With the rise and evolution of the DeFi ecosystem that started approximately during the last quarter of 2020 and might go on for the next 2-3 years, it would not be incorrect to say that Decentralized Exchanges (DEX) are the significant component that fuelled this ecstatic growth.
A crypto exchange that is decentralized and does not have custody of your private keys has brought a crucial utility case to the whole crypto ecosystem. A crypto investor can have better faith in a decentralized ecosystem compared to a centralized one (such as Binance Exchange, FTX Exchange, etc.) which is prone to frequent hacks and thefts.
Today, I have decided to discuss one of the most extensive Decentralized Exchanges (DEX) of the DeFi sector, i.e., Uniswap.
Uniswap is a DEX built to prioritize censorship resistance, security, self-custody, and function without any trusted intermediaries who may seek to collect fees or selectively restrict access.
Basis DeFi Pulse as of May 4, 2021, Uniswap has a Total Locked Value (TVL) of USD 7.36 Billion on the platform.
Uniswap is a simple, smart-contract-based protocol developed on the Ethereum network that can be used to swap ERC20 tokens. There is no intermediary authority to regulate a transaction, just a combination of a code that executes the transaction, a liquidity pool that provides liquidity, and an Ethereum network that records the transaction.
Now, let us understand the founder’s background to know how the idea was incubated and developed.
Hayden Adams – Twitter
Adams graduated from Stony Brook University in New York in 2016. Post-graduation, Adams joined Siemens as a car engineer. Fortunately, Adams was laid off by Siemens after a year.
In 2017, Adam moved in with his parents and started learning to code. Adams was inspired by a post shared by Vitalik Buterin (founder of the Ethereum network) in 2016, which he read in 2017. Shortly, Adams was introduced to the concept of Automated Market Making and started building something of his own. Adams received a grant of USD 65,000 from the Ethereum Foundation, which further helped him develop the project. Finally, Uniswap V1 was launched in November 2018.
From USD 65,000 grant, Uniswap today stands at a market value of above USD 22 Billion.
Trading on centralized exchange is based on the order book model. In this mechanism, buyers and sellers place their bids. A transaction happens when both a buyer and a seller converge on a special price. But there can be a situation where buyers and sellers do not want to agree on a particular price. Further, there can be a situation where there is not enough buying order or selling order in the market to fulfil a counter order. This is where Market Makers come into the picture. Market Makers are the entities that are always willing to buy or sell an asset. By this, they provide liquidity to the platform. This mechanism keeps transactions going on a centralized exchange.
As an alternative to Market Makers, Uniswap has an automated Liquidity Pool where anyone can become a Market Maker by providing liquidity to the Liquidity Pool. Further, it uses Automated Market Maker (AMM) protocol that relies on a mathematical formula to price the assets.
Please note that the transaction on a DEX is not between 2 persons but between a person and the smart contract. Thus, it can also be better termed as a P2C (Person-to-contract) platform.
Any ERC 20 token can be listed on Uniswap, and the token would have its smart contract and liquidity pool. Once a token is listed, it can be traded or provided for liquidity in the available liquidity pool. As the pricing mechanism is based on a mathematical formula, there can be a possibility of arbitrage gain in a short run. However, with increased adoption of the platform, the prices get in line with the price on a centralized exchange.
Each Uniswap smart contract has a liquidity pool with reserves of both the ERC 20 tokens of that pair. For example, WBTC/ETH will have a liquidity pool with reserves of WBTC and ETH tokens.
As we now understand how Uniswap works as a DEX, let us know its features in detail.
The features of Uniswap can be listed as follows:
Any ERC 20 token can be easily swapped with this feature for another ERC 20 token. Input token is the token that you have in your wallet and want to exchange. An output token is the token that you want to have by exchanging the input token.
You have to input the number of input tokens you want to swap, and the AMM (Automated Market Maker) protocol would calculate the value of the output token that you would get from the transaction.
