Summary: Uniswap is a decentralised exchange (DEX) and a key player in the DeFi ecosystem, offering a non-custodial trading platform through smart contracts and automated market makers (AMMs). It allows permissionless creation of liquidity pools for any ERC20 tokens and lets users earn fees by providing liquidity. The Uniswap Protocol has undergone significant improvements from V2 to V3, including custom price range liquidity allocation for better efficiency. Yield earning and fee-sharing features are also expected to be released soon.
Uniswap, while safe due to non-upgradable smart contracts, requires caution for token trading due to potential scams. UNI token holders have governance rights over the protocol, and tokenomics include allocations for community members, team, investors, and advisors.
What is Uniswap?
Uniswap is a decentralized exchange (DEX), serving as a vital component of the Decentralized Finance (DeFi) ecosystem. Unlike centralized exchanges, Uniswap eliminates the need for users to trust a central authority, thus mitigating risks such as hacking, mismanagement of funds, and arbitrary fees. The aim of DeFi is to replace these centralized intermediaries with non-custodial platforms like Uniswap.
The Uniswap Protocol operates through a set of smart contracts that form an automated market maker (AMM), facilitating decentralized token swaps and market making. Liquidity providers (LPs), or market makers, contribute to liquidity pools to earn fees. These liquidity pools, essentially funds locked into a smart contract, serve as sources from which users can trade tokens.
Uniswap is known for its key features such as the permissionless creation of pools for any ERC20 tokens, the ability to swap tokens between any existing pools, and earning fees by providing liquidity. Furthermore, it offers a user-friendly interface, making DeFi more accessible.
Uniswap V2 vs Uniswap V3
Uniswap V2, the predecessor to Uniswap V3, primarily focused on enhancing the user experience, transaction fees, and overall performance. In Uniswap V2, liquidity was evenly distributed across the entire price spectrum, ranging from 0 to infinity. This distribution was governed by the 'constant product' formula, denoted by x * y = k, where x and y represent the quantity of tokens A and B respectively, and k is a constant. The implication is that trades alter the reserve balances, leading to a new price.
In contrast, Uniswap V3 introduced a novel feature allowing liquidity providers (LPs) to allocate their liquidity to specific price ranges, leading to enhanced liquidity efficiency and increased rewards for LPs. In V2, much of the liquidity often remained unused, especially in stable pools where about 0.5% of the total capital was actively traded. The 'concentrated liquidity' feature in V3 encourages LPs to focus their liquidity where it is most needed, ensuring that their capital stays active. This is a market-driven approach to liquidity distribution, rewarding rational LPs for their strategic liquidity placement.
Is Uniswap Safe?
Uniswap is considered one of the safest protocols within the DeFi space, largely due to its use of non-upgradable smart contracts. Both its V2 and V3 products have undergone multiple audits conducted by highly reputable entities in the industry, further attesting to its security.
Despite these safety measures, users need to exercise caution when trading tokens on Uniswap. Its permissionless design allows for the creation of liquidity pools by anyone, which could potentially be misused by scammers. For instance, a scammer could create a pool and provide all the liquidity, while holding the majority of the token supply. They could then entice users to buy the token, only to sell off their entire supply and withdraw the liquidity, thereby exploiting the unsuspecting users.
What Networks is Uniswap Available On?
Uniswap is fairly selective in the chains it supports, having a very Ethereum ecosystem-focused scope. It is currently available on:
- Ethereum (Layer 1 mainnet)
- Polygon (Ethereum sidechain)
- Arbitrum (Ethereum optimistic rollup)
- Optimism (Ethereum optimistic rollup)
- Celo (Mobile-first Ethereum Virtual Machine [EVM])
What Assets are Available on Uniswap?
Uniswap's extensive asset availability is a major highlight. It's a permissionless protocol, which means it's capable of listing any ERC-20 or EVM-compatible token. These tokens can be combined with others to create liquidity pools through the Factory smart contract. This broad compatibility extends across various chains including mainnet, Arbitrum, Optimism, Polygon, and more. Once liquidity is introduced into these pools, they're freely open for trading to everyone.
How to Yield Farm on Uniswap
Yield farming on Uniswap can be achieved in a few ways, with the most prevalent method being to provide liquidity, thereby becoming a "Liquidity Provider" or "LP". It is also anticipated that in the future, the Uniswap protocol will activate a fee switch, allowing stakers to earn a proportion of the protocol fees revenue.
Providing Liquidity on Uniswap
At present, yield generation on Uniswap is primarily through providing liquidity to different pools. Each pool operates on a set fee tier where a portion of each trade is given to the LPs. In the V2 model, this fee is integrated into the pool, enhancing its overall value and consequently increasing an LP's proportional share in absolute terms. However, with V3, fees are individually distributed to each LP and need to be claimed.
To thrive as an LP, it's essential to grasp the concept of impermanent loss (IL). IL refers to a potential loss that occurs when the prices of tokens within a pool fluctuate compared to their initial deposit price. The larger this price deviation, the greater the IL. Thus, the yield garnered from providing liquidity should surpass any IL to ensure net profitability.
UNI Fee Switch
The idea of distributing fees to UNI token holders has been a long-standing debate within the community. The Uniswap 'Fee Switch', a feature coded into the protocol since its inception, is now up for a governance vote. The proposal aims to redirect 10% of the fees given to LPs to a protocol fee pool for select pools, primarily to assess if such a move impacts the depth and volume of liquidity. It's crucial to note that all accrued protocol fees will stay "uncollected" within each pool's smart contract until the governance decides their best use via voting.
Uniswap employs a varied fee structure for its V3 pools, with rates set at 0.01%, 0.05%, 0.3%, and 1%. However, for V2 pools, a standard fee rate of 0.3% is applied. At present, these fees are entirely 'supply-side', meaning they are fully allocated to the liquidity providers (LPs). These fees are paid out in the form of revenue to the LP.
You can track Uniswap's historical and live daily fees here.
Uniswap Tokenomics and Vesting
The UNI token plays a crucial role in the Uniswap ecosystem, offering its holders the ability to propose and vote on alterations to the protocol, such as fee adjustments and management of the Uniswap treasury. This democratic system allows UNI token holders to exercise significant control over the platform's direction.
At the project's inception, 1,000,000,000 UNI were minted, with their release scheduled over a 4-year period. The allocation of these tokens was divided as follows: 60% were assigned to Uniswap community members, with 15% immediately claimed as a retrospective airdrop. 21.266% were reserved for team members and future employees, with a 4-year vesting period. Investors received 18.044% with the same vesting period, and 0.69% were allotted to advisors, also with 4-year vesting. To encourage sustained involvement in the protocol and governance, a perpetual inflation rate of 2% per year will commence after the initial 4 years.
The remaining 43% of the UNI supply is to be retained by the governance treasury, which is fully controlled by UNI holders through governance. This is vested to the treasury in accordance with the following schedule. Team, investor, and advisor allocations will undergo an identical vesting schedule.
In conclusion, Uniswap stands as a flagship decentralized exchange (DEX) in the DeFi landscape, providing a platform for non-custodial trading through its innovative use of smart contracts and automated market makers. It facilitates permissionless creation of liquidity pools, thereby empowering users to earn fees while providing liquidity. Key improvements in the Uniswap V3 have led to enhanced efficiency and user experience, and a broader range of supported networks and assets further bolsters its versatility.
However, despite its inherent safety through non-upgradable smart contracts, users must be vigilant against potential token trading scams due to its permissionless nature. Lastly, the UNI token holders enjoy significant governance rights, fostering a democratic ecosystem where the community actively shapes the platform's future.