Uniswap is a decentralized exchange (DEX) based on Ethereum that facilitates the exchange of ERC-20 tokens between traders. As Decentralized Finance (DeFi) continues to grow, so does the hype for Uniswap’s protocol, but not without reason. In comparison to other DEXs, Uniswap offers the easiest way for anyone to add or list tokens to earn rewards. Furthermore, peer-to-peer (P2P) transactions offer the convenience of executing any trades without the need for an intermediary.
Uniswap, a pioneer in DeFi, aims to revolutionize traditional DEXs with its automated liquidity protocol. Thus, Uniswap is able to facilitate token exchanges without relying on the conventional infrastructure of an order book method as well as curb liquidity issues at the same time.
What is Uniswap DEX on Ethereum?
UniSwap is an open-source protocol built on top of the Ethereum blockchain. It offers an elegant solution to simplify the process of ERC-20 token swaps without any centralized third parties. In other words, users can manage their funds without relying on centralized resources.
Lack of liquidity, such as insufficient funds passing through platforms, prevented these decentralized exchanges from gaining popularity among liquidity providers.
That being said, an order book is not used to determine prices on Uniswap. Rather, the protocol follows an equation, where the total liquidity within the pool stays constant. This model relies on liquidity providers creating a liquidity pool that sustains decentralized lending and trading. That includes listing and swapping ERC-20 tokens without an order book.
How Does Uniswap Work?
Uniswap was inspired by Vitalik Buterin’s concept of an on-chain automated market maker (AMM). Uniswap primarily leverages the Constant Product Market Maker Model, a type of Automated Market Making (AMM) system that sets up liquidity pools for traders to trade against.
Subsequently, in May 2020, Uniswap introduced the updated version— Uniswap V2, along with liquidity pools. Unlike its predecessor (V1), where users can swap between ETH and a single ERC-20 token, V2 uses Wrapped Ether (wETH) in core contracts where users can pool ERC-20 tokens directly with any other ERC-20 tokens. As a result, prices are more reliable and less susceptible to price manipulation.
But how does it work exactly?
Uniswap AMM Formula : Crypto DeFi Liquidity Pools (LPs) Explained
The liquidity pools are liquidity reserves locked in a smart contract, typically funded by liquidity providers. And stablecoins like USDT, DAI are the main constituent of the pool. Since Uniswap exists in a permissionless environment, and liquidity pools are the backbone for Uniswap, it is vital to comprehend its fundamentals.
Basically, anyone can be a liquidity provider (LP), and to be an LP, you need to deposit an equivalent value of ETH and ERC-20 tokens into the pool. One of these AMM features is you can provide liquidity regardless of the liquidity pool’s size. In exchange, you’ll earn a reward in the form of liquidity tokens according to your contribution to the pool. That also means the number of unique tokens you receive is proportional to the pool’s liquidity. These liquidity tokens are used to track your contribution to the pool, distribute your share of the transaction fees, and for multitude usage across DeFi apps (dApps).
In these liquidity pools, the total liquidity derived from the product of the two types of tokens always remains constant, following this simple equation X × Y = K, in which the total liquidity remains constant.
Let’s understand how this equation works using the ETH/USDT liquidity pool as an example. If a user buys ETH (x) from the ETH/USDT pool, the supply of USDT (y) will be more than the ETH after a transaction is made. When the ETH supply is lesser, naturally, there will be a price surge and vice versa. That is where the total liquidity (k) remains constant to determine the pricing. Generally, the larger the liquidity pool, the easier it is to process large orders. However, slippage does happen as the x and y’s ratios are not on a linear scale.
When comparing Uniswap to centralized exchanges, there are no listing fees for verifications on Uniswap. Hence, Uniswap quickly became one of the most popular protocols for swapping tokens. Interestingly, Uniswap took off even when Ethereum was still struggling with scalability issues during the Proof of Work consensus.
The Retrospective Of Uniswap
In 2016, Ethereum’s creator Vitalik Buterin proposed to create a decentralized exchange combined with an “on-chain automated market maker.” In his post on Reddit, he also shared some technical details of how this could be achieved.
Hayden Adams, a former mechanical engineer at Siemens, picked up that idea and started developing a fully-functional platform— Uniswap. Soon after he pitched the idea, the project received some grants and $100,000 from the Ethereum Foundation. Shortly after, the first version was officially launched in Nov 2018. Subsequently, in April 2019, Paradigm (a digital asset investment company) contributed $1million for the further development of Uniswap.
In 2019, Uniswap was crowned the ‘King of DEXs’ and the largest by volume. After Uniswap V2 was launched in May 2020 together with the boost of DeFi, the number of transactions in the Ethereum network quickly rose to the level of the previous peak in 2017.
Uniswap vs. SushiSwap
A few months after its launch, UniSwap exceeded some of the top centralized exchanges by daily trading volume. The use of smart contracts and making money through yield farming or liquidity mining are welcomed by users. Investors, however, quickly realized that they did not have full control over their investments. Developers recognized this opportunity, and were quick to launch SushiSwap (a fork of Uniswap) to address the issue. SushiSwap aims to compete head-to-head with Uniswap by offering an additional liquidity mining reward and launching its native token as an incentive for LPs.
