What is Uniswap (UNI)?

Uniswap (UNI) is a decentralised exchange (DEX) that has blown up in popularity over the last few months. Unlike other exchanges, there is absolutely no intermediary exchanging tokens between individuals. As a result, there are no order books, which you might find on DEXs like IDEX or Binance DEX. Instead, it is the users who offer the cash themselves by creating what is commonly referred to as a ‘pool’. Through a very specific mechanism, the price is set automatically and it is not possible to place a buy or sell order at a given amount.

To appear on Uniswap, you do not have to pay a listing fee as is the case on almost all exchanges. In addition, anyone can start a pool, without the team behind the project needing to give their consent. The only restriction at present is the type of tokens that are tradable through this protocol, as they absolutely must be ERC-20 tokens (i.e. operating on the Ethereum blockchain).

In this article, we will explain in detail what Uniswap is, how it works, its business model, the usefulness of the UNI token and how easy to use this digital asset trading platform actually is.

How does Uniswap work?

The first thing that surprises users when first checking out Uniswap is its radically different design from other exchange sites. As we saw in the introduction, users cannot place orders in a classic order book at the amount of their choice.

Instead, Uniswap works with so-called liquidity pools. These reserves of funds are filled by liquidity providers. Any individual can become a liquidity provider by simply placing equal sums of the two tokens that make up the trading pair concerned. This can be a combination of any pair of ERC-20 tokens, but more often than not, trading pairs are based on ETH or a stablecoin like USDT.

When a user buys or sells from this pool (at a non-negotiable price), a fee is taken and distributed to the liquidity suppliers in proportion to the share they have injected into the liquidity pool.

If this is not fully clear to you, we can illustrate the process with a small example. Let’s imagine that Uniswap has a made-up trading pair of Ethereum (ETH) and TheCoinTribune token (TCT). To calculate the total liquidity of the pool, Uniswap uses a very simple method: ETH x TCT. Uniswap’s goal is to keep liquidity constant, meaning the price of ETH or TCT will automatically adjust depending on supply and demand.

Here is a possible scenario that may play out:   

Bob decides to buy ETH in exchange for his TCT.

In order for total liquidity to remain constant, the price of ETH will increase, as its supply has slightly decreased, while the price of TCT will decrease, as its supply has slightly increased. If there are 1,000 ETH to begin with, and 1,000 TCT, the original liquidity was 1,000,000. When Bob goes to sell 100 TCT for 100 ETH, the price of ETH will become 1,000,000 ÷ 900 = 1111.11, while that of TCT will become 1,000,000 ÷ 1,100 = 909.9.

The opposite reasoning is true if Bob decides to buy TCT in exchange for his ETH.

How do I use or create a pool on Uniswap?

You can start using Uniswap by visiting their website or using their dedicated app. As we have seen, everyone is free to create or join a liquidity pool according to their own wants/needs. There are no restrictions. To create a liquidity pool, you first have to go to the site or the application. Then you need to connect your wallet, which contains your ERC-20 tokens. Any Ethereum wallet (link to the article) will do, although MetaMask is easier to use if you are on a web browser for example.

You then have to choose the two tokens that you want to create a liquidity pool with. As we have seen, there are no restrictions when it comes to ERC-20 tokens. However, avoid creating pairs that are too exotic, as no one is likely to participate in your pool and you may have few customers who will want to buy or sell because the liquidity will be too low. To be popular, always try to link your chosen token to USDT or ETH as far as possible.

Once you’ve made your choice, you’ll need to click the Swap button. A window will then appear on your screen and give you a short breakdown of the transaction. If all the information is correct, then you will need to confirm the transaction. Then you just have to wait until the transaction is confirmed on the Ethereum blockchain and your pool will be up and running.

If you simply want to use an existing pool, you simply need to check that it is available on the list. You can then choose to buy or sell one of the two currencies concerned at the price offered by Uniswap.

Automatic price balancing

Since it is not possible to choose a sale or purchase price on Uniswap, there is a special process for prices to balance on their own. That is something simple: arbitration. If you regularly check Coinmarketcap.com, you can view the average price of a digital asset based on prices on multiple exchanges. This gives you a rough idea of the actual price of this cryptocurrency at the time that you look at the figures.

By going to Uniswap, if you see a big difference from Coinmarketcap’s numbers, then you might decide to sell or buy a given cryptocurrency, just to sell it on an exchange to realise a quick capital gain. If everyone does that on all trading pairs, then the price on Uniswap will tend towards that of the market. Due to the growing popularity of this DEX, most of the time you will buy or sell your digital currencies at market prices. So you don’t have to worry too much about it, because you have virtually no chance of having to pay too much or sell too low.

What is Uniswap’s business model?

To operate, an exchange needs to charge its users a fee to fill its coffers. Without this, it wouldn’t be able to pay its employees. But Uniswap has a different business model because the protocol is open source. Everyone can contribute to the project as they see fit. A 0.3% fee is charged to every transaction, but this is added to the liquidity pool – it doesn’t go into Uniswap’s cash register.

When a supplier wishes to withdraw from a pool, they can get back their starting stake in addition to the portion of the fees earned. In the future, however, there are plans that a portion of the costs that go into the pool will be levied to finance a development team. However, at the moment, that is not yet the case and it may never be.

What is the purpose of the UNI token?

Strictly speaking, the UNI token only gives rights to the governance of the project. This allows each holder to have a right to vote on future developments in the protocol. In total, there were 1 billion UNI tokens issued, 60% of which were distributed to members of the existing Uniswap community. A member of the community is a person who has at least made one transaction using the protocol. The remaining 40% is reserved for team members, investors and advisors over the next four years.

Conclusion

We hope you liked our article on Uniswap and that it allowed you to learn more about this new decentralised exchange. The USP of this platform is that it works without the slightest hint of an order book – it is not possible to place purchase or sale orders on the site.

As we have seen, anyone can create their own liquidity pool on the site on the condition that it is between two ERC-20 tokens. However, in the future other types of tokens may be able to work with this protocol. When you finance a liquidity pool, you will earn 0.3% of each transaction made, in proportion to your overall stake in the pool. It is possible to join, leave, or create your own liquidity pool at any time.

In terms of price, most of the time you should be able to get tokens at a price that shadows the market price, especially on pools with the best liquidity. This means you can buy or sell at a fair price without asking too many questions most of the time.

If you like the project, you can either use it as an exchange to conduct your trading or to get UNI tokens. If you would like to find out more about this project, please check out our list of guides on Uniswap (insert link).