The finance industry has been functioning with centralized exchanges for a very long time. Even when it comes to cryptocurrencies, the underlying models facilitating the functioning have been centralized for long. Although most people are familiar with the centralized models, many have also been the victims of its drawbacks and are now in search of decentralized models where they don’t have to trust a third party with their finances.
This is where Decentralized Finance (DeFi) comes into the picture. As the name suggests, decentralized finance is a way to conduct financial procedures in a decentralized manner, i.e., without any central authorities. There have been many projects to implement the concept in reality, such as decentralized exchanges. Decentralized exchange platforms are the platforms for cryptocurrency exchange, which do not require the users to deposit any funds to begin trading, as users can directly trade from their own wallets to make transactions. Hence, it facilitates peer-to-peer (P2P) transactions. Also known as DEXs, there are numerous decentralized exchange platforms that aim to provide the most secure and efficient DeFi services. One such platform is Uniswap. Listing tokens on Uniswap is not very difficult, but still requires a some technical expertise.
In this article, we will answer the following questions:
- What is Uniswap?
- How does Uniswap work?
- How to list a DeFi token on Uniswap?
- How to remove liquidity from Uniswap?
- What are the advantages of Uniswap?
Let’s begin by learning about the platform — Uniswap.
What is Uniswap?
Created by Hayden Adams, Uniswap is a decentralized exchange protocol that is built on Ethereum to swap ERC20 tokens. It functions as an automated liquidity protocol, which implies that it does not follow the traditional “order book” model. It allows its users to swap tokens and trade without any intermediaries, thus ensuring a high degree of decentralization.
Uniswap is one of the most successful DeFi projects which is not designed to charge any fees. It acts as an open-source tool that removes middlemen from the process and uses token pools to determine prices without charging any platform fees or listing fees. Any ERC-20 token can be launched on Uniswap if there is a liquidity pool available.
In simple terms, Uniswap is a framework that enables its users to swap tokens directly from their wallets without any intermediaries or custody. With Uniswap, you can use smart contracts to:
- swap tokens
- add liquidity/ provide liquidity
- remove liquidity from pools
Now let’s learn about the native token of Uniswap.
Uniswap Token — UNI
The native token of the Uniswap protocol is UNI, which allows governance rights to its owners. All UNI holders can vote for changes to the protocol. Out of the UNI genesis supply, 60% of the tokens are allocated to the Uniswap community members. The remaining 40% are supposed to be made available to team members, investors, and advisors over the time period of four years.
UNI is available through the following four liquidity mining pools:
UNI holders can vote for the addition of more pools after an introductory 30-day governance grace period.
Now that you have gained a basic understanding of Uniswap and its tokens, let’s move ahead to understand how it works.
How does Uniswap work?
Contrary to the traditional architecture of the “order book” model which many crypto exchange platforms use, Uniswap works with the help of the following two components:
- Liquidity Pools
- Constant Product Market Maker Protocol
Let’s begin by understanding what they mean.
Simply defined, liquidity pools refer to token pools locked in smart contracts. They provide liquidity to facilitate trading. Several decentralized exchange platforms use liquidity pools.
Constant Product Market Maker Protocol
The constant product market maker protocol is a form of the much known automated market maker (AMM) model. Basically, automated market makers are smart contracts that hold liquidity pools. These pools are funded by liquidity providers so that the traders can trade against these pools. Traders pay a fee to the pool in return, which is proportionally divided among the liquidity providers, according to their shares. The constant product market maker protocol works similarly, along with the advantage that any token can be added to Uniswap if it is funded with an equal value of ETH or ERC20 token being traded.
So how does it work?
Liquidity Providers, also known as LPs, form a market by depositing two tokens of equivalent value, which can either be an ETH and an ERC-20 token or two ERC20 tokens. Mostly, these pools are made of stablecoins like DAI. Liquidity providers get liquidity tokens in return, which:
- depict their share in the liquidity pool
- can be redeemed for the share they represent.
The main idea behind Uniswap is that the total liquidity in the liquidity pool must remain constant. Let’s understand this with the help of an example.
The liquidity pool we’ll take into consideration is the ETH/USDT liquidity pool. Let’s refer to the ETH portion as x and the USDT portion as y. To calculate the pool’s total liquidity (which we will consider as k), Uniswap multiplies these two quantities
x x y = k
So, if you buy 1 ETH for 300 USDT via the ETH/USDT liquidity pool, you increase the USDT portion and reduce the ETH portion of the pool. This implies that the price of ETH will rise because k must remain constant, so the price of ETH is based on how much shift the given transaction/trade causes between x and y. This is the mechanism that determines the pricing. Hence, it is conceivable that with large liquidity pools, it is easier to process large trades as the shift between x and y is lower as compared to smaller liquidity pools.
This mechanism brings us to the concept of impermanent losses. What are impermanent losses? Let’s discuss.
Liquidity providers earn a fee in exchange for providing liquidity for traders to swap tokens. But often, liquidity providers don’t take every aspect into account while providing liquidity to the pools. One such aspect is impermanent losses, which you’ll understand better with the help of an example.
Suppose there is a pool on Uniswap with 10 ETH and 1,000 USDT, and you deposit 1 ETH and 100 USDT in it. Token pairs have to be of equal value, which implies:
Price of 1 ETH = 100 USDT
This implies that you have a 10% share of the pool. The total liquidity here will be 10,000. If a few trades take place and cause a shift in the ratio of USDT and ETH to 2,000 and 5 respectively, the price of 1 ETH will rise to 400 USDT. Why? The reason behind this is precisely what we discussed earlier, i.e., the total liquidity must be constant. So, the arbitrage traders will remove ETH and add USDT to the pool until the ratio stabilizes.
