What is Uniswap? Decentralized Exchange and DeFi Powerhouse

Uniswap is a decentralized exchange that allows you to buy and sell crypto by swapping ERC20 tokens seamlessly without an exchange and order book. In this article, we explain what Uniswap is and how it is driving the growth of decentralized finance (DeFi).

Origins of Uniswap

Hayden Adams created Uniswap in November 2018. Adams was inspired to build Uniswap by an article written by Vitalik Buterin, founder of Ethereum. Buterin’s post was about the market maker equation X * Y = K.

What is Uniswap?

Uniswap, in simple terms, is a platform that allows you to swap ERC20 tokens. Unlike centralized cryptocurrency exchanges (CEX), Uniswap is a decentralized exchange (DEX) that lets you buy and sell tokens through swaps without an order book.

The DEX uses an algorithm to determine the swap rate based on both tokens’ balances and the swapping pair’s current demand.

Uniswap changes how we interact with markets. Regular markets require traders to provide liquidity, which is difficult to come by all the time. Most exchanges suffer to meet liquidity requirements. Further, before Uniswap, decentralized exchanges (DEX) had difficulties with liquidity.

Uniswap solves the liquidity issue via an automated liquidity provision protocol. With Uniswap, a DEX can run without needing liquidity from traders.

How to use Uniswap – Quick steps

  • Visit the Uniswap platform.
  • Connect a wallet. Find an ethereum wallet supported on Uniswap. eg.Metamask, Trust Wallet.
  • Select the token you want to exchange (what you intend to sell)
  • Select the token you want to exchange (what you intend to buy)
  • Click Swap
  • Check the transaction preview in the new pop-up window.
  • Confirm transaction in your wallet interface
  • Wait for the transaction to confirm.

How Uniswap differs from other platforms

Uniswap uses the “Constant Product Market Maker Model” for pricing. You can easily add any token to the Uniswap exchange by providing an equal amount (in value) of ETH and an ERC token.

For instance, if you want to make a new ERC 20 token available on Uniswap exchange, you need to launch a Uniswap contract for the token. After, you need to provide liquidity for the token.

The decentralized exchange (DEX) uses an x * y = k equation to determine the price of a token. In less technical terms, the equation uses supply and demand – the balance between ethereum (ETH) ETH and ERC20 tokens to determine the price of a token.

Liquidity providers on Uniswap – Are they making money?

Anyone can provide liquidity on Uniswap. You do not need to be a trader – buying or selling crypto to provide liquidity. 

Liquidity providers make money from trading fees. To participate in a liquidity pool, you have to provide an equal amount of ethereum (ETH) and ERC20 tokens to a Uniswap exchange contract. There are several Uniswap liquidity pools you can join.

Anytime a trader makes a swap, the trader has to pay a 0.3% fee for every swap. The fee gets added to the liquidity pool, which is then shared with the providers. Part of the fee is distributed based on the weight a provider has in the liquidity pool.

The bottom line on Uniswap

Uniswap has become the heartbeat of the DeFi ecosystem. Since its creation in 2018, the decentralized exchange has grown through an update from v1 to v2. 

With more interest in DeFi, Uniswap may become one of the most used platforms in the crypto space. At the time of writing, over $1 billion is locked up in the Uniswap protocol, as the world warms up to decentralized finance on the blockchain.

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