Decentralized exchanges solve many of the problems of centralized counterparts such as hacking risks, mismanagement, and discretionary fees. However, they still have their own problems, mainly lack of liquidity, i.e. lack of money moving around the exchange making transactions faster and more efficient. That’s why Uniswap appeared. The protocol is trying to solve the liquidity problem of decentralized exchanges by allowing the exchange to exchange tokens without relying on buyers and sellers to generate that liquidity.
The article will explain how Uniswap works and how it became one of the most popular decentralized exchanges on Ethereum.
What is Uniswap?
Uniswap is an Ethereum-based protocol for swapping ERC20 tokens. Unlike most exchanges that are designed to collect fees, Uniswap is community-driven, a tool for the community to trade tokens without having to pay platform fees or middlemen. Also, unlike most exchanges that match buyers and sellers to determine prices and execute trades, Uniswap uses a simple math equation and a token pool, ETH to do the same thing.
Who invented Uniswap?
Uniswap was created by Hayden Adams, inspired by a post by Ethereum creator Vitalik Buterin.
What’s special about Uniswap?
The main difference of Uniswap from other decentralized exchanges is the use of a pricing mechanism known as the “Continuous Product Market Maker Model”.
Any token can be added to Uniswap by funding it with the equivalent value of ETH and ERC20 tokens being traded. For example, if you wanted to do an altcoin exchange called Poop Token, you would launch a new Uniswap smart contract for Poop Token and create a liquidity pool for example $10 and ETH worth $10.
Where Uniswap differs in that instead of connecting buyers and sellers to determine the price of Poop Tokens, Uniswap uses a constant equation: x * y = k.
In the equation, x and y represent the number of ETH and ERC20 tokens available in the liquidity pool, and k is a constant value. This equation uses a balance between ETH – ERC20 tokens and supply – demand to determine the price of a particular token. Whenever someone buys Poop Token with ETH, supply of Poop Token decreases while supply of ETH increases, i.e. price of Poop Token increases.
Therefore, the price of tokens on Uniswap can only change if a transaction occurs. Essentially, what Uniswap is doing is balancing the value of tokens and swapping them based on how many people want to buy and sell.
Any ERC20 token can be listed on Uniswap without permission. Each token has its own smart contract and liquidity pool. If not, can be created easily. Once the token has its own smart contract and liquidity pool, anyone can trade tokens or contribute to the liquidity pool while earning a liquidity provider fee of 0.3%. To contribute to the liquidity pool, you need equal value of ETH and ERC20 tokens.
How are Uniswap tokens produced?
Whenever a new ETH/ERC20 token is contributed to the Uniswap liquidity pool, the contributor will receive a “pool token”, which is also an ERC20 token. Pool tokens are generated whenever funds are deposited into the pool and as ERC20 tokens. It is free to exchange, move and use in other dapps. When the coins are withdrawn, the token pool is burned or destroyed. Each token pool represents the user’s share of the pool’s total assets and the 0.3% transaction fee share in the pool.
What can you do with Uniswap?
The Uniswap protocol can be accessed through the uniswap.exchange front-end. From there, anyone with an Ethereum wallet like MetaMask can exchange or add tokens to the Uniswap liquidity pool.
Since Uniswap is an open protocol of smart contracts, anyone can build front-end user interfaces on top of it. For example, InstaDApp allows you to add funds to the Uniswap pool without accessing the official Uniswap UI. New interfaces like DeFiZap allow users to add funds to the Uniswap pool using only ETH instead of ETH and another token. The interface even offers simple one-click solutions for buying token pool combined with bZx token strategy.
At this rate, we should see more integrations between Uniswap’s unique token swap system and new DeFi products in the coming years.
Dislaimer: This information is provided as a personal blog, not general information or investment advice. We are not responsible for your investment decisions.
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