How Uniswap is changing the DEX space

March 22, 2024 - Uniswap is a decentralised finance (DeFi) app which uses smart contracts to run as a decentralised exchange (DEX). Uniswap is a platform where users can buy and sell cryptocurrency, as well as stake their cryptocurrency for monetary rewards – known as yield farming.

Since its creation, Uniswap has risen to become the most popular DEX on the market, reaching a daily market volume of approximately $1.2bn.

In this article, we highlight how Uniswap rose to the forefront of the DEX space, how Uniswap works, and how it continues to innovate.

Beginnings of Uniswap

Uniswap was the first well-known DEX to offer an exchange that would rival the dominant centralised exchanges of the time.

EtherDelta (launched in 2016) and IDEX (2017) had been the main options for DEXs in the DeFi spaces. Vitalik Buterin (founder of Ethereum) proposed the idea of a DEX on Reddit in 2016, which then quickly prompted the creation of DEXs across the industry.

Hayden Adams founded Uniswap on November 2nd 2018, offering the best example of a DEX. Several DEXs have modelled their business off the success of Uniswap, such as Sushi and PancakeSwap.

It provides not only a concrete system on which to create liquidity pools, but brands it in an appealing and accessible way to traders and investors. Members of the public can become liquidity providers and contribute to the system easily, without necessarily having to understand the complexities.

How does Uniswap work?

Uniswap uses smart contracts to create liquidity pools, which means that liquidity is created in the market at all times. Users can swap tokens directly from their wallets, creating an efficient trading environment. 

At the same time, any user can also stake their cryptocurrency in a liquidity pool. For the risk involved with their investment, users will be rewarded with annual percentage yield (APY) as well as UNI tokens – Uniswap’s liquidity pool (LP) token.

UNI tokens

Uniswap’s native token is UNI, which is given to those participating and remaining in the liquidity pools. 

Not only can UNI tokens be traded like any other cryptocurrency, they also allow the users to vote on certain changes to the Uniswap protocol. For an industry that prides itself on being democratic and transparent, tokens represent giving agency to users over their own capital.

Uniswap has a guide for beginners on how governance voting works on the platform.

The evolution of Uniswap: V1 to V4

Since its inception in 2018, the Uniswap Protocol has transitioned into several versions, and at the time of writing is currently at v3. 

Each version has aimed to improve UniSwap, and offers greater efficiency for traders. UniSwap v4 is currently in development and is scheduled for release in Q3 of 2024.

Uniswap v1

The first version of Uniswap only had a single liquidity pool of Ethereum and ERC-20, which meant that users had to use these tokens in order to facilitate a swap.

UniSwap v1 was a great success in the DeFI community, and demonstrated that a DEX could work well. However, as the demand for Uniswap began to grow, the demand for a more updated version increased.

Uniswap v2

Released in August 2020, Uniswap v2 expanded on a lot of the success of v1, but added in several features that improved the experience for traders.

Users were now able to swap different tokens and weren’t limited to Ethereum and ERC-20, allowing for much more efficient transactions. Flash swaps were also added in, as well as a new price oracle system, allowing for more accurate pricing.

Uniswap v3

In May 2021, Uniswap launched v3, which offered several huge benefits over v2. 

Uniswap v3 introduced fee tiers for liquidity providers. Liquidity providers can now create pools at three different fee levels: 0.05%, 0.30% and 1%. This meant that users could now choose a level of liquidity based on their risk appetite.

Uniswap also allowed liquidity providers to concentrate their liquidity into specific price ranges. It also put a limit on the number of liquidity providers that can contribute to a liquidity pool, which was done to reduce slippage.

One of the biggest innovations of Uniswap in their v3 update is the introduction of non-fungible liquidity pools.

Uniswap v4

Uniswap v4 is due for release in Q3 of 2024, and will likely make equal strides in innovation as the previous versions have.

Hooks are a novel concept being introduced later in 2024 by Uniswap, and demonstrate yet another way that Uniswap is pioneering the DeFi space. Hooks are essentially a tool which allows developers to customise liquidity pools, for example adding in an order type or custom curves.

Uniswap v4 will also have unlimited fee tiers, so there will be even more flexibility in trading strategies, as each pool can have its own unique fee tiers, catering to all risk appetites.

What are non-fungible liquidity pools?

A novel feature of Uniswap v3 is the introduction of non-fungible liquidity pools (NFPs). This feature is designed to create concentrated liquidity – essentially, liquidity between specific price ranges.

Previously in v2, the assets in the liquidity pools were used at random, which meant that they were essentially ‘fungible’. All cryptocurrency went into the same pool, essentially, all assets went into the same pile that was then spread across the entire trading range.

This works well as a market maker, but is not as efficient as could be. Across the entire curve a lot of the funds would go unused (up to 99% in some cases) as traders are generally trading at a specific point on the curve. 

In Uniswap v3 pools, the assets are ‘non-fungible’ meaning that they are identified by amount, and more importantly, by the original ownership. Users can select a particular price range to offer their liquidity, essentially creating individualised price curves.

NFPs allow liquidity providers to allocate their assets to a specific price range within the liquidity pool, instead of across the entire price spectrum – allowing a way for traders to concentrate the liquidity where they like.

The advantages of Uniswap v3

For liquidity providers, the benefits are simple: equal earnings for less capital. Liquidity providers can choose a custom price range and allocate their liquidity for where it is needed, rather than where trades will rarely happen.

There is also technically more liquidity being provided, or at least more liquidity where it matters. This way the market can be kept even more liquid than before, and trades will be even smoother.

Conclusion

Essentially, Uniswap is making leaps in the DeFi space by giving users more and more tools to control their cryptocurrency trading and earnings, but maintaining the decentralisation philosophy of Uniswap.

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Author

Caleb is a financial copywriter with a specialisation in fintech and forex. Former copywriter at Barclays and Paysafe. Contributing writer for LiquidityFinder. You can message Caleb here.