Uniswap

What is Uniswap (UNI)?

Uniswap is a permissionless, decentralized, open-source trading protocol that allows the exchange of crypto assets on-chain.

A big part of the decentralized finance (DeFi) boom, Uniswap enables trustless token swaps executed from smart contracts on the Ethereum blockchain. Users can create liquidity pools for ERC-20 standard tokens to be launched and traded without listing fees. This eliminates the need for traditional exchanges, market makers, and order books.

Uniswap is also one of the main on-ramps to many ERC-20 tokens, which are unlisted by exchanges and therefore a valuable part of the industry’s infrastructure.

What is a DEX?

A decentralized exchange, or DEX, allows users to exchange tokens or currencies without the need for trusted third parties, which are often centralized trading facilitators.

Trading traditional assets such as stocks typically involves many third parties, all of whom need to be trusted to carry out their contractual obligations. These may include banks, stock brokers, market makers, wholesalers, stock exchanges, and more.

Trading of cryptocurrency tokens can also involve centralized entities, often a cryptocurrency exchange that plays some or all of the roles required, such as the provision of liquidity.

However, users who do not wish to trust such centralized entities may instead use a DEX. DEXes rely on code and smart contracts that are open source and can be publicly audited.

Given this transparency, all of the code’s functionality is known to the user before any interaction. This means that the user chooses to trust the code rather than any for-profit, often self-regulated corporations with opaque processes.

When Was Uniswap Launched?

Uniswap was originally launched in late 2018 without an attached currency, existing at the time as a decentralized platform built atop Ethereum.

The UNI token itself was airdropped in late 2020 to anyone with a wallet that had used the Uniswap protocol prior to the 1st of September of that year. Each wallet could claim 400 UNI, worth around $1000 at the time, starting on the token’s launch date of September 17, 2020.

The protocol, now known as Uniswap V1, originally allowed participants to earn interest by providing liquidity for other users to carry out token swaps.

The original token pairs available were DAI-ETH and DAI-USDC, and pools would earn providers a share of a 0.3% transaction fee on swaps.

Uniswap V2 treated V1 like a proof of concept, adding various features and improvements to the mix, including ERC-20 pairs and flash swaps. A high level of decentralization was achieved, and manipulation-resistant on-chain price feeds were introduced.

What is Uniswap V3?

Launching on the Ethereum mainnet in May 2021, Uniswap V3 introduced major improvements to the protocol in the areas of concentrated liquidity and multiple fee tiers.

It also began with low slippage trade execution, increasing liquidity pools’ exposure to more assets and reducing downside risk.

Concentrated liquidity provides individual pools control over price ranges, allowing individual positions to merge and create one combined curve for users to trade against. Meanwhile, multiple fee tiers allow different levels of compensation based on varying degrees of risk.

Who are the Founders of Uniswap?

Uniswap was founded by Hayden Adams, a former Siemens engineer, who has credited Ethereum creator Vitalik Buterin for the inspiration behind the Uniswap protocol.

Adams was able to talk to Buterin about his concept for Uniswap and received a $65,000 grant from the Ethereum Foundation to help develop the project. He finally launched Uniswap on the 4th of November 2018 at DevCon 4.

Adams is CEO at Uniswap Labs, registered as Universal Navigation Inc. The company is credited by the official Uniswap website as having developed much of the initial code for the Uniswap protocol.

Uniswap Labs raised seed funding from Paradigm in 2019, followed by an $11 million Series A funding round led by Andreessen Horowitz along with investments from USV, Version One, Variant, Parafi Capital, SV Angel, A.Capital, and Paradigm in August 2020.

How Does Uniswap Work?

Uniswap is a decentralized exchange, or DEX, that allows users to swap Ethereum-based tokens using liquidity pools created by other participants via smart contracts.

Each token has a smart contract and a liquidity pool. Users that add their assets to these liquidity pools earn a share of the 0.3% fee charged to other users making use of those pools to trade their assets.

What is an AMM?

Uniswap is an example of an AMM, or Automated Market Maker. As the name suggests, an AMM automates the process of market making by using a mathematical formula for exchange pricing. It also allows users of the platform to contribute their funds toward the provision of liquidity.

The liquidity pools created by users’ assets replace the traditional market of buyers and sellers known as an order book. Order books provide listings of bids and asks on an asset from buyers and sellers respectively. Moreover, when a user finds a listing acceptable, they execute a trade.

On an AMM, users trade against liquidity pools instead, with the price of the tokens determined by a mathematical formula.

In Uniswap’s case, the formula uses a constant where K is a constant, and X and Y are the quantities of paired tokens in the pool:

X * Y = K

What is Impermanent Loss?

Impermanent loss is one of the major risks that contributors to a liquidity pool face.

When contributing to an LP, assets are provided in a certain ratio. However, many assets, especially crypto assets, are volatile.

When one of the paired assets’ value changes on an external venue (such as a centralized exchange), arbitrage traders take advantage by buying up the same asset from the pool until its price equals what the exchange is offering.

As this shift is taking place, the protocol adjusts the liquidity provider’s assets to maintain the original provision ratio. That means that the provider has experienced a notional loss by missing out on the asset’s rally. Instead, they could’ve simply held the asset.

However, this loss is not realized until and unless they exit the protocol and withdraw liquidity. If they keep providing liquidity, volatility on the other side could see the losses recouped, with even appreciation of both assets in the perfect scenario.

As such, one of the key decisions when considering becoming a liquidity provider is whether the fees earned by providing liquidity outweigh the risk of impermanent loss via volatility. Liquidity providers must determine whether simply holding an asset might be more worthwhile.

What Makes Uniswap Unique?

One of Uniswap’s greatest advantages is that it allows the trading of any Ethereum-based token.

