Earn interest on Uniswap DEX

By ScreenTag | The Other Side | 19 Jun 2020

Uniswap is a decentralised exchange of crypto-assets, where holders of crypto-tokens are able to exchange one for another (e.g. from LRC to ETH). Being decentralised, this means it charges very little in fees (0.3% + gas fees). A liitle known transaction though, earning holders a share of the fees is the provision of liquidity. Let's see how this works, and how much you can make.

How does a DEX work

Decentralised exchanges are based on asset-pair pools, where holders are adding one asset in the pair for the other. For instance, if you exchange (called 'swap') Loopring for Ether, in reality you dposit Loopring coins to the pair pool and withdraw Ether from the pair pool. Each swap transaction though, depending on its relative size to the pool size, has an effect on the pair exchange rate. In practice though, popular tokens, like BAT or DAI, have huge pools worth of hundreds of thousands of dollars, and the effect of everyday transactions or several hundreds of dollars of value is minimal.

In this model, if a group of holders were trying to drain one asset from a pair (e.g. all Ether from the ETH-DAI pool), they would be paying insane rates, that would be making such transactions financially meaningless. In short, each pool has - give or take - equal value of each asset, depending on the given exchange rate (e.g. $100,000 worth of Ether and another $100,000 worth of DAI in the ETH-DAI pool).

In liquidity provision transactions though, a holder is depositing (or withdrawing) equal worth of value on both assets of the pair, with no effect on the exchange rate, regardless of the transaction size. In exchange for the assets deposited, the holder receives pool tokens, representing the holder's share in the pool liquidity. This share is used to calculate the holder's share on the transaction fees earned by the pool.

Earnings strategy

To earn a meaningful interest out of liquidity provision transactions, you will need to commit to a popular pair, with lots of transactions - and therefore lots of fees. In Uniswap, there are token pairs earning several thousands of dollars, but they usually refer to exotic pairs (assets that have just launched out of an ICO), that last only for a few days - with the added risk of a liquidity provider being unable to convert those exotic assets into more mainstream tokens.

Two pairs that have sizable liquidity and large number of transactions are those including the two mainstream stablecloins; DAI and USDC agains Ether (DAI-ETH and USDC-ETH). With the latter being in a pool of a lower overall value - where your investment buys you a larger share in the pool - an investment of just $100, buys you 0.0005% in the pool. This means, you have to deposit $50 worth of ETH and another $50 worth of USDC in the pool (plus gas fees). This particular pair is increasing in popularity, so you would expect to be making more in your share of exchange fees as the time goes by. For instance, only one month ago transaction volume was from $68,000 to $240,000, while in the past few days the transaction volume has reached $835,000 (lowest volume for the week was $180,000). Fees accumulated for yesterday (which was the day with the highest volume) was $2,482.

Let's see what interest would that small $100 investment would make.

As mentioned, $100 ($50 in ETH and $50 in USDC), is buying you 0.0005% of the pool. This means that you earn 0.0005% of whatever transaction fees the pool earns. If you multiply $2,482 with 0.0005%, this makes $0.0124. This may not sound much, but if you see it in a longer term, fees for the week were $8,595 and your pool share would make you $0.043. Even at this average transaction volume, the ARR is at around 2.25%. Given though the growth rate of the transaction volume in the pair, you may expect an ARR of at least 9%, without missing the opportunity to make more, if ETH goes up.

We consider such an investment to be one of the safest out there, and as such the ARR is lower compared to riskier investments.

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