A Decentralized Exchange (DEX) is where peer-to-peer transactions occur between crypto traders. DEXs satisfy one of crypto’s primary responsibilities: to foster financial transactions without brokers, banks, payment processors, or any other intermediary.
The most popular DEXs, such as Uniswap and Sushiswap, use the Ethereum blockchain and are one of the growing suites of decentralized finance tools called DeFi. DeFi creates an atmosphere where financial services are made available directly from a compatible crypto wallet.
DEXs are flourishing; they gained approximately $217 billion in transactions through decentralized exchanges in the first quarter of 2021. There were also over 2 million traders as of April 2021, which is up to ten times increase from May 2020.
As mentioned in the second paragraph, one of the leading DEXs is Uniswap. Uniswap is the world’s most straightforward automated market maker (AMM). Since its inception on November 2, 2018, it has been widely accepted in the world of crypto and has exploded in volume, crowning itself as the world’s largest DEX.
Read along to find out how Uniswap became the king of DEXs, the functions of the Uniswap coin, and far Uniswap has dominated the market.
What is Uniswap?
Uniswap is an exchange platform that uses a new trading model called automated liquidity protocol.
Launched in 2018 on the Ethereum blockchain, the Uniswap platform is the second-biggest cryptocurrency project by market capitalization. Uniswap is compatible with all Ethereum Request for Comment 20 (ERC-20) tokens and infrastructures like MyEtherWallet and MetaMask.
Eventually, Uniswap introduced an updated version in May 2020. The new version was called Uniswap V2. While the first version allowed users to swap between ETH and one ERC-20 token, the V2 uses Wrapped Ether (WETH) for core contracts, allowing users to pull ERC-20 tokens directly with other ERC-20 tokens.
Also, the prices became lower and more difficult to manipulate the price. As a result, they released another version in 2021, which was called Uniswap V3. Uniswap V3 gives liquidity providers access to multiple fee tiers and concentrated liquidity for better capital allocation while capturing more fees.
Uniswap V3 also gives easier and cheaper oracle integration with TWAP (time-weighted average price) on demand which calculates for up to 9 days. With this, individual liquidity providers enjoy more control, allowing them to get paid for taking varying risks.
Uniswap operates on two smart contracts: the Factory contract and the Exchange contract. These two are automatic computer programs designed to perform certain functions once you meet specific conditions. For example, the factory smart contract adds a new token to the platform, and the exchange contract facilitates all token swaps.
How Does Uniswap Work?
The Uniswap protocol was motivated by the on-chain automated market maker (AMM) concept by Vitalik Buterin. It mainly uses the Constant Product Market Maker Model (CPM) pricing mechanism. CPM is an alternative to the Automated Market Making (AMM) system for traders to trade against it.
The platform is open-source, meaning anyone can use the code to create decentralized exchanges. In addition, unlike other centralized exchanges that charge very high fees to list new coins, Uniswap allows users to list tokens on the business for free.
Since it is a decentralized exchange, users control their funds every time, unlike a centralized exchange that holds private keys. In addition, this allows the logging of orders to an internal database instead of executing on a blockchain, which can be more expensive and time-consuming.
Retaining control of private keys eliminates the risk of asset loss if the exchange is hacked.
How Uniswap Became A Prominent DEX
Uniswap reigned as the unchallenged leader of the DEX revolution. The exchange depended on an intelligent algorithm available on the platform for buyers and sellers to fix prices on hundreds of ERC-20 token pairs.
Since its rise, there have been several other inventions in AMMs; there has been an emergence of a legion of Uniswap descendants, each with unique features. Though they all have a similar design to Uniswap, they are all designed with particular pricing functions.
Take Balancer, for example; a multi-dimensional surface determines its multi-asset function, or Curve, which uses a mix of constant sum and constant product. They also have shifted curves that needed more inventory, such as the one Foundation uses to sell limited edition goods.
Decentralized exchanges such as Uniswap depend on mathematical formulas to set the price of assets. The technology used for this is called an automated market marker (AMM) which removes the need for an intermediary to set prices for the market.
