The Rocket Fuel of Uniswap: DEX Explained

On August 30th, the daily turnover of the non-custodial trading platform Uniswap for the first time, exceeded the corresponding figure for the largest American crypto exchange Coinbase.

Every day in the news, we see this crypto DEX with a unicorn on its logo. What is so special about the Uniswap exchange? What is the reason for such popularity? Let’s take a look at the Uniswap phenomenon with Changelly.

What Is Uniswap?

Uniswap is an Ethereum-based decentralized exchange that allows anyone to exchange their ERC20 tokens. There is no need for transactions, registration, identity verification, and other things. 

The feature of ERC20 tokens is their interchangeability. They are nearly equal to each other within the Ethereum blockchain. This allows you to exchange them easily. 

Uniswap was created to address the liquidity problem faced by conventional cryptocurrency exchanges. Liquidity is the ability to sell any stock of coins on the platform without significantly affecting the price, which requires a large number of sellers and buyers. 

uniswap liquidity and trading volume charts
The Uniswap Volume and Liquidity as for 9th September

UPD: On September 10, Uniswap lost over 70% of its liquidity as a result of its migration to the SushiSwap fork.

How Does an Ordinary Exchange Work?

Let’s say you want to buy 10 Ethereum tokens for $400. You place a buy order, after which the exchange starts looking for matching orders to sell ETH for $400 or less. If the volume of sell orders exceeds the required amount of 10 Ethers, then the order is executed, and the coins are sold. 

If there are too few sellers – which means not enough liquidity – the order is not fully executed. If there are no response orders, then the original order is sent to the order book. The order book is a list with a digital indication of current orders for purchasing or selling a particular stock market asset at the participants’ prices.

Uniswap Guide with Advanced Tips and Tricks!

How Uniswap Works?

Uniswap creates the market automatically, which makes trades almost instantaneous. Therefore, it is called an automatic market maker. In Uniswap, it is enough to send coins from your wallet to a specific address and receive the necessary tokens in return. 

Uniswap uses smart contracts and liquidity pools. The exchange of tokens is performed automatically without human participation. Smart contracts provide this process. Since Uniswap operates with its help, transactions require more gas than a typical transaction. Accordingly, the exchange will cost more than a simple transfer.

How Uniswap V2 Liquidity Pools Work

Liquidity pools are reserves of tokens in smart contracts. They are available to users for making transactions. If certain coins are not locked within the protocol, you will not be able to buy them. This is a cell with tokens from which platform users can take them in exchange for other coins.

Developers cannot fill the liquidity pool for their projects exclusively with their tokens, since this goes against the rules of automatic market making. The essence of AMM is to continually maintain a balance, taking into account the amount of liquidity on different tokens paired with Ethereum. Liquidity providers must also add the equivalent of the token amount in ETH.

Uniswap exchange does not determine the asset’s price considering the number of buyers and sellers but uses the constant equation x * y = k.

In this case, x and y mean the number of Ethers and ERC20 tokens, respectively, available in the liquidity pool at any given time. k is a constant value.

This equation uses the balance between ETH and ERC20 tokens, their supply, and demand in order to determine a particular token price. Whenever someone buys Coin X with ETH, its supply decreases, and the supply of ETH increases. As a result, the value of the coin X rises because the equation must be observed. Uniswap multiplies the sums and makes sure that k is equal to the same number.

The cryptocurrency rate on Uniswap can only change if a transaction is made. The platform’s task is precisely to balance the cost of tokens and the volume of their swaps, taking into account how actively users want to buy and sell them.

Uniswap Exchange Participants

There are two main parties to Uniswap – buyers and liquidity providers.

Buyers connect their cryptocurrency wallets (most often this is MetaMask), select the desired coin, indicate the desired purchase volume, set the cost of gas for swap, pay fees and receive new coins.

Liquidity providers enable traders to exchange coins and make money on it. Anyone can become a liquidity provider. For this, you need to provide a particular token and an equivalent amount of Ether at the platform’s current exchange rate. You need to fill the already mentioned cell, from which other users will take tokens.

Liquidity providers make money on commissions. From each transaction, they are deducted 0.3% of the trading volume. This encourages providers to share tokens and keep the platform running smoothly.

Uniswap Advantages & Disadvantages

Now, let’s summarize everything mentioned above and discuss some pros and cons of the Uniswap platform. 

Advantages

  • No need for KYC. Uniswap users do not need to verify their identity. No matter how gigantic the trading volume or the platform’s activity, you won’t have to provide documents. The system works based on smart contracts and without any supervisory authorities from above.
  • No need to create an account, specify an email address, and write down a password because there are no accounts on Uniswap. You will need to enter the password only from the MetaMask wallet.
  • Instant swap. Uniswap users do not wait for orders to be executed, as they do on exchanges. Instead, they carry out token exchanges, and the speed of the process depends on the size of the commission.
  • Wide range of tokens. Any token can be listed on Uniswap. Usually, coins appear there much earlier than on large exchanges, so this is the opportunity to make money.
  • Simple interface. It is very easy to understand the working principle, and only a few clicks are needed to make a deal. If you already have MetaMask or experience working with other online wallets, you will not have problems with Uniswap.

Disadvantages

  • Swaps are sometimes too expensive. Token swaps work through smart contracts that spend much more gas than regular transfers. So if now you need to pay 1-2 dollars for a regular shipment, then in Uniswap, it is worth setting up to pay for the operation from 4-5 dollars and more. If the Ethereum network is overloaded, get ready to give away a lot of money.
  • An abundance of scammers. Any token can be added to Uniswap. This is actively used by scammers who create coins with a similar ticker and hope that the inattentive users will buy a useless copy instead of the original. The number of the token’s contract will help to avoid the scammers’ trick.
  • The platform is not suitable for large purchases. It will be less profitable to carry out operations on large volumes than on relatively small sums. With large orders, the balance between x and y in the above equation will shift much more sharply and more actively. 
  • High commission. Uniswap users profit from the growth of token rates, which sometimes happen very quickly. For a faster exchange, they charge a high gas price. As a result, this affects the general level of commissions. As practice shows, if you set the expected processing time of a transaction to “slow,” such an operation will most likely fail. So be ready to spend a lot.

Bottom Line

Uniswap is the next step in the development of cryptocurrency exchanges. The platform works in a decentralized manner and, at the same time, perfectly fulfills its tasks. Its user base, against the backdrop of the boom in popularity of the decentralized finance sector, grew at least twice in August than the previous month, and the indicator does not plan to stop.

In September, Uniswap surpassed Aave and Maker in terms of the value of funds blocked on smart contracts. Profitable farming, which led to a significant increase in trade volumes, became the driver for reaching the leading positions. It seems that we will continue to receive breaking news from Uniswap.