What is Uniswap?
When it comes to DeFi, it is impossible to have not heard about Uniswap. The reason is that Uniswap put DeFi on the map. Prior to Uniswap, EtherDelta was the only decentralized exchange with some traction. EtherDelta, although quite popular at that time, was based on the order book model. Its design didn't fit quite well into a layer-1 blockchain like Ethereum. That being said, let's dig into the early days of Uniswap.
The story of Uniswap begins with its creator, Hayden Adams, who developed the protocol as an open-source project. It was 2017, and Hayden just got laid off from his first job as a Mechanical Engineer at Siemens. Thanks to friend, Karl Floersch, who at the time was working at the Ethereum Foundation, Hayden started to write smart contracts.
Hayden's first work project was to develop an automated market maker, as described by Vitalik in his blogpost. In two months, Hayden managed to develop a proof-of-concept, but the work was far from over.
The concept was limited and the UI was messy. Furthermore, it only worked for a single ETH/ERC20 pair and for a single liquidity provider.
After 9 months of arduous work, Hayden's crypto savings were running low, so he decided to yolo and go to a crypto conference in Seoul, South Korea. There, he met Vitalik, who recommended to write the code for Uniswap in Vyper and to apply for an Ethereum grant.
Fast forward to November 2, 2018, Uniswap was officially launched and quickly gained attention as a groundbreaking decentralized exchange (DEX) built on the Ethereum blockchain.
Uniswap was built on the idea that a DEX could be more efficient and accessible than a centralized exchange by using smart contracts and liquidity pools instead of traditional order books. This approach allows anyone to become a liquidity provider and earn fees for providing liquidity to the platform.
Uniswap launched its UNI token in September 2020, as a way to reward its users and community members who had been using the platform and contributing to its growth. The launch of UNI was also a response to the growing competition in the DEX space, with other DEXs such as SushiSwap offering incentives to users in the form of governance tokens.
The launch of UNI was somewhat unexpected, as Uniswap had not previously announced plans to launch a governance token. However, it was seen as a smart move by the Uniswap team, as it helped to incentivize users to stick with the platform and contributed to a surge in liquidity.
To this day, Uniswap has never been hacked, as it remains the leading DEX on Ethereum 🦄
How does Uniswap work?
Uniswap is a decentralized exchange that uses an automated market maker (AMM) system to provide liquidity to its users. It is the first DEX to have gained mainstream attention and it's regarded as the protocol that kickstarted the DeFi bull run.
All DEXs essentially operate the same way, with adjustments here and there. Because Uniswap has been the inspiration point for all DeFi protocols that exist, there's no better way to explain how AMMs work than here. Starting with the constant product formula.
The constant product formula is a key feature of the Uniswap protocol that is used to determine the exchange rate between two different assets in a liquidity pool.
In the context of Uniswap, a liquidity pool is created by users who contribute equal value amounts of two different tokens. For example, a user could contribute 1 ETH and 100 DAI to a liquidity pool, which would then create a pool with a total value of 100 ETH and 10,000 DAI.
The constant product formula states that the product of the two token balances in the liquidity pool must remain constant, regardless of the size or frequency of trades taking place in the pool. In other words, if the token balances in the pool are x and y, respectively, then the constant product formula is:
x * y = k (where k is a constant value that is set when the liquidity pool is created)
As trades are executed on Uniswap, the relative token balances in the pool shift, and the price of the tokens adjusts to maintain the constant product formula. Specifically, the more of one token that is traded, the more its price increases, and the price of the other token decreases, in order to maintain the constant product value of k.
For example, if a large number of trades occur in the ETH/DAI liquidity pool and a significant amount of ETH is traded for DAI, the price of DAI in the pool will increase, while the price of ETH will decrease. This adjustment in price occurs in proportion to the size of the trade and the size of the liquidity pool.
Uniswap V2
Uniswap V2 comes with support for any ERC20 token liquidity pools. Prior to V2, Uniswap V1 only supported swaps between ETH and a single ERC20 token. While Uniswap V1 is still active, it is no longer being developed.
