Decentralized exchanges (DEXs) have firmly established their place in the blockchain and cryptocurrency industry. They offer a solution to centralization by allowing users to interact with their platform in a self-custodial manner. A prime example of a leading DEX is Uniswap. Since its creation in 2018, it has become the world's largest DEX. According to Total Value Locked (TVL) rankings from DefiLlama for DEXs, Uniswap leads with a TVL exceeding $4 billion. This value is significantly higher than competitors like Curve Finance and PancakeSwap, which, by the end of 2023, had less than half of Uniswap's TVL.
Uniswap has made a significant contribution to the evolution of the cryptocurrency sector, especially in decentralized finance (DeFi), as it continually incorporates the latest technology into its platform. Interested in learning more about Uniswap and how it became a leader among DEXs? Continue reading to discover everything you need to know about Uniswap and the UNI token.
What Is Uniswap?
Uniswap is a decentralized exchange operating on the Ethereum blockchain. It is a cryptocurrency trading platform that enables traders to engage with each other on a peer-to-peer basis. Uniswap does not use order books or intermediaries to facilitate transactions. Instead, it uses an automated liquidity protocol powered by Automated Market Makers (AMMs).
How Does Uniswap Work?
The Uniswap ecosystem consists of several components, each playing a role in ensuring the automation process runs 24/7 without interruption.
Automated Market Maker (AMM)
Automated Market Makers are the foundation of Uniswap. Instead of order books where traders match with their counterparts on the other side of a trade, AMMs provide a liquidity pool that facilitates seamless trading. AMMs ensure constant liquidity in the DeFi ecosystem through liquidity pools to support transactions.
In contrast, traditional markets use buyers and sellers in a system moderated by centralized entities. AMMs operate in an automated, permissionless system that relies on liquidity pools. Users with cryptocurrency tokens provide these liquidity pools. A predetermined mathematical formula then calculates the prices of tokens within these pools.
Uniswap's AMM is a smart contract that manages the pools deployed when trades are executed on the DEX. It uses an algorithm to determine the effective price of a token during active trading. Asset prices on Uniswap are determined based on the principles of supply and demand between the traded ERC-20 tokens and the liquidity pools.
Liquidity Pool and Liquidity Providers
In finance, liquidity refers to the ease with which an asset can be converted from one form to another without affecting its market price. During the early stages of DEXs, it was challenging to solve problems related to liquidity. Given the novelty of the technology, users were reluctant to participate in the ecosystem.
The introduction of AMMs revolutionized how DEXs function. It solved the complex liquidity problem by creating liquidity pools and incentivizing liquidity providers to supply them.
A liquidity pool is a pool of collectively funded cryptocurrencies or tokens used to facilitate decentralized trading. Smart contracts manage the digital assets in a liquidity pool. Developers program these smart contracts to determine the prices of these tokens at any given time. Meanwhile, a liquidity provider refers to anyone who contributes tokens to a liquidity pool to provide liquidity on a DEX or within a DeFi ecosystem.
Stakers—also called liquidity providers—contribute to the liquidity pool on Uniswap. Typically, traders pay a fee of about 0.3% when they execute transactions on Uniswap. Uniswap distributes these fees among liquidity providers based on the proportion of their contributions to the liquidity pool.
Uniswap's Constant Product Formula
To offer ample liquidity, Uniswap integrates a constant product formula to balance the liquidity rate of each cryptocurrency pair. The formula considers the individual tokens that make up a pair as variables. By withdrawing one type of token relative to another, the constant product formula balances the relationship between supply and demand and the price between the two pairs. The programmed formula ensures that the market value remains fair while maintaining liquidity.
Arbitrage Traders
Price efficiency is an essential feature of any DEX. After all, no one would want to trade and swap tokens with a DEX that offers unnecessarily high slippage and large bid-ask spreads. This is why arbitrage traders are important to the Uniswap ecosystem. Essentially, arbitrage traders specialize in seeking price discrepancies across various CEXs and DEXs and using them to secure gains. For example, if Bitcoin were trading on OKX for $42,800 and on Uniswap for $42,750, arbitrage traders would buy BTC on Uniswap and sell it on OKX to secure a lower-risk gain.
What arbitrage traders do on Uniswap is look for coins and tokens trading above or below their average market price. This often happens due to large trading blocks that create imbalances in the liquidity pool, leading to price fluctuations that often go unnoticed. Arbitrage traders then trade these cryptocurrencies until price efficiency is achieved, and the cryptocurrency prices are rebalanced to align with prices on other exchanges. Ultimately, this creates a mutually beneficial relationship between the AMM and arbitrage traders—the AMM achieves its goal of efficient pricing for its coins and tokens aligned with the rest of the DEXs and CEXs in the market, while arbitrage traders enjoy lower-risk gains.
