Are you familiar with the Uniswap DEX? Dive in to learn more about the largest decentralized exchange (DEX) – Uniswap exchange now!
Stock exchanges have been serving as a crucial element in the domain of traditional finance. They offer the foundations of a market for trading equities, derivatives, commodities, bonds, currencies, and other financial instruments. On the other hand, forex markets are prominent platforms for facilitating the exchange of national currencies.
Such exchanges offer critical inputs for market liquidity alongside strengthening the stability of the global financial system. Crypto exchanges such as Uniswap mirror the marketplace dynamic in traditional finance with a platform for trading digital assets exactly like traditional financial instruments and assets.
The growing interest in debates surrounding centralized and decentralized crypto exchanges has attracted promising attention toward top decentralized exchanges. The following discussion aims to offer you an introduction to Uniswap exchange and its fundamentals, including how it works. You can also find out about the governance of one of the largest decentralized exchanges in the world.
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Need for Decentralized Exchanges
Even if cryptocurrencies are primarily associated with decentralized blockchain, you will find that the top crypto exchanges in the world are centralized. It is clear that centralized exchanges can offer the benefits of improved liquidity alongside faster transaction settlement. However, the concerns regarding the autonomy of individual users have led to the development of decentralized exchanges such as Uniswap.
Decentralized exchanges rely comprehensively on blockchain technology alongside leveraging smart contracts for facilitating transactions between sellers and buyers. Most important of all, decentralized exchanges can help in executing transactions in a completely trustless and automated fashion. However, decentralized exchanges are also mired in the setbacks that emerge from the existing limitations of blockchain technology.
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Challenges for Decentralized Exchanges
The popularity of decentralized exchanges like Uniswap DEX has started to gain attention recently. However, decentralized exchanges have been encountering various risks pertaining to segmented liquidity, disjointed user experience, and network scalability.
DEXs present promising opportunities for innovation in asset exchange, albeit with formidable challenges for regulators. Why? There is no way to hold anyone accountable in the case of market failure in the absence of any responsible party.
On the other hand, Uniswap decentralized exchange has introduced favorable improvements to empower the functionality of DEXs with new tools. As a pioneer in the concept of liquidity pool mechanisms, Uniswap has turned into the largest decentralized exchange all over the world. Let us discover more about the world’s largest DEX.
Fundamentals of Uniswap Exchange
One of the foremost questions that might be circling your mind right now would be, “What is Uniswap?” and it is a reasonable one, especially for beginners. It is basically a decentralized exchange protocol running on the Ethereum blockchain, which can enable peer-to-peer (P2P) crypto trades. What’s so special about it, then?
The P2P transactions on the decentralized exchange protocol do not require any centralized intermediary or order books. On the contrary, the Uniswap DEX leverages a liquidity pool model featuring automated smart contracts. Potential traders could access different token reserves funded by users to avail the primary source for market liquidity.
Any individual could list a token on the DEX platform or swap tokens and even contribute tokens in liquidity pools for earning fees. The foundations of Uniswap on Ethereum also ensure flexibility for exchanging ERC-20 tokens on the platform. The most striking highlight of the world’s largest DEX points to the lack of listing fees for a token. This is definitely an interesting improvement over the conventional centralized exchanges.
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Key Highlights of Uniswap DEX
As a newbie to the world of DEXs, you should also make a note of the popularity of Uniswap DEX. Developed by an independent developer in 2018, Uniswap has been successful in raising more than $10 million USD from different seed rounds. Here are some of the most striking highlights of the world’s largest decentralized exchange protocol as of August 2021.
- The total value locked or TVL of assets in the world’s largest DEX platform is over $6 billion USD.
- The platform has more than 72,000 liquidity providers.
- Most important of all, the all-time Uniswap exchange volume has exceeded $302 billion USD.
- The world’s largest DEX platform has facilitated over 58 million trades.
- Uniswap exchange has also featured in more than 200 DeFi integrations.
What Problem Does Uniswap Solve?
Conventional markets rely on the order book model for facilitating trades, and centralized crypto exchanges follow the same model. The order books maintain the open sell and buy orders for any particular asset on an exchange. In the event of large gaps between the prices that sellers are willing to agree on and buyers are willing to pay, reduced trading activity can decrease liquidity profoundly.
As a result, holding assets for longer could create difficulties in selling them. The liquidity pools of Uniswap’s decentralized exchange reduce the discrepancies between the seller’s and buyer’s market orders. Liquidity pools in the DEX protocol could help in developing a massive collection of assets for trading, which subsequently supports the resolution of potential issues for market liquidity. Most important of all, the world’s largest DEX employs an innovative Automated Market Maker or AMM algorithm for improved functionality.
Working of Uniswap
The most important factor that can help you understand Uniswap exchange better would obviously refer to its working. When you dive deeper into how the decentralized exchange platform works, you can find that it depends on two distinct types of smart contracts. The two smart contracts involved in the working of the DEX protocol are known as the “Exchange” contract and the “Factory” contract.
The contracts are basically autonomous computer programs embedded with code for performing specific actions upon meeting predefined conditions. It is important to note that the “Factory” contract helps in the addition of new tokens to the platform. On the other hand, the “Exchange” contract in Uniswap enables all the token transactions. The most crucial aspect driving the world’s largest decentralized crypto exchange is the AMM protocol, which you can also refer to as automated liquidity protocol.