Uniswap liquidity pools work by allowing users to contribute funds in the form of two different cryptos, which are then used to facilitate trades on the platform. For example, a user could contribute 1 ETH and 100 DAI to a Uniswap ETH/DAI liquidity pool. In return, the user would receive liquidity pool tokens that represent their share of the liquidity pool. These tokens can be used to withdraw their share of the contributed funds at any time.
When a user wants to make a trade on Uniswap, the platform uses the liquidity pool to automatically provide the necessary liquidity for the trade. For example, if a user wants to buy 10 DAI using ETH, the Uniswap smart contract will use the ETH/DAI liquidity pool to provide the necessary DAI to complete the trade, while also adjusting the price of ETH and DAI in the pool based on the amount of the trade.
The price of the assets in the liquidity pool is determined by a constant product formula, which balances the relative supply of each asset with its market price. This means that as more users trade on Uniswap, the price of the assets in the liquidity pool will adjust to reflect the market demand for those assets.
Uniswap V3
On May 2021, Uniswap V3 introduced a plethora of new features which will address current problems and provide a more flexible and efficient AMM. The biggest feature includes the concept of concentrated liquidity.
In a traditional AMM, liquidity is evenly distributed. This means users can execute swaps at any price range. By contrast, concentrated liquidity enables LPs to deposit their funds within specific price ranges, rather than evenly distributing them across the entire range.
The concept of concentrated liquidity helps traders optimize their capital efficiency by targeting specific price ranges where they believe trading activity is more likely to occur. By concentrating their liquidity, providers can capture more fees and potentially earn higher returns on their capital.
Additionally, concentrated liquidity enhances the depth and efficiency of the liquidity pool. The narrower price ranges allow for greater capital utilization, reducing slippage and improving the trading experience for users. This is particularly beneficial for large trades that would typically result in substantial price impact on traditional AMMs.
Along with concentrated liquidity, Uniswap v3 introduces the concept of multiple fee tiers, allowing liquidity providers to customize fee rates for different price ranges. This flexibility enables providers to optimize their earnings by setting higher fees for ranges with higher expected volatility or demand.
Uniswap V4
Announced on June 13,2023, Uniswap V4 opens up a world of possibilities for how liquidity is created and how tokens are traded on-chain.
The biggest innovation on Uniswap V4 are hooks. Hooks are smart contracts that run at various points of a pool action's lifecycle. Pools can make the same tradeoffs as V3, or they can add totally new functionality. For example, V4 will allow pools that natively support dynamic fees, or add on-chain limit orders. In a nutshell, hooks are plugins that can be added to create new features for trading pools.
Along with hooks, Uniswap V4 re-designed its architecture. V4 introduces a new "singleton" contract, where all pools live within a single smart contract. To understand this new logic, let's refer to the previous versions of Uniswap V3.
Previously, each Uniswap pool had its own smart contract. The reason behind this design choice is to enable more flexibility and customization for liquidity providers. Each pool can have its own unique characteristics, such as different price ranges or fee structures, allowing for a more tailored trading experience.
Since Uniswap V3 pools have separate smart contracts, swapping tokens between different pools requires interacting with multiple contracts, which incurs additional gas fees.
Estimates show that V4 reduces pool creation gas costs by 99%. This singleton architecture is complemented by a new "flash accounting" system. Instead of transferring assets in and out of pools at the end of every swap in V3, this system transfers only on net balances, resulting in a far more efficient system that provides additional gas savings in Uniswap V4.
How to make money on Uniswap?
Making money on Uniswap is as easy as depositing funds into a liquidity pool. After depositing, you will be credited with LP tokens that represent your position in the liquidity pool. Whenever you decide to exit your position, the LP tokens will be converted to the assets supplied along with the accrued fees.
Here's how you open an LP position on Uniswap:
Open Uniswap app
Click on the "Pool" tab
Select a liquidity pool
Inout the amount of tokens you want to deposit
Click deposit and approve the transaction
After depositing with Uniswap, you will receive LP tokens representing your position in the pool. These tokens accrue transaction fees. The longer you hold them, the more APY they accumulate.
Uniswap V3
Now that we understand the basics of providing liquidity on Uniswap, let's focus on the concentrated liquidity feature. The simplest way to understand how to make money off it is to offer an example:
Imagine you're a liquidity provider on Uniswap V3 and you hold 10 ETH and 1000 USDT. Instead of providing liquidity across the entire price range, you decide to concentrate your liquidity within a specific price range of ETH/USDT, let's say from $1700 to $2000.
