Review: Uniswap Exchange
Uniswap exchange is a decentralized finance protocol used to exchange cryptocurrencies. It runs on the Ethereum blockchain. Through smart contracts, the Uniswap protocol also eases the automated transactions between tokens on the Ethereum blockchain. The company that designed the Uniswap protocol is called Uniswap and has a unicorn logo.
Most crypto trading takes place on centralized exchanges like Binance and Coinbase. According to daily trade volume as of October 2020, Uniswap was ranked as the fourth-largest cryptocurrency exchange and the most prominent decentralized exchange. As of March 2021, Uniswap was generating over two to three million US dollars in 24 hours from the liquidity providers who ease the liquidity market for the traded cryptocurrencies.
Centralized exchange platforms are governed by the company that operates the exchange. Users place their funds under the company’s control and facilitate trading using a traditional order book system.
On Uniswap, traders can exchange tokens without having to trust anyone with their funds.
However, liquidity has always been a source of concern for the platform. This relates to the number of orders and the depth of order on the book at a particular time. Low liquidity delays in the platform affect both the buying and selling of cryptocurrencies.
What Is Uniswap?
Uniswap is open-source software that lets anybody access it and create their decentralized exchange on it. Furthermore, it allows users to list tokens on the exchange for free. It is unique because typical centralized networks are profit-driven and charge heavily to list new coins. You might wonder how trade happens without an order book; well, Uniswap does this by using a criterion that involves creating liquidity pools created by liquidity providers.
Uniswap is a unique Decentralized exchange protocol (DEX) that is controlled by an entity. It uses a particular type of trading model known as automated liquidity protocol. No order book is required to make a trade on the Uniswap protocol.
With an increased level of Censorship-resistance and decentralization, Uniswap enables users to deal without mediators.
In 2018, Hayden Adams created the Uniswap protocol on the Ethereum blockchain. At the same time, the fundamental technology that prompted its performance was first illustrated by Vitalik Buterin, the co-founder of Ethereum.
History of Uniswap
Uniswap was an idea suggested in 2016 by Vitalik Buterin for a decentralized exchange (DEX) that would employ an on-chain automated market maker with specific unique characteristics. A year later, Hayden Adams began working on turning this idea into a functional product. After receiving several grants and a hundred thousand dollars from the Ethereum Foundation, he launched Uniswap in November 2018. The protocol quickly gained liquidity and started facilitating meaningful volume barely six months after it was launched.
Uniswap is unique because it solves the problem of high spreads for illiquid assets on order-book exchanges. This problem exists because there is little incentive for professional market makers to provide liquidity on every traded asset. However, with Uniswap, anyone can be a market maker by depositing assets into a pool and earning fees based on the amount of trading activity. One downside to this model is substantial slippage for large orders as the price paid increases as the quantity demanded increases.
How Uniswap Works
Uniswap uses intelligent contracts such as ‘Exchange contracts’ and ‘factory contracts’ to work. The automatic computer programs are designed to perform functions when certain conditions are met. Exchange smart contracts facilitate all token trades or swaps, while factory smart contracts are used to add new tokens to the platform. The exchanger is an improvement on the traditional architecture digital exchange. It works with a variant of a model called the Automated Market Maker(AMM). Its design model is known as a Constant Product Market maker.
However, the automated market makers hold the liquidity pools that traders can read against. Liquidity pools are funded by liquidity providers — anyone who deposits money equivalent to the value of two tokens in the pool.
As a return, liquidity providers get paid by the traders’ fee, distributed among providers according to their deposit in the pool.
Now, how does this work?
A market is created when a liquidity provider deposits an equivalent value of two tokens. It could be either two ERC-20 tokens or ETH and one ERC-20 token.
Nonetheless, pools are typically made up of stable coins like USDT, USDC, or DIA, though this is not mandatory. Liquidity providers then get “liquidity tokens” as a return, and these are distributed according to their share of the whole liquidity pool. Users can redeem shared liquidity for the claim they denote in the collection.
For example, let’s consider the ETH/USDC liquidity pool. Assuming we call the ETH portion of the pool p and the USDC potion q. Uniswap multiplies the two quantities to get the total liquidity in the pool. We can call this result k. The significance behind this impression is that k must be constant. This means the total liquidity in the collection is stable. Therefore, the formula for total liquidity is:
p * q = k
Now, this is what happens when someone wants to trade
Let’s assume John buys 1 BTC for 500 USDC using the ETH/USDC liquidity pool. In this regard, he expands the USDC portion of the collection and reduces the ETH portion. John’s action effectively inflates the price of ETH. Why? Since there is a lesser amount of ETH in the pool after the transaction, and as we know, the total liquidity (k) must remain constant. They determine the pricing. Sometimes, the price paid for ETH depends on how frequently a given trade shifts the ratio between p and q.
Although, this model may not scale linearly. An outcome, an increase in order, leads to a rise in the shift balance between p and q. It means that larger orders become costlier than small orders, steering at a more considerable amount of slippage. It also implies that it is simpler to process big orders in a big liquidity pool. This is because the shift between p and q will be minor.
Over the years, there has been some variation in the Uniswap technology. So, people who have used Uniswap v2 earlier have a series of complaints. Nonetheless, there have been some new modifications in the pipeline. Here are some effective updates attracted to Uniswap v3.
Uniswap v3 has significant improvements on its capital efficiency since most Automated Market Makers (AMMs) have capital inefficiency. It is because of the characteristics of the p*q=k model we talked about earlier. In summary, an increase in the liquidity in the pool creates a larger order that the system can support in a more significant price range.