Many believe the SushiSwap’s project was meant to be a vampire attack that causes Uniswap to cease its yield-farming incentive program. As a result, Uniswap’s total value locked (TVL) plummeted by more than $1billion, while SushiSwap benefited from one’s misery. However, on 16 Sep, Uniswap launched its UNI token with a significant bounce in TVL whereas, SushiSwap suffered a drastic decline in TVL. While this rivalry is intense, these occurrences don’t seem to jeopardize Uniswap’s position. In fact, Uniswap remains a famous DEX with almost $4.5billion TVL in late March 2021.
How Does Uniswap Make Money?
Uniswap doesn’t make any profits from end-users fees, trades, or any other means that are usually applied in the world of blockchain technologies. The fees users pay are a reward for liquidity providers.
These liquidity providers receive 0.3% of all transaction fees taken by the pool contract on a transaction. However, the free is calculated proportionally to the contribution of each provider. For example, if a provider contributes 10% to the DAI/ETH pool’s liquidity, the provider earns 10% of the collected fees.
Being a liquidity provider, you can either add these fees back to the pool to increase your future profits or withdraw your current earnings at any time.
What Is Uniswap (UNI) Token Used For?
In September 2020, Uniswap released its governance token, UNI. The main goal is to further increase the protocol’s decentralization by offering end-users more governance and ownership rights. The UNI token’s primary purpose is to allow holders to vote for different proposals and enhancements to further improve the platform’s development. Not only does it increase the public confidence in the Uniswap protocol, but it also provides a better safeguarding concept to the users’ treasury.
The release was accompanied by a generous airdropAn airdrop is a marketing stunt, in which tokens or coins are sent out to blockchain wallets. Most commonly, it is done … of UNI tokens, which covered around 50,000 Ethereum addresses. Past users of the protocol were eligible to claim 400 UNI, which was equivalent to approximately $1,200 on that date. A few days later, UNI’s price soared up to $8 while the airdropped amount could be exchanged for $3,200.
There are a total of 1 billion UNI tokens in the network. Uniswap community members received 60% of all the UNI tokens. On the contrary, past users will receive 25% of this portion (equivalent to 15% of the total). The Uniswap team and employees, advisors, and investors will receive the remaining 40% of the UNI tokens over the next four years.
To gain a reward, community members should provide liquidity to one of the following pools: USDT, USDC, DAI, and WBTC, each of these coins paired with ETH.
Users can claim their reward at app.uniswap.org by connecting the wallets that they used with Uniswap in the past.
Is Uniswap Safe?
Despite its outstanding contribution to the DeFi ecosystem, Uniswap does come with some security flaws. After the launch of Uniswap V2, members of the community actively tested the protocol. Two months later, in July 2020, complaints about fake tokens started to emerge.
Since there was no pre-moderation for token listing, scammers took advantage of this loophole to distribute tokens similar to those released by popular DeFi products. They deceived users by making them buy these worthless coins. Unfortunately, there’s no information on how much money has been lost through these scams. However, there were several reports and announcements about these frauds.
In August 2020, Uniswap introduced a new platform (Token Lists) to resolve this problem. This community-led decentralized initiative serves to ensure the legitimacy of newly listed tokens. And the more authoritative platforms, such as CoinMarketCap and Coingecko, listed a token, the better it is. Ultimately, the token ranks higher, together with its trust score. Token issuers can apply for Token Listing rights through Uniswap’s interface. Lower-ranking tokens will serve as a stop-factor, warning users against potential fraud to their treasury.
How To Swap Tokens Using Uniswap?
The process of token swap on Uniswap is pretty straightforward. To convert one ERC-20 token to the other, you will need an Ethereum wallet and access to the internet. As Uniswap is an open-source protocol, anyone can use its code to implement it in a self-made application. Alternatively, you can access it via Uniswap’s native app.
Here’s a step-by-step guide on how the token swap can be accomplished on Uniswap:
- Open Uniswap’s application.
- Connect your ERC 20-compatible wallets, such as Metamask, Trust Wallet, or a hardware wallet such as Trezor or Ledger Nano S.
- Select the pair of tokens you want to exchange to and from, and click “Swap.”
- In the pop-up window, review the transaction details and confirm the request in your wallet.
- You can monitor the transaction status on Etherscan while waiting for the confirmation.
Uniswap Worth Investing In 2022?
The Uniswap team has created a solution that the cryptocurrency community has been long waiting for. Furthermore, being an automated liquidity protocol, coupled with a unique governance system through UNI tokens for ownership, users are more confident, hence, elevating their usage to a new level. With Uniswap, swapping Ethereum-based tokens has become easy and effortless.
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Author
Chris Munch is a professional cryptocurrency and blockchain writer with a background in software businesses, and has been involved in marketing within the cryptocurrency space. With a passion for innovation, Chris brings a unique and insightful perspective to the world of crypto and blockchain. Chris has a deep understanding of the economic, psychological, marketing and financial forces that drive the crypto market, and has made a number of accurate calls of major shifts in market trends. He is constantly researching and studying the latest trends and technologies, ensuring that he is always up-to-date on the latest developments in the industry. Chris’ writing is characterized by his ability to explain complex concepts in a clear and concise manner, making it accessible to a wide audience of readers.
