Today, the majority of trading takes place on centralized exchanges. Even when it comes to cryptocurrencies, which are decentralized systems, the top crypto exchanges such as Binance or Coinbase are centralized systems. Centralized exchanges are governed by a single entity. Users are required to place funds in the control of these exchanges to conduct trading. Traders have been searching for a system where their funds do not have to be placed under the control of third parties.
Decentralized Finance or DeFi is the solution to this problem. Decentralized finance eliminates the need for third parties to be involved in financial procedures. One of the most popular manifestations of this concept is a Decentralized exchange. They are cryptocurrency exchange platforms, which do not demand the users to deposit any money in the platform’s wallet to start trading. Users can trade straight from their own wallets to conduct transactions.
What is Uniswap?
Uniswap is a DeFi cryptocurrency exchange that runs on the Ethereum blockchain. It works based on the “automated liquidity protocol”, which means that Uniswap does not follow the traditional “order book” model implemented by most cryptocurrency exchanges.
In the “order book” model. buy and sell orders are displayed in a list with the total price placed in each order. The number of open orders for an entity is called its market depth. For a transaction to be completed successfully in the order book system, a buy order has to be met with a sell order for the same price and the same or more quantity, and vice versa. The primary dilemma with this system is liquidity. Liquidity indicates the depth and number of orders for an asset on the order book. If the liquidity for an asset is low, buy or sell orders may not be completed.
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Uniswap does not follow this model. It follows the relatively new trading model called the automated liquidity protocol. Uniswap was created by Hayden Adams in 2018 on the Ethereum blockchain as a completely decentralized open-source exchange protocol. It does not charge any transaction fees and even allows users to list tokens on the exchange for free. Centralized exchanges charge large fees to list tokens on their platforms.
How Uniswap works
Uniswap works with the help of liquidity pools and the Constant Product Market Maker Protocol. Liquidity pools are token pools secured in smart contracts. They give the liquidity required to facilitate trading. Many decentralized exchanges use liquidity pools. The constant product market maker protocol is a version of the well-known automated market maker (AMM) protocol. Automated market makers are the smart contracts that secure the above-mentioned liquidity pools. These pools are financed by liquidity providers to enable the traders to trade against these pools. Traders pay a charge to the pool in return, which is shared between the liquidity providers, according to their contributions. The constant product market maker protocol works likewise, with the additional benefit that any token can be listed on Uniswap if it is supported with an equivalent amount of ETH or ERC20 token being traded.
Liquidity providers create a market by depositing two tokens, an ETH and an ERC-20 token or two ERC20 tokens. Often, these pools are composed of stablecoins like DAI.
Liquidity providers receive liquidity tokens in return, which represent their part in the liquidity pool and can be reclaimed for the part they represent.
The chief principle behind Uniswap is that the whole liquidity in the liquidity pool must stay constant. Let’s look at an example of a liquidity pool.
The liquidity pool here is the ETH/USDT liquidity pool. Consider the ETH share as x and the USDT share as y. To find the pool’s total liquidity (k), Uniswap multiplies these two quantities.
x * y = k
If you purchase 2 ETH for 600 USDT through the ETH/USDT liquidity pool, you raise the USDT share and lessen the ETH share of the pool. This means that the price of ETH will increase because k is always supposed to remain constant. The price of ETH is based on the shift caused by the given transaction between x and y. This is how pricing is determined. With big liquidity pools, it is simpler to process massive trades as the shift between x and y is lesser as opposed to smaller liquidity pools. Liquidity providers earn compensation for presenting liquidity for traders to swap tokens.
Advantages of Uniswap
Uniswap presents several benefits, which make it an excellent choice compared to many traditional crypto exchanges. Let’s have a look at some of the advantages of Uniswap.
Uniswap is equipped with high-quality security. As the protocol is non-custodial, Uniswap does not keep hold of your funds. Also, smart contracts are audited by multiple teams, which makes them further reliable.
Uniswap is a non-custodial protocol. It does not keep hold of any funds, and no mediators are involved. So, all trades are conducted straight from your wallets. And the tokens and private keys are your responsibility.
Uniswap presents its users with instantaneous trading access to fresh tokens. Users are able to produce ERC20 tokens and pair them with ETH to create liquidity for new pools.
Uniswap is not intended to impose fees. It does not require its users to pay any platform fees or listing fees. The only cost Uniswap incites is a 0.3% fee per trade, which is very moderate compared to what other centralized exchanges charge.
How to use Uniswap
1. Go to https://uniswap.org
2. Click on “Use Uniswap” at the top right-hand corner
3. Head to “Connect wallet” at the top right corner and select the wallet you own. (You are required to own an ERC-20 supported wallet)
4. Log in to your wallet and connect to Uniswap.
5. On-screen, you can swap tokens directly using the drop-down options.
6. Select the token you want to swap, enter the amount, and click on “swap.”
7. Here you can see a preview window of the transaction and you will be required to confirm the transaction on your ERC-20 wallet.
8. Now wait for your transaction to be added to the Ethereum blockchain.
Read more on Top Cryptocurrency Exchange Clone Script
Uniswap is an innovative decentralized crypto exchange built on Ethereum. With its unique features and advantages, Uniswap has earned a lot of traction and users. It is a promising step towards a decentralized financial system. In this review of Uniswap, we have looked at what Uniswap is, how it works, its advantages, and how to use Uniswap.
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