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Crypto Blog: Coinberry

Everything You Need To Know About Uniswap

Introduction

Uniswap’s story begins with Bitcoin. 

When Bitcoin was released, it wasn’t released into the market expecting competition. It was a lone wanderer, carving out a path for itself and pretty much doing its own thing. If anyone mentioned cryptocurrency, they were talking about Bitcoin. 

This mentality persisted even after the first competitor cryptocurrencies joined the market, and for a time, there were some rivalries between different crypto communities. 

As more cryptocurrencies were developed, the user base grew and people wanted to be able to purchase and sell different cryptocurrencies. This started a new wave of business in the crypto world as exchange after exchange popped up to facilitate buying and selling crypto. 

Today, the rivalries still exist, but to a much lesser degree. And now crypto users will often hold multiple tokens, and would like to transact between the blockchains they use. 

This is where traditionally, exchanges come in. 

The Risks Exchanges Might Carry 

Because most crypto exchanges are unregulated, there are no liquidity requirements like traditional exchanges, like for stocks, have. So they operate in a manner that is slightly different. 

Small and medium exchanges avoid taking risk by waiting for a seller to become available. And large exchanges bank on their trade volumes to provide liquidity, though this isn’t always guaranteed and there have been multiple instances of large exchanges pulling currencies from the trading floor or stopping sales going through. 

Bitcoin is very commonly pulled from trade because of volatility. At times of big Bitcoin volatility, many of the big exchanges will stop orders going through to protect themselves from heavy losses. 

Next time you use an exchange and are unhappy at their fees, remember they are taking on significant risk in return for those fees. 

As cryptocurrency becomes more regulated, it is believed that exchanges will need to conform to traditional trading measures that are imposed upon stock market brokers and exchanges. 

Because of the volatility, it has been theorized that some crypto exchanges will struggle to get third parties to cover the liquidity issue, and may need to do it themselves. This will mean crypto exchanges will have much larger holdings of different crypto tokens, which has caused concern among users that in some cases exchanges might govern tokens like central banks do with currencies. 

This is why projects like Uniswap exist. 

Uniswap is a cryptocurrency platform that enables the trade of crypto tokens with a liquidity feature, in a totally decentralized way. 

Uniswap Creator

Despite Uniswap’s size and trade volume, it isn’t heavily “manned.” 

The creator of Uniswap is Hayden Adams, more on him to follow. Aside from Adams, there are a few other team members. As of this writing, Uniswap is currently advertising for applications in jobs that other tokens would have filled from the get-go. 

At the time of this writing, Uniswap is looking for a frontend engineer, smart contract engineer, stack engineer, an intern to the engineering team and a community manager. 

All of these jobs are typically filled in order to have ongoing operations, and it is very unusual that a crypto gets off the ground without having filled these roles. 

 

HAYDEN ADAMS 

Adams said he had very little interest in cryptocurrency until he was first introduced to a Buterin Reddit post by his friend in 2017. 

He has said he does not fancy himself as a prodigy or genius. He is a quiet and thoughtful founder that doesn’t like to be brash and showy with his creation. 

Despite that, Uniswap has turned thousands of dollars at initial start-up to over a billion dollars of trade in 2020.

Adams is rarely in front of the camera and lets Uniswap itself do most of the talking for him. 

Professionally, he has had very little to do with anything related to crypto and previously worked at Siemens as a junior engineer — which just prior to launching Uniswap, he had been fired from. 

At that point he was sent the Reddit post, he was still living with his parents and hadn’t given any indication that he would be able to get his life in order — let alone spearhead a billion-dollar crypto project. 

But spearhead he did, to successful results. 

He chose to use an Ethereum ERC20 token for Uniswap, because they are incredibly easy to make and take little effort to get the type of investment needed providing the idea is good enough. Something that makes Adams’ leadership unique is the amount of capital he was able to raise from scratch – I will outline how Uniswap is funded below. 

UNISWAP COMPANY AND STRUCTURE 

Given the odd way that Uniswap was started, which is exactly the “started in my mum’s basement” kind of success story, Uniswap doesn’t have a big or organized company structure. Though this is something that Adams is clearly trying to rectify with the job postings on the Uniswap website. 

The real success for Uniswap came in the form of the funds it was able to raise upfront — with not many features in their token and also a very short whitepaper. 

It was the idea itself that attracted the money. 

Venture capital funds all poured money into Uniswap to the tune of millions of dollars. With the likes of Andreesen Horowitz (who initially invested in Skype) putting in a large lump sum of money. 

 

How Uniswap Works

Uniswap is a Decentralized Exchange on the Ethereum blockchain. This means you can exchange (or ‘swap’) cryptocurrencies without anybody being a “third party” that oversees the swap. 

Instead, you swap one coin for another using smart contracts. Further, you are not trading crypto with another person like you are on centralized exchanges. Liquidity on Uniswap is provided by crypto that is deposited into pools by people at an earlier time or date than the date you are trading. 

This makes the crypto readily-available at the time you want to trade it, and eliminates the need for the decentralized exchange to “match up” with someone who wants the crypto you want to exchange. 

On the other end, there are people who provide this liquidity into the pool in the first place. Liquidity providers contribute their crypto to pools because it accrues interest. For them, it is essentially a way of earning passive income. 

So when they want to take their crypto out of the pool, they’ll have earned a percentage of the trading fees paid by the people swapping, or an interest rate. The longer they leave their liquidity in the pool, the more liquidity providers earn on their crypto. 

And that's how the system works in a nutshell. 

What I just described is called an Automated Market Maker (AMM). 

AMMs determine the price you will pay each cryptocurrency based on the ratio of two cryptocurrencies within a pool. 