Automated Market Maker
The key force driving the Uniswap DEX protocol is the Automated Market Maker or AMM technology. It is basically a smart contract used for managing the liquidity pools providing tokens that are used for facilitating trades. The AMM algorithm helps define the effective price of a token according to the interplay between the supply and demand of tokens in the liquidity pools.
As an automated liquidity protocol, the AMM smart contract provides incentives for people on the exchange to take on the role of liquidity providers. Basically, the users on Uniswap pool their money to create a fund that they can use for trades on the platform. It is important to note that each listed token has its respective liquidity pool to which users can contribute. The AMM protocol helps in determining the price of the tokens for trading according to a mathematical equation.
You might be wondering about answers to “What is Uniswap used for?” other than serving as a decentralized exchange. As a matter of fact, you can find the answer in the identity of Uniswap as a decentralized exchange. The AMM system ensures that buyers and sellers don’t have to wait for another party to carry out a transaction.
On the other hand, buyers and sellers could capitalize on the liquidity of specific pools alongside the precise price estimate of tokens. Liquidity providers receive a token representing their stake in the liquidity pool, which they can redeem later for a specific share in the trading fees. Uniswap decentralized exchange imposes a straightforward 0.30% fee for every trade on the platform, which automatically goes to liquidity reserve.
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Determining the Price of Tokens
The next crucial aspect in the working of Uniswap exchange would refer to the approach for estimating the token pricing. As you all know, the world’s largest DEX does not employ an order book system. On the contrary, the price of each asset depends on the highest buyer and the lowest seller with the AMM system.
The Automated Market Maker system adjusts the price of assets on the basis of supply and demand with a popular mathematical equation. The mathematical equation works by adjusting the price of a coin according to the ratio of the number of tokens in respective pools.
When a user needs to add a new ERC-20 token on the Uniswap decentralized exchange, they can start a liquidity pool. In order to do that, the user must add a specific amount of the selected ERC-20 token as well as a similar amount of another ERC-20 token. The price of the tokens is determined by the ‘Constant Product Formula,’ which is, “x * y = k.”
The “x” and “y” in the Constant Product Formula are variable entities representing the total value of one token in the trading pair. For example, if you have an ETH/DAI liquidity pool, you can assume “x” as the total value of ETH and “y” as the total value of DAI in the liquidity pool. The product of the two numbers provides the pool liquidity of the trading pair, represented as “k” in the formula.
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Now, the interesting fact in the working of Uniswap DEX is that pool liquidity should always remain constant. Even if the values of “x” and “y” change, the value of “k” will always be a constant. With multiple trades, the value of “x” and “y” for a liquidity pool would change. For example, a user purchases 1 ETH by depositing 330 DAI in the pool, thereby decreasing the ratio of ETH.
On the other hand, the ratio of DAI increases for accommodating the additional 330 DAI tokens and one less ETH. Therefore, the price of ETH would increase in the liquidity pool. One can clearly notice an answer to “What is Uniswap used for?” in the use of the constant product formula. The DEX platform can be able to maintain an ecosystem with fair market value alongside fostering constant liquidity.
Governance of Uniswap DEX
With the constantly growing estimates of Uniswap exchange volume, it is inevitable to wonder about its governance. What exactly helps in keeping the world’s largest decentralized exchange in place? The answer to this question is clearly evident in the Uniswap token, UNI, which arrived in September 2020. UNI is the native governance token for the world’s largest DEX platform and focuses on empowering computing involvement in governance.
UNI token holders have the privilege of voting on developments in the Uniswap project, which will determine the platform’s future. Furthermore, the UNI token could also serve other functionalities such as funding liquidity mining pools, partnerships, and grants. You can also use the Uniswap token to support many other growth-oriented initiatives for improving the usability of the platform.
The continuous expansion of the Uniswap community would lead to gradually diminishing roles of the founding team in platform governance. By design, the Uniswap token holders would diversify and exercise their privileges in the governance of the platform. You can clearly identify the evidence for the intersection between decentralization concepts and the facility of incentives. Therefore, it is quite clear that Uniswap decentralized exchange presents formidable prospects for fuelling the DeFi revolution.
Keeping in line with the trend of token distribution in the DeFi landscape, Uniswap also carried out an airdrop. The platform distributed 400 UNI tokens to individuals who had used the Uniswap exchange. In addition, it is also important to note how the Uniswap token is more than just a governance token. Investors can also choose the option of trading the token on exchanges and treating it like a speculative investment instrument.
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The detailed introduction to the world’s largest DEX shows more than answers to “What is Uniswap used for?” by diving into its working and governance. As a decentralized exchange protocol, Uniswap serves an innovative role in the domain of crypto trading. One of the significant aspects that have been supporting its growth is the emphasis on decentralization by design. The DEX platform uses automation and smart contracts for facilitating trades of digital assets with the assurance of liquidity.
Liquidity providers serve an important role in the Uniswap exchange by pledging their assets to liquidity pools. The platform also uses an AMM system for determining the price of assets in a liquidity pool, thereby ensuring fair value. Therefore, Uniswap DEX is definitely one of the top alternatives for crypto trades, especially with a focus on DeFi. Learn more about the world’s largest decentralized exchange or DEX.
*Disclaimer: The article should not be taken as, and is not intended to provide any investment advice. Claims made in this article do not constitute investment advice and should not be taken as such. 101 Blockchains shall not be responsible for any loss sustained by any person who relies on this article. Do your own research!