How will ERC-3525 improve the Uniswap v3 LP model?
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How will ERC-3525 improve the Uniswap v3 LP model?
Currently, DeFi has entered a stage of more complex and multi-dimensional financial product design and implementation, and models similar to differentiated position management will emerge one after another.
Navigating Web3 tides with focused insightsAuthors: Will Wang, Ethan Tsai
Will Wang, Co-founder of Solv Protocol and proposer of the ERC-3525 standard
Ethan Tsai, Core technical team member of Solv Protocol and one of the core contributors to ERC-3525
Preface: This article was written on March 23, 2021—the day after Uniswap launched its v3 upgrade.
At that time, the Solv team was submitting the ERC-3525 standard draft to the Ethereum community. Upon seeing Uniswap’s v3 LP design, we were excited that our shared vision of "applying NFTs to financial applications" aligned with an industry leader. We also believed that the ERC-3525 standard we were developing could significantly improve v3—particularly by enhancing liquidity and management capabilities for LPs.
This article explores how Uniswap v3’s range-based market making works, analyzes its inherent limitations, and presents solutions based on ERC-3525 to overcome these key obstacles.
Over a year later, ERC-3525 has become an official Ethereum standard. We believe the improvement proposals outlined here remain valuable, so we are republishing this article.
As the original article was published earlier, some technical content differs slightly from the finalized ERC-3525 standard. This is noted for clarity.
I. Background
Uniswap V3 introduced differentiated position management for market makers, allowing them to allocate varying amounts of capital across different price ranges. When the trading price falls within a specified range, the corresponding portion of capital participates in market making; otherwise, it remains inactive. This is a powerful innovation with significant value and implementation details, which we won’t delve into here. Instead, we focus on one specific aspect: the management mechanism of positions—specifically, the technical implementation of Uniswap V3 LP tokens.
As widely known, Uniswap V2 LPs are ERC-20 tokens. Since V2 does not support range-based position management, each LP token effectively represents a position spanning the full price range. Furthermore, because all positions are uniform, the liquidity pool and LP tokens are inherently unified—a model adopted by most DeFi protocols today.
Due to the limitations of the ERC-20 model, implementing differentiated position management would require creating a separate ERC-20 contract for each unique position—an impractical and costly approach that fails to leverage the liquidity benefits of ERC-20 assets. Additionally, since differentiated positions must still contribute to a shared liquidity pool, the tight integration between LP tokens and the pool becomes less straightforward. To address both issues, Uniswap V3 chose to represent position management tokens as ERC-721s and separated the pool into its own dedicated contract.
II. The Value of Underlying Asset Tokenization
Is Uniswap V3’s solution for position management optimal? To answer this, we must first revisit the core value of the prevailing DeFi paradigm: “tokenization of underlying assets.”
Underlying asset tokenization refers to models where depositing assets into a DeFi protocol results in receiving a token issued by the same contract—this token serves as proof of ownership. This approach has become dominant primarily because it creates a “two-layer asset” structure, decoupling the underlying assets from their tokenized representations, thereby delivering two key advantages:
First, tokenization generates a new derivative asset that greatly enhances the liquidity of the underlying assets. For example, cTokens from Compound or LP tokens from Uniswap V2 derive intrinsic value through their quantifiable relationship with the base assets. These tokens now trade and can be used as collateral across numerous platforms, significantly increasing user asset liquidity.
Second, the separation allows independent handling of the two layers, simplifying asset management for protocols and improving stability of the underlying asset pool. When users want to sell, pledge, or transfer their holdings, they can do so using standard token operations without requiring custom functionality from the pool protocol. Ownership transfers occur via token movement rather than withdrawing and redepositing base assets, preserving the size and stability of the liquidity pool.
The entire DeFi ecosystem's "Lego-like" composability owes much of its power to these two capabilities. Therefore, any DeFi protocol’s asset management architecture—especially its tokenization method—should prioritize maximizing these two values. Efforts toward achieving this goal are well justified.
III. Problems with Uniswap V3 Position LPs
Revisiting Uniswap V3’s LP solution reveals a clear issue: while the use of standard ERC-721 enables differentiated positions, it fails to fully preserve the two core values discussed above. We illustrate this with two scenarios:
Position Modification
Uniswap V3 allows modifying the price range of a position—an essential feature. However, users may desire more granular adjustments. For instance, suppose a user allocates $1 million to an ETH-USDC pair within the 1500–2000 price range and later decides to move $300,000 of that capital to the 1000–1200 range in anticipation of a price drop. In the current V3 implementation, the only option is to withdraw $300,000 from the existing position and create a new one. This contradicts our earlier goal of minimizing direct withdrawals of underlying assets to maintain pool stability.
