Uniswap is a decentralized cryptocurrency exchange and platform that launched in 2018. It enables developers, startups and entrepreneurs to build decentralized financial applications using its infrastructure. The protocol enables the creation of automated token exchanges based on Ethereum-based cryptocurrencies.
While it offers quick token swaps to the general user, Uniswap is not at all like most other crypto exchanges.
How is Uniswap different?
Uniswap helped solve a significant scaling challenge for decentralized exchanges: the lack of liquidity. Many newer tokens could not get traction and build liquidity without spending millions on exchange listing fees. By staking two Ethereum-based tokens (i.e. wBTC/ETH) and making trades in the automated exchange, users are rewarded for moving around tokens and have varying degrees of liquidity – thus giving newer (and any other) tokens liquidity with the need for a 3rd party.
In essence, Uniswap is more an infrastructure project rather than a crypto exchange. Developers can use the open source code and smart contracts to create trading apps, liquidity pools, and systems of decentralized governance (which are run using a governance token). All of these aspects of Uniswap are foundational elements of the DeFi industry.
Decentralized finance had a massive surge during 2020, with Uniswap and a few other protocols (i.e. Compound and Aave) at the very center of the action. By November 2020, Uniswap had a daily trade volume of $264 million and the value of Ethereum-based tokens locked into Uniswap liquidity pools soared to $3 billion.
Uniswap’s binary swapping interface for ERC-20 tokens requires no 3rd parties, no centralized governing entity, and no permissions to use it or build off it.
The simplest thing you can do in DeFi in general is to make a swap (or exchange) between two tokens. In Uniswap, the tokens must be ERC-20 tokens, which are issued off the Ethereum Blockchain. Uniswap has 40+ token pairs available for swapping.
No order book is required and this type of exchange format has helped make decentralized exchanges more user friendly as a result. Instead of a complex trading desk with charts and order books as you see in the DEXes of old and in traditional exchanges, Uniswap provides a super simple swapping interface. You merely choose the tokens you want to swap and the automated system does the rest.
The streamlined swapping feature benefits traders in multiple ways:
To engage in token swaps, you’ll need to:
Decentralized exchanges have for years suffered from the lack of liquidity. Uniswap developed a system of programmable liquidity, which uses smart contracts to allow users to lock in tokens while they earn extra tokens for making trades (swaps).
Each liquidity pool hosts a trading venue for one pair of ERC-20 tokens. When the smart contract for each pool is created, the balance of each token is zero. The first person to provide liquidity and make an initial deposit to each of the tokens in the pair sets the beginning price of the pool. Thereafter, liquidity providers add like amounts of both tokens into the pool.
Liquidity providers (LPs) on Uniswap (and other platforms that use Uniswap’s protocol) add an equal value of two ERC-20 tokens into a given pool in order to create a market. Then, they earn the pooled trading fees that happen within that pool. Token prices may vary after that, creating arbitrage opportunities. At each deposit of liquidity, new “liquidity tokens” are minted and sent to the LP’s wallet. The number of liquidity tokens received is determined by each user’s proportion of the pool’s liquidity.
Liquidity pools track liquidity reserves, which are automatically rebalanced and updated each time a trade is made within that pool. So each pool can be used for token swaps without any counterparty; there is no other side to the “trade” as it is all accomplished algorithmically with the locked token pairs.
A flash swap gives traders a way to get a hold of digital assets and use them somewhere else before returning or paying them back. With Uniswap’s advanced automated trading system, this can be done in one transaction, providing arbitrage opportunities for seasoned traders. One can view flash swaps as like a free loan, although there is the regular swap fee (0.03%). Paying back the flash swap (loan) can be accomplished using either one of the tokens in the swap pair.
Uniswap’s protocol has been used by many DeFi projects, such as SushiSwap, to build out decentralized applications (dApps). The features that are available to development teams include:
UNI tokens represent voting shares in Uniswap governance. UNI holders may vote on each proposal that is submitted to the autonomous organization, or they may delegate their votes to a third party.
60% of the original “Genesis” supply of 1 billion UNI tokens went directly to Uniswap community members (users). The remaining tokens, while they’ve been minted, will only become accessible over a 4-year scheduled allocation that also carries a 4-year vesting requirement.
The Importance of “Coomunity” in DeFi
Something that should be mentioned pertaining to decentralized platforms like Uniswap is that often customer support is happening live in community channels, namely Discord and Telegram. Community members are encouraged to help out newcomers, and relevant resources are usually pinned at the top of these channels.
