, 2 years ago

Uniswap explained: How does Uniswap work?

In the summer of 2020, the cryptocurrency space encountered a new phenomenon that was in the making for quite some time. A new form of DApp emerged that offered a set of completely new use cases for blockchain technology. One of the most notable inventions that fall into that category is Uniswap. It is an example of the stunning success story of decentralized finance.

In this article, we like to explain what Uniswap really is, how its basic functions work and how you can profit from the options this particular platform offers.

What is Uniswap?

Uniswap is a decentralized service that allows to swap Ether, the native currency of the Ethereum blockchain, and tokens that are also native to the same blockchain. Such a decentralized service always faces one central problem, namely to provide enough liquidity to become an attractive marketplace for a large number of users. Without enough liquidity and availability of a large collection of assets, the order books for some trading pairs might be empty, and the exchange is unable to process orders on demand.
Uniswap is solving this problem by offering users to earn interest by providing liquidity. The liquidity is gathered in pools. A liquidity pool always comes in pairs, and liquidity has to be provided in a 50/50 ratio. Such a pair for a liquidity pool could consist of Ether and USDC, but every other combination is also possible. In return, liquidity pools are awarded with an interest rate.

This interest rate can vary a lot and, in some cases, even provide returns of 1000 % APR or even more. Generally speaking, the interest rate is also reflecting the risk that liquidity providers are taking to provide the liquidity. Those pairs that are in high demand and already have significant liquidity offer usually a low percentage, while less popular parings might offer a huge reward.

What do I need to start using Uniswap?

Since Uniswap is a decentralized protocol, you will need a suiting Ethereum wallet to interact with the platform. MetaMask is a very common choice to do so. Once the wallet setup is done you will need Ether, the native token to the Ethereum blockchain. You can easily buy ETH on LiteBit and send it to your own wallet.
To connect to Uniswaps web interface, you have to connect and unlock your browser wallet first. Please note that all interactions and transactions on Uniswap are final and each one will require you to pay a fee. If you are looking to boost your security with this and any other decentralized service, a hardware wallet in combination with MetaMask is recommended. Once you are connected to you might swap tokens or use one of the liquidity pools to earn interest.

How can I provide liquidity on Uniswap?

In order to provide liquidity, you will need the desired token and hold them in your wallet. Let’s say you would like to provide liquidity for MANA and ETH. You can buy both on LiteBit and send them to your
wallet. Once the funds have arrived in your wallet, you may visit Uniswaps website and follow these steps:

• Select the pool menu and look up if the desired pair is available
• Review the fee tier and adjust it accordingly
• Set a price range
• Deposit the amounts
• Approve the transaction and add the liquidity to the pool

Once you have sent the amount to the smart contract, you will automatically receive LP Tokens in return to your wallet. These tokens represent your share in the liquidity pool and once you exit your position with the pool you can redeem them for the tokens that you gave earlier. Please note that the amount that you receive back can differ due to rebalancing that occurs on a regular basis.

What is the biggest risk using Uniswap?

There are a lot of risks involved that are usually part of trading and the cryptocurrency space. But there is also a lot of additional risks because Uniswap is a decentralized application. One of the most common problems is that the smart contract that runs Uniswap might have a vulnerability. While Uniswap is thoroughly audited and is receiving updates an exploit can always happen.

Many other DeFi protocols already have been exploited and the smart contract risks remains with all products in this space. Please note that these are not the only risks involved using Uniswap and DeFi in general. There is no central authority that can intervene or revert malicious transactions caused by an exploit or any other unforeseen event.

The Uniswap Token

Uniswap also has its own token with the ticker UNI. The token is used for governance of the platform and its value partly stems from the fact that it is attractive to have a saying how the protocol will move forward in the future.

Everybody holding the Uniswap token is considered a part of the community and receive the right to vote and make proposals to the community. This way the protocol can adapt to the needs of the community and the whole market in general.

Is decentralized finance the future?

There are already a lot of amazing products available in the DeFi space and Uniswap is one of them. One can only dream of all the possibilities with this particular technology and its thriving community. But DeFi has to mature first. Aside from exploits many projects are in an early stage. Something that is also underway and needed are Layer 2 solutions that allow more speed and less expensive transaction fees.

There are also a lot of use cases that cannot built on top of DeFi yet. Most of them require some sort of legal clarification before coming into reality. Let’s say you would like to start a decentralized insurance company. How does that fit in with the regulatory framework? This and other questions need to be answered before reliable products can be built entirely on the blockchain.

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