yielded negative returns compared to just holding assets. Bancor was Ethereum’s earliest automated market maker. It’s a competitor to Uniswap, one of the DeFi ecosystem’s most popular decentralized exchanges. Topaze Blue, meanwhile, is a boutique advisory firm specializing in the crypto and fintech sectors. 

The study analyzed more than 17,000 wallets providing liquidity across 17 Uniswap V3 pools, which accounted for 43% of the exchange’s total value locked. It found that, while the pools generated $199 million in fee income during the sample period of five months, they incurred over $260 million in impermanent loss, leaving 49.5% of the liquidity providers with negative returns. 

Impermanent loss describes the difference in value between depositing assets in dual token liquidity pools or simply holding the same assets. It refers to the value liquidity providers would have had if they passively held onto their assets instead of providing liquidity. The study found that the number of liquidity providers underperforming a buy-and-hold strategy exceeded 50% in multiple pools, including MATIC/ETH (51%), COMP/ETH (59%), USDC/ETH (62%), and MKR/ETH (74%). 

Interestingly, the researchers also found no difference in profitability between “active” liquidity providers who managed or adjusted their positions more frequently and “passive” users who didn’t.

The only group that consistently outperformed a basic buy-and-hold strategy were so-called “just-in-time” liquidity providers who provide liquidity for a single block to absorb the fees and instantly remove their position. These are more sophisticated market makers who leverage automated bots to provide liquidity and represent a tiny fraction of the broader user base.

Commenting on the findings, the authors of the study said:

“Our core finding is that overall, and for almost all analyzed pools, impermanent loss surpasses the fees earned during this period. Importantly, this conclusion appears broadly applicable; we have collected evidence that suggests both inexperienced retail users and sophisticated professionals struggle to turn a profit under this model.”

Uniswap launched its V3 update in May, introducing a pioneering “concentrated liquidity” feature that allows liquidity providers to select the price range they provide liquidity for. Uniswap Labs, the team behind the project, sparked controversy in the DeFi community by protecting the update with a business source license. Several other decentralized exchanges including Curve Finance and Sushi’s upcoming Trident project have adopted their own takes on concentrated liquidity since Uniswap V3 shipped.

The study’s findings raise questions about the efficacy of constant function-based decentralized exchanges and concentrated liquidity features like those Uniswap V3 pioneered. As the DeFi market matures and ever more liquidity providers realize the dangers of impermanent loss, liquidity on decentralized exchanges could dry up, leading to higher slippage and significantly reduced efficiency and usage.

Disclosure: At the time of writing, the author of this feature owned ETH, SUSHI, and several other cryptocurrencies.

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