Uniswap (UNI), the Decentralized Ethereum Token Exchange Protocol

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Uniswap (UNI), the Decentralized Ethereum Token Exchange Protocol
Uniswap (UNI), the Decentralized Ethereum Token Exchange Protocol

Uniswap (UNI) is a decentralized exchange (DEX) operating on the Ethereum blockchain. It is one of the pioneers in the field, and Uniswap has maintained its leading position over the years despite growing competition. We will be introducing one of the most popular decentralized finance (DeFi) projects in this article.

What is Uniswap (UNI)?

Uniswap (UNI) is a decentralized exchange (DEX) operating on the Ethereum blockchain. Created in 2018 by Hayden Adams, Uniswap quickly received financial support from the Ethereum Foundation and Vitalik Buterin to grow.

Before the appearance of Uniswap, cryptocurrency trading was dominated only by centralized exchanges (CEX) such as Binance or Coinbase.

In just a few years, Uniswap has established itself as a reference in the DEX world by generating daily more than a billion dollars in transaction volume and by having more than 5 billion dollars locked on its protocol.

Unlike CEXs, DEXs make it possible to exchange cryptocurrencies in a completely decentralized way without having to resort to an intermediary. These are – in practice – censorship-resistant exchanges, but since version 3, Uniswap is no longer open source: the protocol is copyrighted.

The only popular DEX before Uniswap was EtherDelta. This was based on an order book and had many flaws, including a severe lack of liquidity and a very limited user experience.

Uniswap was the first protocol to take DEXs to the next level with an automatic market maker (AMM) that gathers liquidity deposited by users and makes it available to traders via an algorithm.

Uniswap operates on the Ethereum blockchain, it is possible to exchange only ERC-20 tokens and ETH there. It is also the largest DEX on the Ethereum blockchain and an essential decentralized finance (DeFi) platform in the cryptocurrency landscape.

Uniswap is, at the time of writing, in its third version. Uniswap V1  was the first version of 2018 and only allowed swaps between Ether and ERC-20 tokens.

In May 2020, Uniswap V2  implemented Wrapped Ether (WETH), which allowed users to swap any ERC-20 token with another ERC-20 token in a liquidity pool without converting them to ETH. Uniswap V2 was thus able to offer swaps between two ERC-20 tokens.

Uniswap V2 also implemented a  decentralized and manipulation-resistant oracle to offer the correct exchange rates at each swap.

Finally,  Uniswap V3  was launched in May 2021. This further improves the protocol, and then we will see in more detail how Uniswap has its own native ERC-20 token, the UNI.

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Uniswap (UNI) logo, by Cryptoast

The Uniswap ecosystem

Here we will see how Uniswap works with its version 3. The liquidity available on Uniswap is provided by users who lock their tokens in exchange for rewards. Thanks to them, traders can carry out swaps without having to resort to a single intermediary.

Trader’s Point of View on Uniswap

The entire Uniswap protocol was developed with the aim of enabling token swaps in a simple, secure and decentralized way.

It is, therefore, possible to exchange any ERC-20 token there with another ERC-20 token, using the Ethereum blockchain or 2-layer solutions like Polygon, Arbitrum and Optimism, which have been integrated to offer the choice of a more scalable and less costly solution for users.

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Figure 1: Overview of a swap on Uniswap V3

After connecting a wallet like MetaMask to it, all you have to do is select the token you want to exchange and the one you want to receive in return.

The Uniswap algorithm then proposes the best routing to perform the swap in a totally transparent way. In this case, in this example (figure 1), we observe that for an ETH to UNI swap, the algorithm will use the WETH token and the swap with USDC tokens in the WETH/USDC liquidity pool to then swap the USDC with the equivalent amount of UNI tokens in the USDC/UNI pool.

Liquidity provider perspective

Uniswap needs liquidity, and for this, it offers compensation to liquidity providers who lock their tokens in pools.

To provide liquidity, simply click on the “Pool” tab in the Uniswap app. Then you have the option to add liquidity directly into a liquidity pool by choosing the two tokens from the pool you want.

In return, these liquidity providers recover part of the fees paid during swaps carried out with the pools in which they participate.

The Concept of Concentrated Liquidity

Liquidity providers (LPs) have the ability to concentrate their liquidity by limiting it to a chosen price range. This choice is made using cursors on a graph displaying the distribution of liquidity on the pair of tokens.

This is what Uniswap calls Concentrated Liquidity. The goal is to use the capital of LPs more efficiently, and this is new in version 3 of Uniswap.

Concretely, in the case of a pair of stablecoins like USDC/DAI, the LP can choose to allocate all its capital within a range of 0.99 to 1.01 dollars. Therefore, traders performing swaps will benefit from more liquidity in this price range, and the LP will enjoy more swap fee rewards.

In previous versions, liquidity was evenly distributed between $0 and infinity. Thus, a good part of this liquidity was never used since the assets tend to trade within a much narrower price range.

