Uniswap is an open source protocol and non-custodial crypto exchange that allows you to securely exchange Ethereum (ETH) and ERC-20 tokens without using the traditional order book model.
Uniswap bundles tokens into smart contracts, creating liquidity pools. Platform members can exchange assets, create new trading pairs, and add tokens to pools to receive commissions.
The peculiarity of ERC20 tokens is that the coins on this standard are interchangeable, that is, they are essentially equal to each other within the Ethereum blockchain. This allows you to exchange them without any problem.
Uniswap was created to address the liquidity problem faced by conventional cryptocurrency exchanges. Liquidity itself is the ability to sell any stocks of coins on the platform without significantly affecting the price, which requires a large number of sellers and buyers.
How to achieve such a result when transactions for any pair are carried out instantly, everything is done without a centralized authority, and users do not need to register? This is possible with a help of the main components of Uniswap – smart contracts and liquidity pools.
The Uniswap protocol includes a series of smart contracts that allow any user to directly trade with each other on the Ethereum blockchain. Technically, it is a decentralized exchange (DEX).
Uniswap is a publicly available tool that distributes rewards to liquidity providers. Providers support the exchange by “locking” tokens, which allows other users to trade in a decentralized system.
The platform does not require registration and KYC and AML procedures. All you need is an Ethereum wallet like MetaMask. A hallmark of Uniswap is the use of a mechanism called the Constant Product Market Maker.
You can freely add an Ethereum asset to Uniswap by funding it with the equivalent value of ETH and a tradable ERC-20 token. For example, if a user wants to exchange Poop Token, he launches a new smart contract for Poop Token and creates a liquidity pool with $ 10 Poop Token and $ 10 ETH.
Uniswap does not connect buyers and sellers to set the Poop Token price, but uses the equation: x * y = k. In the equation, x and y represent the number of ETH and ERC-20 tokens available in the liquidity pool; k is a constant.
Based on the balance between ERC-20 tokens and ETH, as well as between supply and demand, the equation calculates the price of a particular token.
Each token has its own smart contract and liquidity pool. Any user can trade this coin or deposit funds into the liquidity pool, receiving a 0.3% commission on exchange transactions.
Whenever new tokens are added to the Uniswap liquidity pool, the user receives an ERC-20 pool token. Pool tokens can be exchanged, moved and used in other decentralized applications.
The Uniswap protocol is available through the uniswap.org interface. You can connect to it using an Ethereum wallet, for example, MetaMask.
The user can exchange tokens or add assets to the Uniswap liquidity pool. It is necessary to select the token that the user wants to receive and the asset that needs to be paid. The user then has to approve the transaction using their wallet and confirm the transaction by paying a commission to the Ethereum network.
Since Uniswap is an open source smart contract protocol, several user interfaces have already been created for it. For example, InstaDApp allows you to add funds to Uniswap pools without accessing the exchange interface.
The Zapper.fi interface makes it possible to add funds to Uniswap pools using only Ethereum, not ETH or another token. This service also offers one-click solutions for buying pool tokens in conjunction with bZx strategies.
When funds become demanded, pool tokens are burned. Each pool token represents the user’s share in the pool’s total assets and the pool’s share of the trading commission of 0.3%.
There are two main parties to Uniswap – buyers and liquidity providers. With the first, everything is clear: they connect their cryptocurrency wallets (most often it is MetaMask), choose the desired coin, indicate the desired purchase volume, set the cost of gas for swap, pay commissions and receive new coins.
At the same time, liquidity providers enable traders to exchange coins among themselves and make money on it. Anyone can become a liquidity provider: for this you need to provide a certain token and an equivalent amount of ether at the current exchange rate of the platform. That is, in fact, you need to fill the already mentioned cell, from which other users will take tokens.
Liquidity providers make money on commissions – 0.3 percent of the trading volume is deducted from each transaction. This encourages providers to share tokens and ensure the normal operation of the platform.