At this price, according to your 10% share, you own 0.5 ETH and 200 USDT (total 400 USDT), which is lesser than what you had deposited (total 500 USDT at this price). The loss here is “impermanent” because as long as you don’t withdraw your funds from the pool, this loss can be recovered or balanced:
- when the price of ETH returns to its original value, i.e., 100 USDT.
- by earning LP fees over time.
However, if you withdraw your funds at this time, then your loss will become permanent as you’ll only receive a total value of 400 USDT.
Now that you understand the working of Uniswap, let’s discuss how you can list a DeFi token on Uniswap.
How to list a DeFi token on Uniswap?
In order to list your DeFi token on Uniswap, there are a few prerequisites which you must take care of:
- Install MetaMask
- Deploy your ERC20 token contract to Ethereum mainnet
- Deploy your ERC20 token contract to Ethereum mainnet
- Send your ERC20 tokens to your MetaMask wallet
Now, take the following steps to list your DeFi token on Uniswap:
Create an Exchange
The first thing you need to do is create an exchange so that Uniswap knows about your token. You may take the following steps to create an exchange:
Step 1: Go to https://uniswap.exchange/. This screen will appear.
Step 2: Connect with your MetaMask Wallet.
As you can see, it will give a few other options to connect a wallet and ask you to download MetaMask if you haven’t done it already.
Step 3: Select the “Pool” option on the upper right corner of the screen.
Step 4: Select “Create Exchange”
Step 5: Press the “Select a Token”option.
Step 6: Enter your token’s address in the “Search Name or Address” field. Now select your token from the dropdown.
Step 7: Click on the “Create Exchange”option.
Step 8: A pop-up will show up. Click on the “Confirm” option.
Now that you have created an exchange for your tokens, it is time to add liquidity. You will have to deposit both ETH and your own token. The price will be set according to how many tokens you deposit. Why? Because, as we discussed earlier, the tokens are supposed to be deposited in pairs and should be of equal value, as the total liquidity of the pool must remain constant. Hence, if you deposit 1 ETH with 1 of your token, then it would imply that your token price will be equal to 1 ETH.
Step 1:Click on the dropdown on the same page and press “Add Liquidity.”
Step 2: Put in the amount of ETH you wish to deposit.
Step 3: Now select the “Select a Token” option.
Step 4: Enter your token’s address in the “Token Address” field and select your token from the dropdown.
Step 5: Press the “Unlock” option. You’ll find it next to your token symbol.
Step 6: Click on “Confirm” once the pop-up shows up. Your transaction will be confirmed.
Step 7: Now, in the same way, enter the amount of your tokens you wish to deposit. Make sure to check the calculated exchange rate.
Step 8: Now, select the “Add Liquidity” option and click “Confirm” once the pop-up shows up.
You have now listed your token to Uniswap exchange.
Now let’s discuss the steps you should follow in order to swap your token for ETH.
How to Remove Liquidity from Uniswap?
Suppose you sell your tokens to investors and wish to remove your liquidity/deposits from the platform. You may follow the following steps to do so:
Step 1: Go to https://uniswap.exchange/remove-liquidity.
Step 2:Press the “Select a Token” option.
Step 3: Put in your token’s address in the “Token Address”field.
Step 4:Choose your token from the dropdown.
Step 5: Uniswap will provide you with your pool’s balance. Enter the amount you wish to withdraw.
Step 6: Uniswap will show you the funds you’ll receive for both ETH and your token. Press the “Remove Liquidity” option.
Step 7: Select the “Confirm” option when the MetaMask pop-up shows up.
Now you understand how Uniswap works and how you can use it. But why should you use it? What makes Uniswap the better option in comparison to the traditional crypto exchanges? There are several advantages it offers. Let’s learn more about them.
Blockchain technology can be a beneficial solution to this problem. Blockchain solutions are decentralized. Hence, instead of the information being stored in a single database, it is stored on multiple nodes in a network. If a change or update is made to the information in one node, it is updated in all network nodes. It makes it very easy to share updated information with any doctor or healthcare provider quickly. The information stored on a blockchain is authentic, updated, and timestamped, making it very easy for the providers to go through it and act accordingly, especially in case of emergencies. It also assists providers in providing more personalized treatment plans and conducts faster diagnoses.
Let’s look at the following real-world example of how blockchain technology is being used for improving provider-patient communication.;
What are the advantages of Uniswap?
Uniswap offers many advantages, which make it the preferable choice as compared to the traditional crypto exchanges, such as:
- New Tokens
- Low Fees
Let’s discuss these advantages in detail.
Uniswap provides high-rank security. As the protocol is non-custodial, it does not hold any funds. Also, its smart contracts have been audited by several teams, which makes it more reliable
Uniswap provides high-rank security. As the protocol is non-custodial, it does not hold any funds. Also, its smart contracts have been audited by several teams, which makes it more reliable.
As we discussed earlier, Uniswap is a non-custodial protocol. It does not hold any funds, and there are no intermediaries involved. Hence, all trades take place directly from your wallets. You are the custodian, with the responsibility of your:
- private keys
Uniswap provides its users with instant trading access to new tokens. Users can create an ERC20 token and then pair it with ETH to produce liquidity for new pools.
Uniswap is not designed to charge fees. It does not charge its users with any platform fees or listing fees. The only cost it incurs is a 0.3% fee per trade, which is very low as compared to other protocols or centralized exchanges.
Uniswap is a very innovative protocol built on Ethereum, and with the advantages it offers, it has managed to gain a lot of traction from the right investors. It is an intriguing step forward towards a trustless and decentralized financial system.
If you wish to get a DeFi application developed for your business or to get started with Uniswap, contact our blockchain experts.
Originally published at https://www.leewayhertz.com on December 9, 2020.