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Figure 2: Overview of how concentrated liquidity works on Uniswap V3 (APE/ETH pair)

This feature, therefore, makes it possible to be much more efficient in terms of the allocation of LP liquidity. Since Uniswap implemented it, many DEXes are interested in it since this gain in efficiency makes it possible to reduce the costs of slippages and increase the rewards distributed to LPs.

Flexible Swap Fees

Swap fees are no longer fixed as they may have been in previous versions of Uniswap; there are now 4 tiers of swap fees :

  • 0.01% for stablecoin pairs like DAI/USDC and USDC/USDT;
  • 0.05% for relatively stable pairs such as USDC/ETH or FRAX/USDC;
  • 0.30% for most pairs like APE/ETH or LINK/ETH;
  • 1.00% for more exotic pairs like 1INCH/USDT.

There may be identical pools with different swap fees. For example, two WBTC/ETH pools exist, one with 0.05% swap fees and the other with 0.30%.

These swap fees are collected at a given price range and then automatically distributed to each LP in proportion to the amount of liquidity contributed within that range. This is why the concept of concentrated liquidity is more beneficial to liquidity providers.

What are the Roles of the UNI token?

UNI is an ERC-20  token issued on the Ethereum blockchain. UNI token holders are responsible for governing the Uniswap protocol by voting on proposals that influence its future, as well as voting on the addition of new liquidity pools.

In order to be able to submit a proposal, it is necessary to own at least 1% of the total UNI supply, i.e. 10 million UNI tokens. It is possible to delegate your tokens to a member of the community in order to help him achieve this very high requirement.

The UNI token has a governance function in this ecosystem.

Uniswap Fundraising and Tokenomics

Uniswap Labs got its start in 2018 with $100,000 in funding from the Ethereum Foundation. Later in 2019, the company did a private fundraising round, the amount of funds raised for which was never revealed.

Finally, in August 2020, Uniswap Labs raised $11 million in Series A, led by a16z, an American venture capital fund.

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Figure 3: Uniswap (UNI) Tokenomics

At the Tokenomics level of UNI tokens, the maximum number of UNI tokens is set at 1 billion units, while the circulating supply is 719 million UNI tokens at the time of writing.

15% of UNI tokens were distributed as an airdrop in 2020 to individuals who used Uniswap before a certain date. The rest of the tokens allocated to the community are managed by Uniswap’s treasury or governance.

This treasury has the task of distributing them to the community as rewards in the liquidity pools or to provide financial support to developers in the ecosystem, for example.

After 4 years, i.e. from 2024, it is expected that perpetual inflation of 2% per year will be established.

Uniswap Team and Partners

The Team

The company behind Uniswap is Uniswap Labs, located in the United States, and it employs nearly 80 employees who are now focused on building a suite of products to support the Uniswap ecosystem:

  • Hayden Adams: Founder of Uniswap and CEO of Uniswap Labs;
  • Mary-Catherine Lader: Director of Operations at Uniswap Labs.

Find the full Uniswap Labs team on LinkedIn.

The Partners

One of Uniswap Labs’ most notable partnerships is with European outfit Team Secret. This e-Sport organization evolves on several competitive games like League of Legends or Valorant.

Concretely, Uniswap Labs sponsors the team and, through this, has the possibility of reaching a new young audience that is more receptive to new technologies.

How to buy UNI tokens?

The UNI token is available on many exchanges like Binance, Gate.io, FTX and, of course, Uniswap.

Explanations for buying UNI on Binance

  • Register on Binance;
  • You will receive an email and need to click on a link to verify your account;
  • Deposit funds on the platform;
  • Click on the Market menu and look for the  UNI/USDT pair;
  • All you have to do is buy UNI for the amount of your choice;
  • Congratulations, you are now in possession of UNI tokens.

Our Opinion on Uniswap

Uniswap is a DEX that was one of the pioneers of the field and the most remarkable thing is how it has maintained its leading position after all this time.

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Figure 4: Uniswap DEX market share (May 20, 2022)

Uniswap is constantly innovating, it is the first DEX to have implemented the mechanism of concentrated liquidity, for example, q allowed it to keep this position.

This DEX generates the most daily transaction volume on the Ethereum blockchain at the time of writing, ahead of protocols like Curve or SushiSwap.

Its ecosystem is constantly growing since Uniswap is integrated with many protocols such as Aave, 1inch, OpenSea, TrustWallet and many others.

Finally, if Uniswap continues to refine its user experience and implement mechanisms that increase the efficiency of the protocol, it has a good chance of staying ahead of its competitors.

However, it should be noted that even Uniswap is very far from the trading volumes generated by centralized exchanges such as Binance, FTX or Coinbase. In addition, Uniswap’s governance is relatively decentralized at the time of writing, particularly because of the large number of UNIs required to submit a proposal.

This decentralization is also undermined since, in the past, Uniswap Labs has already reserved the right to restrict access to tokens on Uniswap to comply with regulations. This is an amazing practice for a decentralized exchange.