How Uniswap (and other DEXs) is making money

By ScreenTag | The Other Side | 7 Oct 2020

Many crypto-enthusiasts, believe that decentralized exchanges are some kind of a public service, where crypto developers are writing code just for fun or fame. They also believe that decentralized exchanges are not making any money, and all gas fees are going to the greedy miners. Truth couldn't be farther from that perception. Decentralized exchanges, lead by Uniswap are making loads of money on your expense. They only take extreme care to hide that from their users, so they can get more supporters.

Here are how they make money on your back.

Transaction fees

This is where users tend to blame miners for high gas fees. In each transaction, about half of the fees are pocketed by the exchanges. This is no news, as the protocol allows various fees to be imposed when interacting with smart contracts (0x was the first protocol to adopt this practice en-masse). The difference is on how much these fees are accounting for. For instance, at the time of writing Uniswap had transaction volume for the past 24 hours of about $428.5M (including liquidity provision), consuming over $875k in transaction fees. For the same volume, a centralized exchange would have charged some $428k in fees. With half of the gas fees pocketed by Uniswap, the exchange made some $435k, or $7,000 more than a centralized exchange.

Decentralized exchanges advertise they do not charge you any fees, but in reality they are charging you more than centralized exchanges. The difference is that they disguise those fees, to remain hidden under gas fees.

Liquidity pools

Uniswap and other decentralized exchanges advertise they are paying fees to liquidity providers, usually at 0.3% on the transaction value happening in each pool. These fees are subtracted from the exchanged value on each transaction, not paid directly from the fees paid through gas fees. In reality, if you swap any pair at a 1:1 rate, what you actually get as that rate is a 1:1.003 rate, only shown as 1:1. Centralized exchanges follow the same practice, but they only charge 0.1% on any given transaction value. Decentralized exchanges charge 3 times more.

You may think now: 'At least, those fees go to the liquidity providers, so this is not entirely wasted'. Technically, yes. Practically, no. In our last post 'Uniswap: The market is rigged' we have shown several instances where Uniswap is the major liquidity provider, pocketing up to 97.5% of those fees. At the time of writing, liquidity provision fees for the past 24 hours were at $1.3M, with $200k attributed to the USDC-ETH pair, where Uniswap holds 97.5% share of liquidity provided. $195k in fees from one pair alone, on top of the $435k, this makes us $630k in just one day.

Pump and dump

There is the famous quote by the Gordon Gecko character: 'Greed is good'. That's why all decentralized exchanges are looking to create their own token - supposedly for community governance, but this is just the story they are selling you; users will never be allowed to decide for anything. It doesn't really matter how each exchange distributes their tokens. Uniswap decided to combine airdrop with liquidity provision incentives - in fact, many users decided to offer their airdropped tokens in liquidity pools, to maximize their returns. This made both volume and liquidity to skyrocket within just a dew hours. The day prior to the airdrop, on September 16th, Uniswap's liquidity had dropped to $916.6M. By the end of September 17th, Uniswap's liquidity climbed to $1.4B, and the day after, on September 18th, to $1.91B with Uniswap token priced at an outrageous price of $8.10, 2.5x the price of the previous day. When pumping stopped, having served its purpose, dumping started. At the time of writing, Uniswap token is struggling to hold $2.50. Despite though Uniswap's price falling by over 60% from September 18th, liquidity in the token dropped from $27.8M to $19.7M, or 29.2% - or half the price drop rate. Somehow, despite the price plummeting, users decided to provide double liquidity in the token, rather than removing liquidity.

Historically, both 0x (ZRX) and Kyber network (KNC) have followed the same strategy. Kyber Network pumped up to $4.50 only to drop to $0.20 during dumping (now at around $0.90, thanks to listing to centralized exchanges), and 0x pumped to $2.50, and dumped down to $0.15 (now struggling to hold $0.30).

Decentralized does not mean community-owned

DEX developers are not working to build a community around their exchange out of noble emotions. The contrary. they are building communities to take advantage of the community members and their social circle. Don't be fooled by the stories they are selling. They don't give a dime about the community. They only care to make money, by pretending they care about others, just like corrupt politicians do.

This behavior alone, is outright fraud.

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