Decentralized finance (DeFi) is fundamentally changing the way people around the world gain access to financial services. Based on blockchain technology, DeFi protocols cut out intermediary gatekeepers like banks, and put financial control back in the hands of the people.
Such a revolutionary technology does not come around very often. Fortunes are currently being made betting on the next set of DeFi winners.
Uniswap (UNI), is one of the largest DeFi projects by both market capitalization and users, exploding in popularity in recent years. As a decentralized exchange (DEX) it holds the vast majority of digital tokens available on the market and serves as the entry way to the exciting DeFi world.
What is Uniswap?
Uniswap is a decentralized exchange built on the Ethereum blockchain. It was founded in 2018 by Hayden Adams, based on a suggestion by Vitalik Buterin (a co-founder of Ethereum). It is currently the largest cryptocurrency exchange in the world in terms of the number of tokens available on the protocol.
The Uniswap token (UNI) is a primary ingredient of the Uniswap ecosystem by allowing users to participate in voting, governance and shared ownership of the protocol. The UNI token has also become a popular method to speculate on the continued astonishing growth of the platform.
Since Uniswap is an automated liquidity protocol (or automated market maker), there is no order book or centralized party facilitating trades (as is the case with centralized exchanges). Instead, Uniswap gains liquidity by allowing users to temporarily contribute (or pool) their tokens in exchange for yields via UNI tokens. Trades are executed via smart contracts that adhere to Uniswaps decentralized exchange protocol rules.
Uniswap Use Case: Voting and Governance
Governance is the primary use case for the UNI token. Uniswap is a decentralized autonomous organization (DAO). This means that community members are able to participate in and vote for decisions related to how the protocol will expand and change over time. Holding a certain amount of UNI tokens, the protocols native governance token, is the basis to qualify to participate in such votes.
Once a topic has been proposed on the governance site, the governance process involves 3 phases:
1) Temperature Check: This phase determines sentiment regarding making changes in the first place. Two days are allotted for votes, after which a majority vote of yes amongst token holders is necessary to move to the next step of the process.
2) Consensus Check: During this step feedback is incorporated and formal discussions around the proposal take place.
3) Governance Proposal: This is the final step in the governance process. Feedback from the previous step is incorporated and the final on-chain code that will be implemented is reviewed. One last vote takes place over 7 days, after which another majority vote of yes is necessary for the revision to finally be implemented.
Uniswap Use Case: Speculating On Protocol Growth and Price
Since Uniswap has grown so large at such a fast rate, it is natural that people will want to bet on the continued growth of the protocol, and this growth increasing the price of the token over time. Much like many use Bitcoin to store their wealth, in hopes that the price will rise in regards to their native fiat currency, UNI tokens are held by individuals who believe that doing so will increase their purchasing power over time.
At the time of writing, the current price of the UNI token is trading for roughly $18 USD, while at this same time last year, a UNI token cost just $3.51 USD. Those that have held through have seen a more than five times price increase in just one year. With the continued growth of the protocol and considering its dominance as the largest DEX in the world, it is reasonable to assume that the price could continue to rise over time.
Uniswap Use Case: Token Swap and Trading
Uniswaps primary feature is as a decentralized exchange where users can swap and exchange a wide variety of different crypto assets without a third party intermediary.
Unlike traditional exchanges, Uniswaps decentralized protocol makes it easy for anyone to list their digital asset with minimal requirements (with the exception of needing to be an ERC-20 token), which accounts for the exceedingly wide collection of tokens available. Virtually any trading pair involving ERC-20 tokens is available on Uniswap.
To trade on Uniswap the user attaches their Ethereum wallet and selects their chosen ERC-20 token in their wallet that they would like to trade, as well as the ERC-20 token that they would like to trade for. When the user selects the volume of their token that they want to swap, Uniswap automatically converts that amount into the corresponding amount in the token they are trading for based on the token price and exchange rate.
Uniswap Use Case: Liquidity Pooling and Yield Farming
Unlike traditional centralized exchanges, which rely on book-based trading (an order book controlled by a centralized entity), when you trade on Uniswap, the protocol automatically executes trades based on smart-contracts.
In order to provide the tokens that users can swap between, Uniswap needs a liquid market. This is where liquidity providers (LPs) step in by providing their tokens into a liquidity pool in exchange for yields in the form of a percentage of pool trading fees. Anybody who meets the minimum requirement of tokens can lend them into a pool in exchange for a fee that is paid to them every time a transaction is made from that respective pool. These fees are paid in liquidity tokens which represent the total percentage of the entire liquidity pool owned by that liquidity provider.
There are specific rules for how long you must lend your tokens out for and how many tokens you must provide, which differ depending on the liquidity pool, so it always best to check the Uniswap app for current rules. Often will have to combine two different tokens, called a token pair. This ensures that there is adequate liquidity for people swapping to and from a certain pair.
Types of LPs
Liquidity providers also differ in their use cases, including:
- Professionals focusing on market making full-time. They generally utilize custom tools to track their liquidity positions and monitor markets.
- Passive LPs are generally retail holders of the token who simply wish to accumulate extra fees on top of their holdings.
- Token projects can also create their own liquidity pools for their projects, since liquidity is necessary to list on Uniswap.
Uniswap in DeFi
In conclusion, Uniswap is the largest decentralized exchange, and one of largest crypto exchanges in the world and doesn’t show any signs of losing those titles any time soon. Given the explosive growth of DeFi this past year, there is little reason to believe that growth in Uniswap will slow anytime soon.
Uniswap is the primary exchange of the DeFi revolution, and holding the UNI token gives participants a chance to influence and own part of the network, while also speculating its continued growth increasing the value of the token.