Once you initiate a swap transaction, the input token goes from your wallet to the respective liquidity pool, and the output token goes from the liquidity pool to your wallet.
As already discussed above, every pair has its Liquidity Pool. The person who provides liquidity is known as the Liquidity Provider. Liquidity Providers are incentivized to deposit these tokens to the pool.
All trades on Uniswap are subject to a fee of 0.3% of the transaction value. The fee collected by Uniswap for trades executed from a particular Liquidity Pool is distributed proportionally to the Liquidity Providers. Currently, Uniswap does not keep any share of the fee collected. However, in the future, it may keep 1/6th share of the fee collected as Liquidity Provider fees.
Anytime you provide liquidity to a particular pool, a new token known as Liquidity Token is minted and sent to your wallet. It is like a receipt of assets provided to a specific Liquidity Pool.
This feature allows you to take any ERC 20 token as a loan without any collateral with the condition that you either pay for the withdrawn tokens or deposit an equal number of tokens withdrawn by the end of the transaction.
This feature can be used to have arbitrage gain when there is a difference in the price of 2 exchanges.
You can read more on the Flash Swaps here.
Oracles help a platform to incorporate off-chain data on a smart contract. For example, to determine the asset’s price being swapped, the smart-contract needs price information from outside the platform. This is where oracle comes into use.
Uniswap v2 uses a decentralized on-chain price oracle. Uniswap v3 has made substantial upgrades in the price oracles.
The cost of transaction on Uniswap is as follows:
|Type of Cost||Description|
|Protocol Fee||Uniswap does not charge any fee for the protocol.|
|Liquidity provider Fees||0.3% of the transaction value|
|Price Slippage||There can be a difference in price at the time of placement and execution of a swap.|
|Ethereum network gas fees||Every transaction on the Ethereum network is subject to a gas fee which is paid to the transaction validators.|
The list of wallets supported by Uniswap is as follows:
Uniswap ensures complete user anonymity. No user information is required to transact on Uniswap can further mean as follows:
This allows you to keep your identity anonymous.
The user interface of Uniswap is the Unique Selling Point of the platform. It has one of the most user-friendly interfaces I have come across. A user can connect with Uniswap either through the web app or through the respective mobile wallet app mentioned above.
However, the user interface does not provide price charts like centralized exchanges such as Binance Exchange and FTX Exchange.
Uniswap team has recently announced that they will be launching an upgrade on the platform known as Uniswap v3. The target date of the launch is May 5 2021.
The upgrade would result in:
Read more about the Uniswap v3 upgrade here.
Now, as we know the features that Uniswap offers, let us understand how you can use Uniswap.
Watch this video to know how to use Uniswap.
UNI is the in-house governance token of the Uniswap platform used to govern and upgrade the protocol. In other words, the UNI token allows to propose, vote, and implement changes on the Uniswap platform. The platform is decentralized and is governed by the community through UNI tokens.
The circulating supply of UNI token is 519.8 million (52% of maximum supply) with a maximum supply of 1 Billion. Further, the market cap of the platform is USD 22.90 Billion. The market cap of UNI is 23% of the market cap of BNB, the in-house token of Binance Exchange (market cap USD 93.75 Billion).
You can buy UNI token from these exchanges:
Now let us understand the pros and cons of the Uniswap platform
The benefits of Uniswap Exchange can be listed as follows:
However, there are some limitations as well.
The limitations of Uniswap Exchange can be listed as follows:
In my understanding, Uniswap has proved itself to be the Big Bull of the DeFi space. The exchange is simple, functional, and addresses several security and privacy issues of its users. Moreover, the v3 upgrade would change the game for the platform and licensing would restrict it from copycats who might copy the same code on their platform.
This would mean a far better adoption of the platform, leading to an upside of UNI token.
Please note that I am not a financial advisor, and this is not financial advice. DYOR before investing.
I hope this article would provide you a good insight into the DEXs and Uniswap. Let me know the DeFi projects that you would like me to review.
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