Moreover, liquidity providers allot liquidity for a price range between zero and infinity. Every capital is reserved for a scenario when one of the assets in the pool is 100x-s, 10x-s, or 5x-s.
So, if the need arises, such as a scenario where there is no liquidity in the pool, the available assets secure the remaining liquidity and prevent the exchange from going bankrupt.
Also, it can mean that a small fraction of the liquidity sits where maximum trading occurs.
For instance, currently, about five billion dollars of liquidity is locked on Uniswap. Also, it does approximately one billion of volume per day. It might not be a formal way of doing things, but the Uniswap team agreed to this. So, Uniswap v3 addressed this problem.
Uniswap LP tokens as NFTs
Uniswap’s LP token is unique because each depositor can set their price range. Each LP position is a non-fungible token (NFT). Earlier, someone could use the Uniswap LP position in other parts of DeFi; this is one of the benefits. It is no longer possible with v3 because each situation is unique.
Uniswap layer 2
Last year, the transaction fees on Ethereum soared, and it made using Uniswap economically not feasible for several users.
However, Uniswap v3 provides a better solution to the Optimistic rollup– a layer 2 scaling solution. It is an innovation to scale smart contracts while still earning security from the Ethereum network. The deployment led to a massive boost in the lower fees for users and transaction throughput.
Uniswap (UNI) token
The native token of the Uniswap protocol is called UNI. It gives its owner governance rights. This infers that UNI holders are authorized to vote on changes to the protocol. Earlier, we talked about how the platform has been acting as beneficial for the public. The UNI token solidifies this idea.
Over 1,000,000,000 UNI tokens have been minted at genesis. 60% of these tokens are allocated to the existing Uniswap community, while 40% was made available to team members, investors, and advisors over four years.
Some of the community distribution occurred through liquidity mining. That is, UNI will be distributed to those who provide liquidity to the following Uniswap pools:
Any Ethereum address that has interacted with the Uniswap contracts are the Uniswap community members.
How To Claim Uniswap (UNI) Tokens
If you’ve used Uniswap before, you can likely claim 400 UNI tokens per address that you used to open Uniswap. To claim your tokens:
- Go to https://app.uniswap.org/.
- Connect the wallet that you previously used to open Uniswap.
- Click on “Claim your UNI tokens.”
How To Trade On Uniswap
Trading on uniswap is effortless. All you need to have is an ERC-20 standard token or ETH and a cryptocurrency wallet that can support your trade.
You can use MetaMask to trade these tokens. MetaMask wallet enables you to run dApps even if you are not a node on the Ethereum network. We mentioned the MetaMask wallet earlier because it permits direct interaction with dApps from your wallet. Some other wallets are; Coinbase wallet, WalletConnect, Portis wallet, Formatic wallet, Trust wallet, etc.
After getting your wallet, you need to add Ether (ETH) to trade and pay the gas fee (Ethereum transaction fee).
Gas fee price depends on the number of people using the network. Payment is made using three choices depending on how fast you want your transaction to be processed.
Payment choices include: Fast, Medium, and Slow. Fast is the most expensive while slow is the cheapest.
Uniswap trading Steps:
- Log on to Uniswap exchange, click on “Connect your wallet” at the top right side of the page. You can connect using a wallet like Metamask, Trust Wallet, Coinbase wallet.
- Browse and select the token pair from a dropdown of accessible ERC-20 tokens on the “Swap” section of the website. Select the token you want to buy and.
- Go to the settings icon at the top left corner of the Swap interface. Set things like Slippage tolerance and Transaction deadline.
- Click “Swap” to preview the order (including Uniswap fees).
- Confirm transaction through your wallet.
After confirmation, the AMM model finalizes the transaction on the Ethereum blockchain, and you receive your new tokens in your wallet automatically. You can keep track of your transaction progress by checking your wallet address or transaction ID on the blockchain explorer.
Uniswap Trading Fees and Charges
Most times, exchange protocols charge traders a lot depending on the model of the coin or blockchain. On the Ethereum blockchain, gas fees increase as the number of trades increases. Due to this, the gas fee or transaction fee on the Ethereum blockchain can be very high.
Uniswap protocol has a three-tier charge range which are 0.05%, 0.30%, and 1.0%. The charge range depends on the pair of tokens or coins you choose to trade. However, the most common trading fee pair is 0.30%. Trade charges do not depend on your trade size. You are charged a fee per trade regardless of your trade size.
Some stablecoin pairs, such as USDC/EURS, USDT/DAI, USDC/USDT USDC/ETH, etc., each have a charge fee of 0.05%.
Some Uniswap pairs such as SHIB/ETH, 1 INCH/USDC, ETH/CRV have a charge fee of 1.00%
You can check for other Uniswap pairs on Uniswap to get the trading fee and charges.
How Secure Is Uniswap?
Uniswap decentralized protocol is a popular decentralized platform that provides maximum security to its users, access to new tokens, and low trading fees. With the security in the platform, it is easier for users to identify scams in the platform. Uniswap users should be able to identify warning signals before using pools or tokens on the protocol.
In summary, the Uniswap exchange platform is an imaginative protocol developed on the Ethereum blockchain. Anyone who has an Ethereum wallet can use it to exchange tokens without involving any central body.
Although it has some limitations, this platform could help you to build your crypto portfolio and gain access to financial freedom.