By concentrating your liquidity within this range, you are effectively providing liquidity for trades that occur within that price band. If the market activity primarily revolves around that range, your capital will be more efficiently utilized, resulting in potentially higher earnings.
Now, let's assume that the price of ETH increases within the specified range, reaching $1900. As a result, more trading activity occurs within that range, and traders are drawn to your concentrated liquidity pool. Since you're providing liquidity within that range, you will earn trading fees on those trades proportional to your share of the liquidity pool.
As the trading volume increases, the fees collected by liquidity providers also increase. Thus, you can generate income from the fees earned based on the trading activity within your chosen price range.
However, it's important to note that if the price of ETH moves outside of your specified range, your capital will not be utilized, and you may miss out on potential trading fees. Therefore, your LP position needs to be actively monitored and adjusted to adapt to market conditions.
It's worth mentioning that concentrated liquidity has its risks. If the price of the asset you provide liquidity for experiences significant volatility or moves outside of your chosen range, you may face impermanent loss, which can affect your overall returns. The safest liquidity pools have the most TVL. On the other hand, fees are spread between more LPs.
Price Prediction for Uniswap — Can it hit $1000?
Buying and hodling UNI — the native token of Uniswap — is one way of potentially making money on Uniswap.
By looking at its current price, it’s natural to think about the chance of UNI hitting $1000 per token. This can happen sooner, or way in the future, and is determined by a couple of ever changing factors.
Let’s examine the potential growth of the UNI token by analyzing its tokenomics. UNI’s current market cap sits comfortably at ${MARKET_CAP}. With {CIRCULATING_SUPPLY} UNI tokens being in circulation today, that means a price of {PRICE} per UNI.
How did we come to that calculation? It’s quite easy, the price of a UNI token is equal to its current market cap divided by the number of tokens in circulation. Dividing ${MARKET_CAP} by {CIRCULATING_SUPPLY} gives us a result of {PRICE} for each UNI coin.
By changing the order in the simple formula above we can use it to calculate other things as well. This helps us a lot because we can deduce the market cap of UNI at different token prices. Then, we can use the result to compare it to the current state of the network and see what would be required for UNI to hit that price.
At a price of $1000 per token, that means the current market cap of UNI would equal ${{CIRCULATING_SUPPLY} * 1000}. Remember that we arrived at this number by multiplying the amount of circulating tokens by $1000.
Now let’s shift our attention to the fully diluted market cap.
Some blockchains may have their tokenomics built in a way that only a small percentage of tokens are circulating at the beginning. This can be misleading because we don’t have the full picture and only take into account the current number of coins released in the market.
The fully diluted market cap represents the total value of a coin if all tokens were in circulation. UNI’s whole supply of tokens is {MAX_SUPPLY - TOTAL_SUPPLY + CIRCULATING_SUPPLY} UNI which means that no more coins above that number will ever be created.
These tokens are not created at the discretion of a specific entity. They are created automatically by the network to reward different actors that keep it secure.
How does this impact the price of UNI? Taking into account the current price of a UNI token, that would result in a fully diluted market cap of ${MAX_SUPPLY - TOTAL_SUPPLY + CIRCULATING_SUPPLY * PRICE}. UNI coins that have been burned are not taken into consideration because they have been permanently removed from circulation.
Whether it seems gigantic or not, the number we came to above only takes into account the current price of a UNI token. Doing the same calculation but with a price of $1000 gives us a result of ${{MAX_SUPPLY - TOTAL_SUPPLY + CIRCULATING_SUPPLY} * 1000} for the UNI protocol fully diluted market cap.
These are all crucial details to know when calculating if UNI can reach the price of $1000 per token. If the diluted market capitalization is way too high, the token has little room left to grow. Blockchains in general have no cap on the value they can reach, whether that number seems possible it’s totally up to you.
The future of UNI depends solely on its growth as a network used by tens and hundreds of millions of users.
If you’re looking to add some UNI to your portfolio, the most trusted places to get some are Binance and Coinbase.
