What is Uniswap (UNI)? How Does It Work?

If you have been in the crypto space long enough, you might have spotted a token with a cute pink unicorn logo, which is associated with Uniswap. Perhaps you once thought that this Ethereum-based token is one of those weird game tokens or NFTs like Cryptokitties.

Uniswap on the front-end may look friendly. Yet, underneath the marketing facade lies one of the most complex software engineering marvels found anywhere in the DeFi space. The Uniswap protocol powers millions of US dollars of daily value exchange, and has locked up $3 billion in crypto assets.

But what exactly is Uniswap? Stick around as we take a closer look into the famous decentralised token exchange (DEX).

Explore DeFi:  What is DeFi (Decentralized Finance)?

What is Uniswap?

When someone mentions “Uniswap”, the person can refer to one of the following:

• Uniswap Lab is the company behind the development of the Uniswap platform.

• The Uniswap protocol is the software behind how the DEX works, and communicates with the Ethereum blockchain.

• The Uniswap platform is the web/mobile app platform where you can execute trades and swaps, which was built and deployed on the Ethereum blockchain. 

• The Uniswap token (UNI) is the governance token that you can buy, vote with, and to trade or swap on exchanges.

As a crypto investor, you are probably more interested in the Uniswap token (UNI). However, it makes sense to first talk about the Uniswap protocol and why its performance over the years has given value to the UNI token.

Simply, Uniswap is a decentralised token exchange platform. While it was technically developed and maintained by Uniswap Labs, it is decentralised, meaning that not even the founding team could make changes to its core infrastructure, without creating an entirely new Uniswap platform (there are two versions of Uniswap now, but we’ll get to it later.)

Being decentralised also means that the ecosystem is permissionless. Anyone can use the platform to swap or trade (ERC-20) tokens, and anyone can enlist new tokens and write new smart contracts to initiate a new market for a token pair. 

Anyone can also make a clone of Uniswap, as the source code is open for public viewing. In fact, there are now dozens of clones of Uniswap, with the most popular being Sushiswap.

Interestingly, Sushiswap appears to be in direct competition with Uniswap. 

Avoid scam DeFi clones: 4 Ways on How to Identify DeFi Scams.

What is the Uniswap (UNI) governance token used for?

With any decentralised projects, there has to be a democratic way to determine their direction. On Uniswap, there are many decisions to be made, such as the swap fees, new features to research, and how the UNI token is distributed to the various players in this ecosystem.

The UNI token was issued in 2020, even though Uniswap has been around since 2018. Unlike many other cryptocurrencies and tokens, UNI was not distributed through a pre-sale or initial coin offering (ICO), but it was simply airdropped to users and investors. 

On the first round of airdrop, 150 million out of maximum 1 UNI tokens have been distributed to anyone who has ever used the Uniswap platform, which accounts to 400 UNI per person. 

Related: Beginners Guide to Crypto Airdrops.

Uniswap plans to distribute more UNI tokens at a predictable schedule over four years, with 60% attributed to the community, 21.5% to the Uniswap Labs employees, and the remaining 18.5% attributed to investors and advisors.  

UNI governance token will play a crucial role in the upcoming Uniswap v3. Since Uniswap is a decentralised application, Uniswap v1 and Uniswap v2 exist simultaneously, and traders can choose whether to trade on one platform or the other.

Curious about tokens? Exploring the Types of Cryptocurrency Coins and Tokens.

What is the purpose of a decentralised token exchange?

There are dozens of cryptocurrency exchanges around the world, and many of them are centralised, meaning they are owned by a single authority, such as a company. 

For instance, Easy Crypto is a centralised crypto exchange. The primary responsibilities of a centralised crypto exchange is to follow government regulations, protect consumers, and guide them through the complexities of the crypto space — to provide them with a team of customer support. 

Decentralised exchanges (DEXs) have none of these features. Uniswap is technically an application of decentralised finance (DeFi), and we know just how risky this new industry could become to people who are not yet familiar with the technology. Not even Uniswap Labs can help prevent an initial coin offering of a worthless scam token. 

No matter how much risk a decentralised application may pose, many DeFi enthusiasts believe that when it comes to crypto trading, even the trading platform itself should be decentralised, permissionless, censor-resistant, and always available for as long as Ethereum exists.

Get started: Buy UNI tokens easily.

How does Uniswap work?

While Uniswap is a platform where buyers and sellers of crypto tokens come together to trade, it does not work exactly like conventional exchanges. To fully understand how Uniswap works, let’s take a look at how an ordinary exchange works.

