What is Uniswap? Uniswap is an Ethereum protocol that is useful for trading ERC20 tokens. Its creator is Hayden Adams who was inspired by Vitalik Buterin who is none other than the founder of Ethereum who created the Ethereum postal protocol. Hayden Adams’ protocol was created in 2018.
On September 16, 2020, the Uni Token was also released, which is used to manage the Uniswap protocol. This token is also distributed free of charge to users who have assets in the platform’s liquidity pools. This token has also been released on several well-known platforms with other token pairs.
Going forward there will be more than one billion tokens released on the network of which 60 % will be allocated to community members while 21.51% will be for prospective employees. While 17.80% is devoted to investors who have a four-year vesting cycle.
Uniswap that is created on top of the Ethereum blockchain has an infrastructure like a wallet service such as MyEtherWallet or MetaMask. The uniqueness of this Uniswap Exchange is that in matching buyers and sellers in trading, it relies on simple mathematical equations, ETH and token pools to do its work.
How Uniswap Works
Uniswap takes advantage of the participation of liquidity providers in the form of trading fees. By participating in the liquidity pool by awarding the same amount of ETH and ERC20 tokens as the Uniswap contract. The reward for every swap transaction is that the swapper will pay a fee of 0.3% per swap.
This fee will later be added to the liquidity pool. Then the liquidity provider will also get a part of the transaction fee whose value is equal to the weight of the contribution in the liquidity pool. The way Uniswap works itself when grouped is divided into two things, namely as follows:
- Automated Liquidity Protocol
Uniswap was created as a solution to the centralized exchange system used in an automated liquidity protocol. This system usually works by providing incentives to parties who trade through exchanges so they can become liquidity providers (LPs).
The system in Uniswap itself uses a decentralized exchange and the way it works is that each registered token has its own set that can be used by users. The price for this token is also not arbitrary because it uses a computer-generated mathematical algorithm.
As a result there is no waiting period for both the buyer and seller in completing the transaction. Both can complete transactions instantly because the price is known as long as liquidity is considered sufficient to facilitate it.
Later each LP that gets a token represents a contribution to be staked to the pool. To understand this mechanism, you can listen to the following example :
If you contribute USD 20,000 to the liquidity pool while the capacity is USD 100,000, then you will get 10 percent of the pool. There will also be a fixed fee of 0.30 percent charged to the user for each transaction. These funds will later be sent to the liquidity reserve automatically.
If one day the LP chooses to leave, they will receive part of the total fee. Then the token which keeps the record regarding the asset will be destroyed afterwards.
- Token Pricing
In determining the Uniswap token price, an automated market maker (AMM) system is used. This system works by adjusting asset prices based on demand and supply by including mathematical equations.
The AMM system is able to lower or increase the price based on the ratio of coins in the pool. If someone adds a new ERC-20 token then he/she is required to add ERC-20 tokens to be able to start the liquidity pool.
In calculating the token price you can use the formula below:
x*y = k
X: Number of A tokens
Y: Number of B tokens
K: A constant value that doesn’t change in value
In trading there is a liquidity pool size factor that functions to determine how much the token price will change. If a lot of money is used, it will be easier to trade large amounts. It also doesn’t cause the price to drop too much.
If you have a lot of funds or have liquid assets, then using Uniswap can be an option to make a profit.
Advantages and Disadvantages of Uniswap
The advantage of this exchange platform is its decentralized nature which makes it easier for users to access the crypto market. This allows everyone to access without having to register or log in to the market first. You only need to use your personal wallet for buying and selling crypto transactions. You can also see other advantages below:
- The advantage of this platform is that it is able to include new tokens that directly access liquidity by adding tokens in exchange with the Uniswap V2 router contract.
- Liquidity providers will benefit if they put their funds into the liquidity pool
- Relatively low trading fees compared to other platforms
- The platform is decentralized because it is completely open source which means that anyone can copy the code to create their own decentralized exchange. As a result users can have full control over the funds they have.
This is different if the nature of the exchange platform is a centralized exchange which involves traders and investors in handing over control over private keys. As a result orders can be recorded through the order book.
Even though it has many advantages, Uniswap also has weaknesses. Some of its weaknesses include the following:
- It still relies on arbitrage trading to balance its market
- Has a fee fee that is still relatively high even though the trading costs tend to be low
- Has a high risk so it needs good risk management to avoid losses in the future
- There is a list of fake tokens passing by because they are still permission less
- Vulnerable to attacks on the flash loan/swap feature
Uniswap feature
Uniswap has a unique mechanism for setting its price, namely the “Constant Product Market Maker Model”. This mechanism is capable of making ERC20 tokens added in the Uniswap protocol. The value will be equivalent to ETH and you can trade it at a later date.
Features in Uniswap include being able to provide liquidity automatically. This has an impact on the mechanism of buyers and sellers in trading, they do not need to create their own liquidity.
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Author: Muhammad Zaki Fajrul Haq
Follow me at @mzfajrulhaq (Instagram) or @ZakiFajrul (Twitter).