What is Uniswap?

6 min read

If you want to know what Uniswap is, you have come to the right place. Here I will tell you in a summarized way the best about this protocol and how it works.

The crypto world is shocked because a revolution in the financial industry is being built on the Ethereum block chain, as we saw in our article on what decentralized finance is

Uniswap is perhaps the most interesting project built on these foundations and consists of a uniswap protocol that allows buyers and sellers to exchange tokens through intelligent contracts and without the need to use an exchange or depend on an order book.

To do this, Uniswap uses an algorithm that automatically assigns the applicable exchange rate based on the relationship between the tokens and the exchange demand.

We’ll explain this protocol and its implications in more detail below, so get on the unicorn!

History of Uniswap

The creation of Uniswap was oriented to provide two services: on the one hand to be a DEX (decentralized exchange) within the Ethereum based ecosystem and on the other hand to serve as an automated liquidity protocol (known as AMM).

The choice of Ethereum as a basis is justified by the fact that thanks to the use of Uniswap smart contracts it does not require any kind of centralization to work. And another advantage is that it automatically integrates with the number of ERC20 tokens that exist on Ethereum.

In short, Uniswap is an autonomous protocol that responds to its own programming that is transparent and immutable.

The project starts after a series of posts made by Vitalik Buterin (creator of Ethereum) in the year 2017 and in the year 2018. In the first one, he predicted the possibility of creating a DEX on Ethereum and in the second one he talked about the MMA (automated market maker).

These ideas were taken up by Hayden Adams to create Uniswap and transform it into what is today one of the largest DeFi systems at Ethereum.

How does Uniswap work?

As I told you a few paragraphs ago, the operation of Uniswap focuses on two issues: offering a decentralized exchange (DEX) and offering an automated liquidity protocol (AMM).

Uniswap DEX works as most exchanges do. A person wants to exchange one krypton currency for another and the exchange performs the transaction. The difference in Uniswap is that this is done in a decentralized manner through smart contracts.

Thus, the control of the funds is always in the hands of the users and, in addition, due to the large base of users and liquidity providers, the exchanges are carried out with an admirable speed.

Now let’s talk about its AMM model, which is where Uniswap also stands out from the rest. This is because it works under a design called Constant Product Market Maker (CPMM). This design allows users to create liquidity reserves (or liquidity pools) with which traders can quickly trade.

To explain it more directly, certain users deposit their crypts in a liquidity pool (e.g. DAI/ETH) and that money is used by other people who want to trade.

In return, depositors receive part of the trading fees depending on the amount they have deposited.

This is what has driven Uniswap to reach incredible volumes, since this injection of liquidity means more profits for users, and giving rise to a very fashionable phenomenon nowadays: liquidity mining.


How cash pools work

As we said, Uniswap’s objective with these pools is to obtain liquidity from certain users, so that other users can make their exchanges smoothly. This way, a win-win is generated: traders experience better transactions and pool depositors get commissions for adding liquidity.

These pools are configured so that the depositor must enter two tokens (e.g. ETH and DAI). The purpose of this is to create a liquidity system that is balanced and that allows the creation of interesting exchange options for the platform users.

Thus, for example, if the liquidity providers (depositors) inaugurate a DAI/ETH pool, they must deposit value in both DAI and ETH. Once the pool is created, it will be listed so that users can exchange that pair.

Let’s assume that Andrés Iniesta uses Uniswap because he wants to exchange 50 DAIs for ETH. He then goes to the DAI/ETH pool and makes an exchange request and waits for it to be processed.

The DAI/ETH pool will take Iniesta’s 50 DAI and send him $50 in ETH in exchange. This will be reflected in a new cash flow amount that will have lost $50 in ETH and gained 50 DAI.

Andres Iniesta, on his part, will receive the total minus the service fee, which will be used to pay the liquidity generators.

With those 50 IADs, he will invite Xavi for an ice cream while he explains to him what Uniswap is.

Advantages and disadvantages of Uniswap

Now let’s review the pros and cons of using Uniswap, because like everything in life, it has good parts and bad parts:

Advantages of Uniswap

– It is decentralized.

– Any ERC-20 token can be exchanged.

– Trade within the platform is economical.

– Liquidity pools offer great returns for depositors.

Disadvantages of Uniswap

– The protocol, like most DeFi initiatives, is in an experimental phase so the risk is high.

– The scalability problems of Ethereum make the price of gas very high, increasing the costs of operation.

– It is possible to list false tokens so you must be very careful and check several times that you are operating with the correct token.