How Has Uniswap Evolved?
Uniswap has changed over the years since its launch in 2018. A series of upgrades and protocol adjustments have led to different protocol versions.
Uniswap v1
Uniswap v1 is the oldest version of the protocol with the basic attributes of a DEX. Despite the buzz generated by the protocol, it simply allowed users to trade ERC-20 tokens directly on the Ethereum blockchain.
Its main feature was the implementation of the AMM model, which used a constant product formula (x*y=k) for liquidity pools. This formula was crucial for automatically adjusting token prices, providing fair and adaptable prices, and preserving consistent liquidity when changing trade sizes and market conditions.
Uniswap v2
The first Uniswap upgrade came in 2020 with Uniswap v2. One of the key features of Uniswap v2 was the introduction of ERC-20 to ERC-20 trading pairs. With this version, liquidity providers had the power to create pair contracts for any two ERC-20 tokens. It also eliminated the need for ETH as an intermediary token to support trading between ERC-20 tokens.
The v2 platform offered a new price oracle system and applied the existing liquidity pools on the platform to provide more accurate and tamper-proof price information. This improvement aimed to reduce the possibility of price manipulation and oracle attacks, strengthening the platform's reliability.
Uniswap v3
Uniswap v3 is the latest and most current version of the DEX. One of the important features of Uniswap v3 is the ability for liquidity providers to set their custom price ranges within which they wish to provide liquidity. This means that a liquidity provider who sets a price range between $1,000 and $5,000 can only allow trades that fall within that range. This update solves the problem of capital inefficiency observed with undefined liquidity ranges.
While Uniswap v2 has fungible liquidity positions in the form of ERC-20 tokens, Uniswap v3 uses NFTs to represent these positions. Each liquidity provider (LP) selects unique price ranges and fee levels.
Uniswap v4
In 2024, significant advancements were made with Uniswap, and there is now a focus on Uniswap v4. Uniswap has allocated a $300,000 budget to develop its v4 edition. The updated version of the DEX enhances several elements, with special emphasis on making the user interface more intuitive for pool launchers and liquidity providers.
Despite being introduced over two years ago, Uniswap v3 has not overshadowed the popularity of v2, which still manages a significant total value locked (TVL) of $1.8 billion. The v4 iteration aims to further elevate the user experience and is scheduled for launch in the third quarter of 2024.
The funding allocated for this project is expected to cover two years of development and may be extended depending on its success. A notable element of v4 development is a specific benchmark, known as a key performance indicator (KPI), which stipulates that 5% of Uniswap's total value locked (TVL) must be achieved through tokens launched using the new interface within one year. This equates to approximately $150 million in current currency.
UniswapX
To expand on-chain trading and improve self-custody swapping, the Uniswap team recently announced the UniswapX protocol. As a permissionless, open-source protocol based on a Dutch auction, UniswapX aims to improve the core characteristics of Uniswap v2 and v3 in two main areas: scalability and protection against Maximal Extractable Value (MEV). In doing so, UniswapX offers token swappers the best prices and the best possible user experience. Several key features of UniswapX that deserve highlight include:
- Enhanced security and MEV protection: UniswapX employs several mechanisms, such as private transaction relays, auction-based routing, and decentralized MEV protection, to mitigate the risks associated with MEV. These risks can harm users on traditional DEXs and cause common problems like network congestion and expensive gas fees.
- Flexible trading mechanisms: By leveraging an auction-based routing system instead of the AMM model used in Uniswap, UniswapX enables dynamic price discovery and potentially better execution prices compared to the fixed-price model.
- Cross-chain swaps: UniswapX facilitates seamless swaps between tokens on different blockchains through its integrated "UniswapX Bridges." It offers an easy-to-use experience that merges swapping and bridging into one seamless action for cross-chain asset transfers.
- Gas-free limit swaps: For specific token pairs and trade sizes within its internal network, UniswapX allows users to perform swaps without paying transaction fees, potentially reducing overall costs and improving swap efficiency for users.
The Uniswap Token (UNI)
Although Uniswap was launched in 2018, it did not introduce a native token until 2020. Uniswap launched UNI in 2020 as a governance token on the Uniswap platform. It is an ERC-20 token created on the Ethereum platform and stored in any ERC-20 compatible wallet. UNI holders retain the right to vote on changes and improvements to the Uniswap protocol. Like other governance tokens, a UNI holder's voting power is proportional to the share of UNI held. Voting on Uniswap is decentralized, and anyone holding UNI tokens can submit a proposal and vote whenever necessary.