Asset Liquidity
As previously noted, Uniswap V2 LP tokens have gained broad recognition as valuable assets. V3 LPs will likely follow suit, leading to growing demand for staking, trading, and other uses. However, due to ERC-721’s constraints, such flexibility is difficult to achieve. Consider two platforms offering V3 LP staking services. A user unsure which offers better returns might wish to stake 50% of their assets in each. While trivial under ERC-20, this is impossible today. Would the user need to create two identical-range LP positions just to split exposure?
Uniswap’s proposed workaround involves external or third-party re-fungibility schemes (e.g., wrapping ERC-721s into ERC-20s), but this is far from ideal. Issuing a separate ERC-20 for each ERC-721 ID leads to catastrophic contract fragmentation, complicating integration for platforms accepting LP tokens. Alternatively, bundling multiple IDs together increases user management complexity and introduces challenges in pricing determination. Those familiar with re-fungibility mechanisms in the NFT space understand that such approaches struggle with highly complex financial instruments like position LPs.
In sum, standard ERC-721-based LPs fall short in replicating the management flexibility and liquidity characteristics of ERC-20 LPs—precisely the features that constitute the core value of LP tokens. If Uniswap V3 relies solely on this model, it risks hindering the nascent LP asset market.
IV. Solution
Our ability to quickly analyze these issues stems from prior experience solving similar problems in designing fixed-term lending products in credit markets and time-locked vesting products in investment platforms. We developed solutions superior to standard ERC-721, and we believe this same framework applies effectively to Uniswap V3 LPs, granting them improved liquidity and manageability.
The answer lies in a novel asset protocol we call SFT (Semi-Fungible Token)—a collective term for a suite of interfaces detailed incrementally in future releases. In simple terms, an SFT is a quantity-aware NFT capable of splitting, merging, and partial transfers. To better support the “two-layer asset” model, SFT includes native support for describing underlying assets at the protocol level, enabling standardized implementation. Moreover, to ensure seamless interoperability with existing DeFi infrastructure, SFT maintains compatibility with ERC-721—meaning any protocol supporting ERC-721 can treat SFTs as standard NFTs.
Technically, the protocol includes the following interfaces (partial list):
function safeTransferUnitsFrom(address from, address to, uint256 tokenId, uint256 targetTokenId, uint256 transferUnits) external;
function split(uint256 tokenId, uint256 newTokenId, uint256 units) external;
function merge(uint256 tokenId, uint256 targetTokenId) external;
function approveUnits(address to, uint256 tokenId, uint256 units) external ;
Here, “units” represent the quantity contained within an NFT.
Flexible Asset Management
By introducing quantity attributes along with split, merge, and partial transfer capabilities, SFT resolves the aforementioned issues with Uniswap V3 LPs. For example, when shifting part of a position to a new price range, you simply split the existing LP token by amount, then modify the price range of one portion—no withdrawal required. Transfers, trades, and staking can be similarly handled. Since LP quantities directly correspond to underlying assets, LP pricing remains transparent and calculable, eliminating the need for wrapper protocols or ERC-20 conversions. Both users and DeFi protocols gain near-ERC-20 levels of operational ease.
Integration of LP and Pool
Furthermore, thanks to SFT’s built-in support for describing underlying assets, the mapping between tokens and base assets becomes as flexible as in ERC-20 systems. This enables Uniswap V3 to easily reintegrate LP tokens with the pool contract, reverting to the simple and clean “two-layer asset” model used in V2 and most current DeFi protocols.
From Uniswap’s perspective as a DEX, this integration isn’t mandatory—the V3 documentation explicitly states that separating LP and pool contracts was intentional. Nevertheless, we believe the consistency in handling dual-layer assets offered by integration plays a crucial role in enhancing LP liquidity and reducing trust friction, making it a compelling alternative worth serious consideration.
Of course, realizing this integrated model involves additional considerations—for instance, whether the larger ERC-721 base contract exceeds the EIP-170 size limit. These are practical challenges we’ve already addressed in real-world implementations and believe solvable at the technical level.
V. Conclusion
In summary, we conclude that DeFi has entered a phase of increasingly sophisticated, multi-dimensional financial product design. Models like differentiated position management will continue to emerge.
To preserve the liquidity and manageability of LP-type assets in this evolving landscape, adopting a new class of asset protocols is both necessary and worthwhile. SFT represents our solution to meet these objectives.
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