Uniswap is one of the largest decentralised exchanges (DEXs) in the cryptocurrency industry. It runs on Ethereum and allows you to exchange any ERC-20 tokens using an Automated Market Maker protocol (AMM) instead of a standard spot market order book.
This guide will teach you how to use uniswap, trade in and out of pools, provide liquidity in return for rewards, and make you aware of the risks involved throughout.
Uniswap and other DeFi protocols are experimental works in progress. Funds deposited into Uniswap or DeFi protocols in general can be at risk of smart contract vulnerabilities, malicious developers and hacks. Uniswap is governed by token holders through a DAO (decentralised autonomous organisation).
Uniswap works by incentivizing liquidity providers to provide collateral and make liquidity pools. Traders then use these liquidity pools to trade, instead of trying to find a matching buyer or seller on the spot market.
The software used to run the exchange without an order book is a design known as an Automated Market Maker (AMM) model. This model relies on a mathematical formula to price assets instead of using an order book. AMMs are smart contracts that hold liquidity pools that you can trade against. Liquidity providers fund liquidity pools. Anyone who deposits an equivalent value of two ERC-20 tokens into the pool can become a liquidity provider for the protocol.
The difference between centralised cryptocurrency exchanges like Binance and Coinbase and a decentralised AMM cryptocurrency exchange like Uniswap is that there is no order book or a centralised party that facilitates the trades with the latter. Furthermore, there is no listing process for ERC-20 tokens on Uniswap due to its decentralised nature, and this enables the launch of any token if there is a liquidity pool for the traders. Thus, there are no listing fees for ERC 20 tokens as well.
The protocol was launched in late 2018 by creator Hayden Adams, who is a software developer. His inspiration to design the protocol arises from a post that came from Ethereum co-founder Vitalik Buterin. Uniswap is currently running the v3 design of its platform, with the latest update coming in May 2021, which mainly improves capital efficiency of the liquidity pools, which is a recurring issue with yield farming protocols.
There is no listing process for ERC 20 tokens on this exchange due to its decentralised nature, and this enables the launch of any token if there is a liquidity pool for the traders. Thus, there are no listing fees for ERC 20 tokens as well.
To trade on Uniswap, you need to have ETH or any other ERC-20 standard token. These tokens can then be traded through Metamask's wallet. Metamask is a browser plugin that is used as an Ethereum wallet. It allows you to run dApps without participating in the Ethereum network as an Ethereum node.
What sets it apart from other wallets you might have heard of is the fact that it allows you to interact with dApps directly from your wallet. Other compatible wallets are Coinbase Wallet, Trust Wallet, Formatic, Portis Wallet, and any wallet compatible with WalletConnect.
Trading on Uniswap is done in four simple steps:
Slippage tolerance is an aspect you need to be aware of before using Uniswap and similar DeFi protocols. Slippage is the variance between the expected price of the swap and the actual execution price of the swap. Thus, slippage tolerance is the change in price (as a percentage) from the expected price you are willing to accept. Although slippage can occur for a number of reasons, it has the highest chance of happening when there is a high level of volatility in the market.
For example, if the quoted price on a trade for 1 ETH is 3,000 USDC, then a slippage tolerance of 1% would mean the price could fluctuate in either direction by up to 30 USDC (1% of 3,000). You could end up with as much as 3,030 USDC, or as little as 2,970 USDC for that trade.
Slippage tolerance allows you to set the range of price movement you are willing to accept before the trade doesn't execute, as a result of not adhering to the set tolerance levels (the price deviated too far from the price you were willing to accept). Tolerance is calculated as a percentage of the amount of tokens you are willing to receive.
Another setting to keep in mind is the transaction deadline which can also be chosen in the Swap settings. It indicates the maximum amount of time you're willing to wait for the pending Swap to execute. If the time elapsed exceeds the transaction deadline, then the swap is reversed automatically. It is another fail-safe feature built into the interface.
The price impact conveys an approximation of the expected slippage based on the size of your order or what's really happening in the market.
Both slippage tolerance and the transaction deadline can be adjusted using the settings button in the top right corner of the Swap window (the cog icon).
Despite the simplicity with which you can trade ERC 20 tokens on Uniswap, there are certain risks attached with trading on Uniswap:
Once you have connected your wallet to the Uniswap interface, you can access the liquidity features of the protocol through the "Pool" section of the website. In this section, you can either add liquidity to an existing pool using the "Add Liquidity" feature or create a new liquidity pool for a particular token pair using the "Create a pair" feature.
Most people will just want to add liquidity to an existing pool, so we've outlined the steps for you to add liquidity to Uniswap below.
As a reward for providing liquidity to the protocol, you will be rewarded 0.3% of all the trades with this pair in proportion to your allocated share in the pool. The rewards can be claimed by withdrawing liquidity and will keep accruing in real time in the pool until that time.
Once liquidity is added to a pool, you get liquidity tokens which are minted and sent to your wallet. They are a representation of your contribution to the pool as they are distributed in proportion to your share in the pool. These tokens represent the fees earned by the protocol for fees on trades.
Below are the steps you would need to follow to remove liquidity from Uniswap:
Although liquidity mining provides a good opportunity for you to create passive income, in addition to the risks mentioned for trading on the DEX, there is one main risk attached to providing liquidity on Uniswap:
The Uniswap AMM model uses a formula to calculate and balance liquidity on the platform:
x * y = k
Where
For example, in an ETH/DAI pool, "x" is the ETH portion of the pool, and "y" refers to the DAI portion of the pool. "k" is a fixable constant and refers to the total liquidity of the pool. The core of the AMM model is that the total liquidity of the pool (k) remains fixed so as to minimize price variations. Market incentives are used to ensure users top up either side of the pair to keep the pool balanced.
UNI is the native token of the Uniswap protocol, which gives holders voting rights to the platform's governance.
Uniswap distributed the token through an airdrop of 400 UNI tokens to each wallet address that had interacted with the exchange before September 2020. One billion UNI tokens were minted during the genesis. Over time, 60% will be distributed amongst the existing members of the community, and 40% is reserved for team members of the protocol, which will be distributed over four years.
A portion of UNI tokens are distributed through liquidity mining.
To make comparing even easier we came up with the Finder Score. Supported coins, account fees and features across 28 cryptocurrency trading platforms are all weighted and scaled to produce a score out of 10. The higher the score the better the exchange - simple.
Let's take a look at the pros and cons of using Uniswap for both trading and for staking coins as a liquidity provider.
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