Uniswap (UNI) Tokenomics
In terms of tokenomics, UNI has a maximum supply of 1,000,000,000, with 753,766,667 UNI tokens currently in circulation. As of mid-December 2023, UNI had a trading price of $6.33, representing an 85.9% drop from its all-time high of $44.97 on May 3, 2021. With 60% allocated to the community, most of these UNI tokens have already been distributed to early Uniswap users who supported the DEX by interacting with it and making active swaps and trades. One aspect to note is that UNI has a perpetual annual inflation rate of 2% that will take effect once UNI reaches its maximum supply and is fully distributed. According to Uniswap, this will help incentivize continued participation and contribution to the Uniswap DEX.
UNI Utility
Some commentators claim that UNI has no form of utility beyond governance and voting rights in determining Uniswap's future. Many believe this differs from other DEX tokens like CAKE and JOE, which offer attractive benefits for token ownership, including bonus staking yields, reduced trading fees, and trading revenue payouts.
This has led to a discussion point about how UNI tokens are essentially disconnected from the success of Uniswap as a DEX. Although the platform continues to succeed in attracting token trades and swaps, many believe there is no advantage to holding UNI long-term, aside from hoping that value will be transferred to token holders in the near future.
Although there have been rumors about how some of these benefits might materialize in the near future, the main reason for cryptocurrency traders to hold UNI is access to voting rights in governance proposals. Ultimately, this aligns with Uniswap's core vision of providing limited benefits to UNI token holders and maintaining the Uniswap platform as a public good owned and governed by UNI holders.
Trading on the Uniswap DEX
👉 Explore advanced trading strategies on decentralized exchanges. Trading on the Uniswap DEX involves a few simple steps that differ from trading on centralized exchanges. Anyone with a cryptocurrency wallet containing ERC-20 tokens can connect and perform trades on Uniswap by following these steps:
- Visit the Uniswap website and connect your Ethereum wallet.
- From the list of ERC-20 tokens, select the one you want to trade on Uniswap.
- Enter the amount of the selected ERC-20 token you wish to trade. The platform will automatically calculate the estimated equivalent value of the alternative token you will receive.
- Click the "Swap" icon to initiate the transaction and confirm the process with the following prompt.
- After confirmation, the trade will be executed instantly, and the tokens will be reflected in your wallet.
Uniswap's Impact on the DeFi Industry
Many believe that Uniswap played a significant role in promoting DeFi. The entity helped drive the industry by supporting the infrastructure of decentralized exchanges, permissionless listings, liquidity provisioning, token price discovery, and interoperability.
For many, Uniswap is the revolutionary that introduced the current DeFi revolution sweeping the cryptocurrency industry. It also provided users with the opportunity to benefit by participating in liquidity pools. By doing so, users can earn passively from the transaction fees charged on the exchange, depending on the proportion of their contribution.
Conclusion and Next Steps
Overall, Uniswap remains a market leader among DApps by being the DEX with the highest trading volume in the DeFi space. From revolutionizing how DEXs work with AMMs to offering an impressive variety of coins and tokens to swap and trade, Uniswap seeks to maintain this TVL leadership for a long time, continuously innovating and being a bastion for DeFi in the crypto community. Although some cryptocurrency traders may emphasize that UNI tokens offer no value beyond governance and voting rights, Uniswap enthusiasts often argue that a UNI token offers the equivalent of a vote, which will help dictate the direction of Uniswap's growth as a DEX in the future.
Frequently Asked Questions
What is the disadvantage of Uniswap?
Uniswap operates on the Ethereum blockchain and shares some of Ethereum's weaknesses, including high gas fees during network congestion.
How does Uniswap set prices?
Uniswap automatically sets token prices using its pre-programmed constant product formula.
Is Uniswap risky?
Like any other decentralized exchange, there are inherent risks on Uniswap that users should be aware of, such as smart contract volatility and slippage. There is also the risk of impermanent loss on Uniswap.
Does Uniswap have high fees?
Transaction fees on Uniswap are generally competitive. However, because it operates on the Ethereum blockchain, Uniswap users may experience high gas fees during network congestion.
Is it safe to connect a wallet to Uniswap?
Connecting your wallet to Uniswap is generally considered safe if you observe basic wallet protection protocols.