While a smart contract and a pool need to be set up for most tokens by users, if one doesn’t exist, the Uniswap protocol does that job automatically.

Unlike many DEXes, Uniswap also doesn’t require a native token for transaction fees. Given that it started without UNI, everything is done on-chain. Gas fees can also be paid in ETH when using the platform on Ethereum.

Notably, Uniswap has integrated with Layer 2 solutions as well, making swaps even faster and cheaper in terms of gas fees. Uniswap also doesn’t charge any management fees.

Furthermore, user assets are not held on the Uniswap platform. While they can be locked in pools and trades can be made with ease, Uniswap as an entity does not take custody of user assets.

How is the Uniswap Network Secured?

Uniswap is built on the Ethereum blockchain and UNI is an ERC-20 token. As a result, the underlying Ethereum blockchain is what secures Uniswap.

Currently, Ethereum is a proof-of-work blockchain that’s secured by thousands of computers contributing their computing power to solving cryptographic puzzles. This process is called mining. Its goal is the creation and verification of new blocks to add to its distributed public ledger.

With its upcoming Ethereum 2.0 move, however, Ethereum will shift to a proof-of-stake consensus mechanism. It will reward holders of the currency for acting in good faith and punish misbehavior by slashing, or destruction, of their account balances.

What is the Use of UNI?

While the Uniswap protocol is designed for the swapping of Ethereum-based crypto assets via the incentivization of liquidity providers, the UNI token itself is purely a governance token.

This means that UNI is quite similar to traditional stock in a company, except that in this case, holders of UNI receive a vote in the governance of the Uniswap DAO.

Who Controls Uniswap?

Uniswap is controlled by Uniswap DAO, the decentralized autonomous organization of UNI holders voting over matters including its roadmap, development, and treasury.

Holders of over 1% of the UNI supply are eligible to submit development proposals, but all holders are entitled to vote over these proposals. UNI holders can also help to fund grants, partnerships, liquidity pools, and much more.

Adoption of proposals, or a quorum, requires 40 million ayes—4% of the total UNI supply.

How Much UNI Is In Circulation?

A total of 1 billion UNI tokens were minted in 2020, with a dilution schedule featuring vesting of up to 4 years.

According to Uniswap Labs, 60% of the total supply is distributed to the community, with 21.51% going to the team and future employees, 17.8% to investors, and 0.06% to advisors.

As part of the community share, 10% of the supply was split across all 250,000 wallets that historically used the Uniswap protocol, each receiving 400 UNI.

How Do You Buy UNI?

One of the best places to buy UNI, naturally, is on Uniswap itself!

However, it is also available on most major exchanges, given its prominence in the industry.

Purchasing UNI requires little more than an alternate currency (including fiat, if you’re purchasing it on an exchange) and an Ethereum-compatible wallet to store it in.

Is It Possible to Buy UNI Instantly?

Transaction speed when purchasing UNI on Ethereum depends on the blockchain itself and may incur gas fees.

When transacted on Layer 1 Ethereum, buying UNI may take a few minutes depending on network congestion. Using a Layer 2 such as Optimism or Arbitrum, however, is a lot faster.

Purchasing UNI on a centralized exchange (CEX) may seem faster, but the actual settlement of your UNI won’t happen until you withdraw it to a private wallet.

This may be a slow process because CEXs may not initiate withdrawal transactions immediately, often having to complete KYC (Know Your Customer) and AML (Anti Money Laundering) procedures first.

How Do You Store UNI?

UNI can be stored in any Ethereum-compatible wallet, which can then be connected to Uniswap’s governance portal in order to exercise governance rights.

There are two main kinds of Ethereum wallets:

• Cold wallet. Cold wallets keep private keys offline and out of the reach of potential attackers. They could be electronic devices not connected to the internet, paper, or some other physical copy of the private key.
• Hot wallet. Unlike cold wallets, these need to be online in order to be used. They could be desktop clients or online wallets that store credentials with the online wallet provider rather than the user’s hardware.

You can also store UNI on an exchange account, but exchange holders are not able to exercise governance rights and vote on the direction of the platform.

In fact, while the account holder pays to buy UNI on a CEX, it is the exchange that retains ownership of the UNI tokens and receives the right to vote.

As a result, a large amount of UNI being held by an exchange provides that CEX with a disproportionate amount of voting power.

This is an especially paradoxical situation, given that DEXes tend to be viewed as competitors to CEXes.

Uniswap Energy Consumption

As an ERC-20 token, UNI is dependent on and supported by Ethereum. As such, consensus is also provided by Ethereum, meaning that Uniswap doesn’t really have much of an energy footprint on its own.

It can be argued that Uniswap contributes significantly to the number of transactions on and the value of Ethereum itself. On the other hand, Ethereum 2.0 is currently on the horizon, and Ethereum’s relatively costly proof-of-work consensus will eventually shift to the far cleaner proof-of-stake method.

Is Uniswap a Good Investment?

The UNI token has one main utility: governance.

While it is possible to adjust the protocol to charge a fee that would be distributed to UNI holders, this fee is at 0% on Uniswap by default, as it would shift income from liquidity providers to UNI holders. This would disincentivize participation in the protocol itself.

While future utility for the token isn’t out of the question, an investment in UNI represents the idea that having a voice in the future of the Uniswap protocol is of value.

Uniswap is certainly the first name in the DEX space, but being open source, it is easy to duplicate, and copycat platforms can emerge very quickly.

Furthermore, Uniswap exists only on Ethereum, whereas there are currently cross-chain DEXes in development that may rise to prominence in the future.

However, Uniswap brought some of cryptocurrency’s biggest innovations to market. Not to mention, it has a history of major iterative development along with an experienced team and institutional backing; all building blocks in place for future growth.