How conventional exchanges work

Regardless of what market an exchange serves, they all work the same way, and that is through order books. What this order book contains is a list of all open trade offers, which is divided into two lists — the buy (or bid) and the sell (or ask) list. 

A transaction is executed when a buy order matches a sell order. For example, Alice wants to buy ADA at the bid price of  $1.10, while Bob wants to sell ADA at the ask price of $1.20. Using this traditional way, both Alice and Bob have to wait for other traders to agree on their prices. 

Meanwhile, most trades at the time occur at $1.14, where buyers and sellers “meet in the middle”. Alice could raise her bid price to $1.14, and Bob could lower his ask price to $1.14, which results in a matched order.

Unfortunately, this dynamic change of the bid and ask price in the order book will not scale very well on the blockchain, and can get expensive as the Ethereum network must keep up with this demand.  

How the automatic market maker protocol works

The automatic market maker (AMM) protocol was introduced to avoid the order book model. Instead of facilitating exchanges between traders, Uniswap facilitates trades between traders and liquidity pools.

A liquidity pool is a stock supply of a token pair. For example, there is a liquidity pool for ETH/LINK pairs, and a liquidity pool for UNI/USDT. A buyer can buy some tokens from a liquidity pool even if there are no sellers currently present.

You can think of a liquidity pool like a supermarket for crypto token pairs. In this supermarket, when the supply of one of the tokens increases, the price will get discounted. Like supermarkets, liquidity pools need to be restocked to keep the market liquid (i.e. to make it easier for buyers and sellers to get the stock that they want in an instant).

Liquidity providers (LP) are incentivised to lock up their crypto assets into a liquidity pool. Once their funds are locked up, they receive a liquidity pool token to redeem the locked up assets in the future. On top of that, they also receive a share of the profits generated from the 0.30% trading fee on the Uniswap platform. 

How the price of tokens are determined automatically

On Uniswap, traders trade with a smart contract, which sets the current market price and would execute the transaction only if the trader agrees to the set price.

For every token pair market there is a smart contract that facilitates the buy or sell orders. The exchange rate depends on the supply of one token in proportion with one another. Technically speaking, both tokens form the following mathematical relationship:

[token A] x [token B] = [some constant k]

The constant k is not as simple as multiplying the supply of the two tokens. It’s usually optimised with other multipliers or even functions to increase the efficiency of the exchange.

Let’s take a look at an example case. In a liquidity pool, there is a stock of 100 EZC (a hypothetical coin) and 200 USDT. This balance is set by the issuer of EZC who decided that 1 EZC will have an initial price of 2 USDT.  

100 EZC x 200 USDT = k = 20,000

The constant k will remain at 20,000 in this case. Let’s say Alice wants to buy 1 EZC with some USDT. How much would she pay in USDT for 1 EZC? A quick maths operation in your head would give the answer of 2 USDT. After all, 1 EZC should cost 2 USDT, correct?

However, according to the Uniswap protocol, Alice would have to pay slightly more, and that is before the trading fee. Let me explain a bit.

If Alice is planning to buy 1 EZC, she will subtract 1 EZC from the liquidity pool. Then, there will be an imbalance in the equation. The amount of USDT has to be restored so that k = 20,000. So,

(100 EZC – 1 EZC) x (200 + X USDT to pay) = k = 20,000

Working on the simple algebra, we find that X = 2.02 USDT before the trading fee. 

Now if Bob is willing to buy say 50 EZC from the current stock, he’d have to pay way more than 2.02 USDT per EZC as the stock of EZC becomes more scarce, and therefore more expensive.

(99 EZC – 50 EZC) x (202.02 + X USDT to pay) = 20,000

We find that Bob will need to pay 206.14 USDT, which effectively means that he bought 1 EZC for 4.12 USDT, at more than twice the rate that Alice had paid for.

How to buy Uniswap (UNI) in South Africa

The Uniswap platform is a technological marvel in itself. Seeing that it operates independently and automatically, without missing a heartbeat with 24/7 runtime since 2018, the platform has become one of the highest performing DeFi applications yet.

Uniswap is also benefiting from good branding, which attracts even more demand for the UNI tokens. Its 1 billion token supply cap and a controlled “inflation rate” from the distribution schedule make it all the more desirable.

With that said, you can easily add Uniswap (UNI) to your crypto portfolio with our platform at Easy Crypto.

Uniswap is just one of over 160+ altcoins that we offer in South Africa, with others ranging from NFT tokens, Metaverse, DeFi, and many more.

Start here: Read our simple guide on buying cryptocurrencies in South Africa.

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