Uniswap UNI: The Decentralized Exchange and its Automated Market Maker

By 2sats | 2sats | 12 Jan 2022

*obligatory not financial advice*


What is Uniswap?

Uniswap was one of the first few decentralized exchanges on the Ethereum blockchain. It doesn't use an order-book system to match buy and sell orders but instead uses provided liquidity to offer instant trading by setting its prices automatically based on the supply of tokens. The project has become one of the most successful DeFi applications and its token is pretty much a blue chip investment into the DeFi market.

Cryptocurrencies are all about decentralization, so it’s a fundamental flaw if they entirely depend on centralized exchanges for trading. Uniswap is based on an idea that the Ethereum founder Vitalik Buterin had in 2016. A year later Hayden Adams started to attempt making his vision true, he received $100,000 from the Ethereum Foundation to build the DEX and he managed to launch Uniswap in 2018. The protocol quickly became very popular and gained a lot of liquidity due to a strong demand for decentralized trading.

Until Uniswap became a thing most exchanges handled their trades with an order-book that matched buy and sell orders, but they had a problem with illiquid assets because there was no incentive for market makers to provide their liquidity. Uniswap solves this by allowing everyone to become a market maker by adding their tokens in a pool and it rewards them with the collected trading fees.

The liquidity pools each hold 2 assets that are offered to traders and the protocol adjusts the price for them with an Automated Market Maker (AMM) that weights the total supply of both assets the same. Let’s say there is a pool with 10 ETH and 10,000 USDC. The total supplies of both tokens have the same value, so the pool will sell 1 ETH for 1,000 USDC. Should the supply change to 9 ETH and 11,000 USDC, the price of 1 ETH will change to 1,222 USDC. This is how the prices are set automatically. This requires that people offer their tokens to the liquidity pools, that’s why the protocol is collecting fees for each trade that is used to reward the providers.

One problem of an AMM is that there can be a big slippage in price if the liquidity of a trading pool is too low. And providing liquidity isn't without risk either because should one of the tokens in the trading pair lose value and the other token gain a lot of value it will cause an "impermanent loss" scenario where the providers would have made more profit by holding their tokens individually. Still this enables anyone to trade instantly and in a decentralized way while also letting investors earn a yield with trading fees.

Since Uniswaps success there has been a big revolution in the entire DeFi market. That is partly because dApps and developers of new projects can utilize a DEX to launch a new token or to let their application make trades while staying completely decentralized. A lending protocol for example can use a DEX to sell the provided collateral of a failed DeFi loan to cover the outstanding debt. Applications can also have a buy back and burn mechanism where a part of their fees is being used to buy their governance token back from a DEX to destroy them. A decentralized exchange is a necessary infrastructure for a DeFi ecosystem.

Uniswap isn't the only DEX out there and many newer exchanges offer great features that Uniswap is missing. For example, DODO uses a newer model of the AMM to reduce price slippage and Balancer allows liquidity pools with more than 2 tokens that can be used as automatically rebalanced portfolios. Many DEXes on other blockchains can also have much lower fees. However, Uniswap is still the most popular DEX and has much more liquidity than most of its competitors and is partnered with many other applications.

Uniswap runs on the Ethereum main net and it’s Polygon and Optimism second layers.



The UNI Token

Uniswap has its own governance token called UNI. The holders can vote on possible updates to some of the parameters in the protocol and on what assets should be in its default token list.

There is a max supply of 1,000,000,000 tokens. 21.5% was kept by the developers and founders, 17.8% was sold to early investors, 15% was airdropped to early users and the remaining 45.7% is going to the liquidity providers of the protocol as an additional incentive. So most of the supply is going to users, but a big piece of the cake also went to team members and investors. The airdrop was sudden and played a big part in making Uniswap so popular. Any address that ever interacted with Uniswap before September 2020 received 400 UNI tokens, even 12,000 addresses that only sent failed transactions to the protocol. This 400 UNI were worth more than $15,000 at the ATH of the token and if you used multiple addresses you received this multiple times.

The value of a governance token depends on how much liquidity is in its smart contracts, because you can copy a protocol but you can't copy liquidity. Since Uniswap is one of the most famous and most used DEXes, its token is a relatively safe investment in comparison to most other cryptocurrencies. However, there is a lot of competition. DODO, BAL and many more offer useful features that Uniswap doesn't. It also didn't migrate to different blockchains like SushiSwap does.

UNI is supported by every bigger exchange like Binance for example. Of course Uniswap itself offers it too. A Ethereum wallet like MetaMask can store the token and interact with the Uniswap app.





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