Uniswap
how does it work?

Uniswap is a popular decentralized trading protocol, known for its role in facilitating automated trading of decentralized finance (DeFi) tokens. An example of an automated market maker (AMM), Uniswap launched in November 2018, but has gained considerable popularity this year thanks to the DeFi phenomenon and associated surge in token trading. Uniswap now serves as critical infrastructure for decentralized finance, empowering developers, traders, and liquidity providers to participate in a secure and robust financial marketplace. In this article, you will learn: What is Uniswap and how does it work? What are the benefits and risks of using Uniswap? How to use Uniswap to swap, provide liquidity, and stake tokens?. Uniswap is also completely open source, which means anyone can copy the code to create their own decentralized exchanges. It even allows users to list tokens on the exchange for free. Normal centralized exchanges are profit-driven and charge very high fees to list new coins, so this alone is a notable difference. Because Uniswap is a decentralized exchange (DEX), it also means users maintain control of their funds at all times as opposed to a centralized exchange that requires traders to give up control of their private keys so that orders can be logged on an internal database rather than be executed on a blockchain, which is more time consuming and expensive. By retaining control of private keys, it eliminates the risk of losing assets if the exchange is ever hacked. According to the latest figures, Uniswap is currently the fourth-largest decentralized finance (DeFi) platform and has over $3 billion worth of crypto assets locked away on its protocol. Automated liquidity protocol The way Uniswap solves the liquidity problem (described in the introduction) of centralized exchanges is through an automated liquidity protocol. This works by incentivizing people trading on the exchange to become liquidity providers (LPs): Uniswap users pool their money together to create a fund that’s used to execute all trades that take place on the platform. Each token listed has its own pool that users can contribute to, and the prices for each token are worked out using a math algorithm run by a computer (explained in “How token price is determined,” below). With this system, a buyer or seller does not have to wait for an opposite party to appear to complete a trade. Instead, they can execute any trade instantly at a known price provided there’s enough liquidity in the particular pool to facilitate it. In exchange for putting up their funds, each LP receives a token that represents the staked contribution to the pool. For example, if you contributed $10,000 to a liquidity pool that held $100,000 in total, you would receive a token for 10% of that pool. This token can be redeemed for a share of the trading fees. Uniswap charges users a flat 0.30% fee for every trade that takes place on the platform and automatically sends it to a liquidity reserve. Whenever a liquidity provider decides they want to exit, they receive a portion of the total fees from the reserve relative to their staked amount in that pool. The token they received which keeps a record of what stake they’re owed is then destroyed. After the Uniswap v.2 upgrade, a new protocol fee was introduced that can be turned on or off via a community vote and essentially sends 0.05% of every 0.30% trading fee to a Uniswap fund to finance future development. Currently, this fee option is turned off, however, if it is ever turned on it means LPs will start receiving 0.25% of pool trading fees.

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How to use Uniswap

Getting Started

Getting started with Uniswap is relatively straightforward, however, you will need to make sure you already have an ERC-20 supported wallet setup such as MetaMask, WalletConnect, Coinbase wallet, Portis, or Fortmatic.

Step by step

Once logged in, the trading interface will appear. In the top field, select the token you wish to exchange for the token you want. We’ll select ETH. In the bottom field, search for the token you wish to purchase, or select it from the drop-down menu, in this case UNI.

Next Step

Once you've completed your first trade on Uniswap, there are plenty of options for more advanced users. Since Uniswap is an open protocol of smart contracts, a number of different front-end user interfaces have already been created for it. For example, InstaDApp allows you to add funds into Uniswap pools without needing to access the official Uniswap user interface.

Uniswap V2 and V3

Though Uniswap launched back in November 2018, it wasn't until relatively recently that the protocol began to see significant traction. The release of Uniswap V2 in May 2020 saw a major upgrade that allows for direct ERC20 to ERC20 swaps, cutting Wrapped Ether (WETH) out of the equation where possible. Uniswap V2 also added support for incompatible ERC20 tokens like OmiseGo (OMG) and Tether (USDT), and added a host of technical improvements that make it more desirable to use.

Uniswap V2 Pair

The contract represents the liquidity pool itself, and you can find it in this link. It holds the ERC20 token balance, mints/burns the liquidity token, and in general, handles all the liquidity pool logic. To illustrate the deployment of Ethereum-based applications to Moonbeam, and in the process of creating a tutorial describing it, we deployed an example instance of Uniswap to Moonbase Alpha, the Moonbeam TestNet.

Uniswap V3 Efficiency

One of the most significant changes coming with Uniswap V3 relates to capital efficiency. This is because most AMMs have proven to be rather capital inefficient, the majority of their funds at any given time are not used. For instance, Uniswap currently has $5 billion locked in its contracts, however, it does only $1 billion in volume per day.