Here’s an example: 

Suppose you have 10 ETH and 10,000 USDC in an AMM pool. This means each ETH is worth $1,000 USDC. Because 10,000 divided by 10 is 1,000. 

If someone were to come and buy one ETH from the pool, this would involve taking out one ETH and putting in one USDC. This would make the next ETH worth around $1,222. Because $11,000 divided by 9 is about 1,222. 

If the current price of ETH on centralized exchanges is still just $1,000, this would give an incentive to arbitrage traders to buy one ETH from a centralized exchange and sell it on this theoretical AMM for a $222 profit. 

This restores the price of ETH in the pool back to what it should be. 

Now—this example is simplified and a bit exaggerated to show you the point. In practice, the change in price when you actually buy or sell a crypto in an AMM pool is so small, it’s often unnoticeable. 

This is because there are thousands, if not millions of dollars of both cryptocurrencies in almost every pool, at any given time. Meaning any sales or purchases will have a minimal effect on price. 

That said — there are some cases where there is not enough cryptocurrency in the pool to dampen the effect of a large trade. Meaning, you end up over-paying for that cryptocurrency. 

The example pool I just gave you would fall into this category. Because you’d pay a $222 premium if you actually decided to buy that 9th ETH from that liquidity pool. 

When a DEX trade causes you to overpay for a cryptocurrency relative to its current market value, this is called Slippage. 

Naturally, the ratio of assets in a liquidity pool can and often does change as time goes on. If the price of ETH goes up, that means there will be less ETH and more USDC in the pool. And when the price of ETH goes down, that means there will be more ETH and less USDC. 

Sometimes, when the price of ETH goes up, it would have actually been more profitable for liquidity providers if they’d just held onto their ETH instead of putting it into the pool, where it gets gradually converted to USDC as the price of ETH rises. 

This difference in profit is called Impermanent Loss, which becomes permanent when the cryptocurrency being provided as liquidity in an AMM pool is withdrawn. 

Impermanent loss is a term to keep in mind. It’s central to the idea of a Decentralized Exchange. 

 

LP Tokens

Whenever a liquidity provider provides liquid crypto to a pool, they receive a corresponding amount of LP tokens. 

LP tokens are like receipts. They are basically vouchers that allow you to get the liquidity you provided into the pool back into your possession, along with the extra interest or fees you earned for the time it was in the pool. 

LP tokens can actually be traded for other cryptocurrencies on DEXs like Uniswap. Whoever you swap them with can then redeem your LP tokens for the liquid crypto you originally put into the pool. 

LP tokens are the backbone of DeFi applications to build on each other like “money Legos”. You can take LP tokens to another DeFi protocol like Aave to use as collateral to borrow more crypto. 

You can then use this borrowed crypto to provide even more liquidity to that same Uniswap pool, which would give you even more LP tokens, that you can use for collateral on Aave, and so on. 

Now that you know what LP tokens are for — make sure not to confuse them with the… 

UNI Token

The Uniswap token UNI is used for governance.  It is safe to assume that in return for their investments, each venture capital firm was given a certain amount of UNI. 

I have trawled online to see if UNI had a secondary ICO, but it seems that all investment was raised through private means and not through an ICO, making Uniswap a very unusual ERC20 token as most opt to go straight to ICO rather than source private investment. 

Presumably, all return on investment for those investors would be the selling of the UNI token in the future. Still, this hasn’t been confirmed by Uniswap. 

It is unclear exactly how much was raised from venture capital firms, but it is thought to be in the tens of millions, putting Uniswap on par with some of the most successful ICOs. 

The other thing that remains unclear is why the allocation of UNI is so one-sided considering it is supposed to be a decentralized platform. 

Tokenomics

The total supply of UNI is 1 billion tokens. These will become available over the course of four years, after which Uniswap will introduce a “perpetual inflation rate” of 2% to maintain network participation. 

The breakdown provided by Uniswap for UNI allocation as of launch is: 

  • 21.51% allocated for the development team, which includes Adams. It also includes future team member allocations as well. 
  • 17.80% to investors. 
  • 0.89% to advisors. 
  • 60% to the community. 

From these statistics, 40.2% of all UNI will be in the hands of either investors or those that started UNI. 

While that doesn’t look like a majority ownership at first glance — the 60% of UNI owned by the community will not be one entity that acts in a uniform way. 

That 60% will likely be owned by thousands if not hundreds of thousands of people, many of which won’t be active on the UNI platform because they will be traders. 

 

Conclusion + V3

Despite being one of the most copied protocols in DeFi, Uniswap has managed to maintain a dominance as the go-to DEX. 

This dominance has been slipping a bit as of late, which is likely why Hayden Adams and the rest of the team are working to get Uniswap V3 (Version Three) out of the door, with new features for liquidity providers and several exciting new ways to make the whole DEX more efficient. 

It’s likely that stablecoin AMMs like Curve finance could lose a significant amount of liquidity to Uniswap’s V3. If it does what Uniswap says it is going to do, liquidity providers might see it as the better option and migrate platforms. 

 

SOURCES

https://coinmarketcap.com/currencies/uniswap/

https://app.uniswap.org/#/swap

https://docs.uniswap.org/protocol/v2/introduction

https://www.getsmarter.com/blog/market-trends/how-decentralised-exchanges-will-affect-the-cryptocurrency-market/

https://medium.com/terra-money/survey-of-automated-market-making-algorithms-951f91ce727a

https://uniswap.org/whitepaper-v3.pdf

https://uniswap.org/blog/uniswap-v3/

https://medium.com/aave/aave-amm-market-released-73ae76a7cbc0 

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