Since Uniswap is community-run and its users earn much of the revenues from the swaps, they don’t seem to mind chipping in and sharing content about Uniswap, helping out newbies, and chiming in with their opinions. It’s a very different way of running a platform; something interesting to see. Check out their Discord channel.
Decentralized applications and protocols, while they may lack the normal centralized leadership and corporate organization, depend on their larger communities to step up and take active roles in the governance and promotion of the protocols. Since they are incentivized to do so, and helping out only makes the Uniswap more potentially successful, they are generally happy to be active within the community.
Since Uniswap is not a spot market and has no order book, they have a different system of fees:
With DeFi booming in 2020, and most of it happening on the Ethereum Blockchain, network congestion became a real problem and drove up the transactions costs, or gas fees, to the point where only large trades/swaps would make any sense. The Ethereum 2.0 scaling solution is under development and offers varying ways to mitigate the congestion issues.
You will need Ether (ETH) to get going on Uniswap and in order to pay the gas fees. Users generally use a browser wallet like MetaMask that connects to Uniswap whenever they activate the wallet. In MetaMask, ERC-20 (Ethereum derived) tokens can be transferred in and out from other Ethereum compatible wallets. The browser wallet is enabled when a user is on the Uniswap website and allows them to use these tokens to provide liquidity and make swaps.
Withdrawals work the same way as with Funding Options. When you are providing liquidity on the platform, your MeteMask tokens are held for that purpose – but users can back out at any time and reclaim their tokens (less gas fees). After that, any gains a user may have made can also be moved in and out of MetaMask to other wallets and exchanges.
Uniswap is an open source, decentralized protocol. No verification or KYC is required; you can sign up with just an email address to use the platform.
While the interface is sleek and dynamic, it most likely will be a very unfamiliar experience to traditional traders and newcomers to crypto markets. It’s not at all like any financial institution or traditional exchange; it’s really not like any other crypto exchanges either! That being said, users are cautioned to take their time, do their own research, and only play around with tokens they can afford to lose until they get the hang of it.
This is a decentralized protocol that essentially provides no customer support other than its ample documentation. It’s one of the reasons Uniswap is more for advanced traders. It requires users do their own research; they must RELY on their knowledge and research to successfully navigate the platform. If a problem occurs, the user may ask for help from the community in social platforms if available documentation does not suffice.
Uniswap was one of the top DeFi protocols during 2020 when the industry blossomed. By the end of that year, Uniswap had over 72,000 liquidity providers and had processed over 32 million trades. Additionally, over 200 other protocols and platforms were already integrated with Uniswap.
As far as reliability, decentralized protocols are highly complex, new, and risky. Even when Uniswap is well respected in the DeFi community, it doesn’t mean there won’t be future bugs in the code or some scammer won’t impersonate them and try to scam people out of their tokens. Users, especially crypto novices, should tread very carefully and research as much as possible before delving into DeFi protocols like Uniswap.
Uniswap has not been hacked per se, but SushiSwap created a copycat protocol in 2020, basically copying Uniswap’s code with a new platform and “stealing” liquidity from Uniswap’s pools into its own. It created a sensation and was followed by many other copycats.
Some nefarious developers engaged in “rug pulls” using Uniswap’s open source code. These rug pull scams happened when initial depositors (the developer) made big deposits into a new liquidity pool, attracting others to also deposit their ETH and the corresponding tokens. Then, due to a now fixed bug in the code, the initial depositor would withdraw all the tokens (including everyone’s ETH and the secondary tokens), crashing the secondary token price leaving the other LPs high and dry.
Regardless of copycats and scams, Uniswap has maintained a high level of liquidity as well as popularity among “degens”.
Uniswap provides cryptocurrency traders with a way to exchange many more tokens in a completely private fashion. When users interact with Uniswap by providing liquidity and receiving additional tokens in the liquidity pools, they can do all of this while still maintaining full ownership of their cryptocurrency tokens (remember, not your keys, not your coin).
Decentralized exchanges are now experiencing increased liquidity while offering their users permissionless trading and a high level of monetary security (through automation, blockchain technology and encryption).
Projects issuing brand new tokens no longer have to rely solely on paying millions to get listed on crypto exchange, as now they can get access to liquidity by using a Uniswap smart contract.
However, there are many risks and much of the activity on Uniswap is done by experienced traders who are able to capitalize on flash swaps and automated arbitrage trading. Additionally, due to its reliance on the Ethereum Blockchain (which is heavily congested) transactions are getting more expensive, to the point where only very large trades may be profitable.