Uniswap gained mass adoption because anybody can offer liquidity to the platform, publish a token without signing up, or undergo rigorous identification verification. The exchange depends on a sophisticated algorithm rather than a central order book to dictate the values of the hundreds of trading pairs of ERC-20 tokens. Also, it has cheap trading costs and a user base that is rapidly expanding.
Benefits of Uniswap
1.It is Simple to Implement
Uniswap is simple to implement, meaning there is low complexity, low integration costs, and low surface area for hacks. Also, it has low gas costs, which is very important when implementing your trades on an equivalent decentralized graphing calculator.
2.It Has A Small Regulatory Surface
Uniswap is decentralized and requires no off-chain inputs. Unlike other book DEXs that operate an exchange, Uniswap is free to utilize pure financial innovation.
3.It Is Easy to Provide Liquidity to Uniswap
With a click on “set and forget it, “it is much easier to provide liquidity than getting active market makers to give liquidity on an order book exchange, especially since DeFi is beginning to attract serious volume.
Beneficent whales provide most of the liquidity of Uniswap and are less sensitive to returns. The one-click experience on Uniswap makes it less stressful for them to participate. Unfortunately, most crypto designers ignore mental transaction costs and assume market participants are infinitely industrious. However, Uniswap makes liquidity provisions that have eventually paid off.
4.It Is the Most Successful Decentralized Exchange
Not only does Uniswap allow you to swap crypto tokens, but it also allows you to earn interest on your crypto holdings with liquidity pools.
The Uniswap Coin
Uniswap coin is a token given through an airdrop to every Ethereum address that has joined the Uniswap platform before September 2020. Every participant received 400 UNI tokens. At the time, the token was worth $3 per coin, which amounted to a $1,200 airdrop, which was a lot. Anyone with a Uniswap coin can decide the direction of the Uniswap protocol.
The more Uniswap coin a person has, the more influence they have when deciding whether to support ideas that would affect the Uniswap protocol. For instance, Uniswap token holders can vote on the first community request to decrease the barrier to propose a modification to the protocol.
Someone could disrupt the protocol with around $35 million worth of Uniswap. However, many will be able to influence this decision if they lower the barrier because many are holding coin worth close to that amount.
The Uniswap Method
Uniswap is the leading candidate in Ethereum decentralized exchanges. Although there are more than 500 trading pairs registered under Uniswap, only about 50 of these trading pairs hold more than $500,000 volume per day.
Coins on the Uniswap platform don’t trade against Ethereum (ETH) but with Wrapped Ether (WETH), which is the most noticeable feature of the network. Like WBTC, WETH is just Ethereum wrapped in a smart contract to create an ERC20 token. The ERC20 token is available on Uniswap and dozens of protocols in the DeFi ecosystem.
For anyone who wants to create a system that supports both Ethereum and ERC20, you will need to put more effort than just converting ETH to WETH. However, WETH holders have unlimited access to an on-demand ETH conversion service.
How Uniswap Acquires Liquidity
Controlled exchanges increase the platform’s liquidity by connecting sellers and buyers. Uniswap is unique. On Uniswap, a user who adds two coins to the forum in an equivalent amount to the one the provider wants to trade is called a liquidity provider. For example, an equivalence of $50 of DAI to WETH.
Depending on the number of DAI or WETH they deposit into their liquidity pool, each liquidity provider gets a trading fee incentive. Also, the liquidity provider may request that their coins be returned anytime. Uniswap now has $3 billion from various liquidity sources, compared to less than $2.5 million secured in May 2020, meaning they are expanding exponentially.
In daily trading activity, the decentralized exchange sees more than $100 million with a rise in transaction volume. As a result, Uniswap is one of the notable decentralized global exchanges regarding daily trading volume.
Uniswap enjoys being the first-mover, and they might be leading in the competition for trade volume so far. However, if Uniswap can maintain this win, only time will tell. Nevertheless, the company manages the platform effectively, and its success in the future seems inevitable.
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