Uniswap
UNI to USD
Project history
Uniswap is the most successful implementation of a decentralised exchange to date. It was launched in November 2018, after just a year of development by a mechanical engineer, Hayden Adams, who claimed he first had to learn to code.
The concept is built on the first automated market making initiatives of the early 1990s and learnings from earlier projects, such as 0x and Bancor. The project gained Ethereum founder Vitalik Buterin’s support and was launched a few months after receiving a grant from the Ethereum Foundation in November 2018.
The UNI governance token was launched in September 2020 via airdrop, in part to incentivise liquidity providers on Uniswap.
Technology
Uniswap is built on the Ethereum protocol as a smart contract interface for swapping ERC20 tokens (the most popular token standard for applications on the Ethereum platform). Uniswap uses an automated market maker (AMM) algorithm, with a pricing mechanism that is based on the bonding curve approach (a mathematical formula used to create a smooth virtual order book).
Liquidity providers deposit tokens into a smart contract and earn the trading fees as compensation. The frontend interface for traders and liquidity providers is open source.
Version 2 of the protocol, launched in May 2020, removed the need for token pairs to trade via Ether (thus halving the transaction costs for cross pairs), and introduced further upgrades and enhancements.
Version 3 of the protocol launched in May 2021; it introduced changes to achieve greater capital efficiency for liquidity providers and flexible community governed fees.
Following the Version 3 launch in 2021, Uniswap was deployed on Ethereum scaling solutions Optimism and Arbitrum, and in December 2021, on the Polygon network to achieve lower fees and thus access to a wider user base.
Supply model/Tokenomics
1 billion Uniswap tokens were issued in a bid to decentralise the governance of the project. Once all the tokens earmarked for liquidity providers have been issued, the supply will increase by 2 percent each year.
Tokens were issued at launch via airdrop to all traders and liquidity providers who had previously interacted with the Uniswap exchange. The airdrop came as a surprise to many and was seen as an act of generosity, although it would have made a mockery of decentralised governance if all or most of the circulating tokens were held by investors and the Uniswap project team.
Even so, many criticise Uniswap for not being truly decentralised with 40 percent of the issued tokens earmarked for team members, investors and advisors – although the Uniswap team promised not to participate in governance for now. It is a concern that even though the tokens awarded to investors and advisors vest over four years, the vesting tokens can be used to vote.
A protocol fee of 5bp had been approved for V2 and changed to a flexible range of 10-25 percent of the trading fees for V3. However, the fee switch has not been activated yet. Sharing the fee with token holders slightly disadvantages liquidity providers (who also receive UNI tokens as rewards, in addition to receiving the trading fees), because a significant portion of the tokens are held by the project team and investors. If the fee switch is not activated, it is hard to see what gives the tokens value.
Key value drivers
The Uniswap trading platform is in a strong competitive position, because although the protocol can be forked, liquidity and customers cannot. Other projects have used “vampire mining” practices to siphon off liquidity from Uniswap; however, ultimately Uniswap continued to grow its traded volumes.
Recent competition from decentralised exchanges that follow the order book model has been strong, and there is debate about whether AMMs or order books are more efficient.
Liquidity is a very important driver of where traders go, and this favours Uniswap as a market leader. However, it is possible that over time competition will put pressure on trading fees.
Whether the fee switch is turned on affects the fundamental value of Uniswap tokens. At the same time, delaying the fee switch may be due to the SEC enquiry into Uniswap – although the UNI tokens are not the focus of the enquiry.
There have only been minor security incidents with the Uniswap platform, as well as trading losses due to the listing of fake tokens, which some investors mistakenly bought.
Solutions to the “impermanent loss” that liquidity providers can incur are also important to follow. In 2021, ProtectionMarket prototyped a pay-as-you-go impermanent loss insurance for Uniswap liquidity providers.
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