When you google a cryptocurrency, one of the first things to come up is always a cryptocurrency exchange. There are a ton of cryptocurrency exchanges out there, and almost all of them will claim to offer the lowest fees, the most secure storage, or the fastest settlement times. There’s nothing inherently wrong with these exchanges, they offer a perfectly viable way to trade cryptocurrency.
But for cryptocurrency purists, using this kind of cryptocurrency exchange is like forcing a vegan to work in an abattoir.
Many people may marvel at how progressive and technologically advanced cryptocurrency is, and almost everyone is impressed by the rate at which it has grown. However, very few people stop to think about why cryptocurrency needed to be established in the first place. One of the fundamental reasons cryptocurrency was developed was to create a world that was decentralised: where businesses were not owned by individuals and bureaucracy. Decentralisation has a wealth of benefits. It allows people to have a genuine, valued opinion on how corporations are managed, it allows personal data to remain sacred and secure, it removes the need for trust, and it is, by default, indiscriminatory.
Crypto-purists are incredibly passionate about keeping cryptocurrency decentralised.
The level of decentralisation that cryptocurrencies have managed to maintain is nothing short of impressive. Through consensus algorithms, mining mechanisms and the rise of the Smart Contracts, cryptocurrencies have (for the most part) stayed true to their motivations. When you consider the admirable amount of integrity that cryptocurrency has maintained, it’s understandably disappointing that a centralised exchange must be used in order to delve in to the cryptocurrency world.
For a long time, cryptocurrencies turned a blind eye to the centralised nature of these exchanges because they facilitated industry growth. But these exchanges certainly do not harmonise with what cryptocurrency stands for.
Decentralised Exchanges (DEX)
Uniswap is a decentralised exchange (DEX) that runs on Ethereum’s block chain. Uniswap isn’t really a cryptocurrency in its own right, it doesn’t even have its own native coin. Instead, it is living proof of just how successful Ethereum can be, as Uniswap is really just an app (or DApp as they are called in Ethereum world) that runs on Ethereum’s network.
Uniswap can be used to trade any ERC20 token, that is any token issued on the Ethereum Blockchain. While many cryptocurrencies have their own blockchain, for some it is more efficient to use Ethereum addresses and Ethereum transactions. However, this doesn’t mean that they’re all tiny coins that you’ve never heard of. Some big names use the Ethereum blockchain, such as EOS, ICON and Zilliqa.
In order to maintain the decentralisation that is fundamental to cryptocurrency, in September 2020 Uniswap launched a special kind of coin called a governance coin. Governance coins can be staked in certain decisions or polls to ensure users of the platform can influence how the platform is developed and evolved in the future. This allows the team that created Uniswap to step back so the platform can become totally decentralised.
There are other DEXes but Uniswap offers above and beyond their competitors and is already proving much more successful. And the proof is in the pudding. With 38,000 daily users, Uniswap is by far the most popular DEX. Moreover, Uniswap has a daily trading volume of $263 million, which makes up about 95% of all DEX trading. The success of Uniswap’s governance coin, UNI, speaks volumes. Since its launch in September 2020, UNI has become the 8th largest cryptocurrency by market capitalisation. This is all the more impressive when you consider that it was only launched for governance purposes.
Even beyond decentralisation, Uniswap has a lot to offer. Because it wasn’t built to garner a profit, Uniswap can offer competitively low trading fees. Of course, there is still a fee, but this only goes towards developing the platform and incentivising the users that keep Uniswap alive. These users are called LPs (liquidity providers).
As well as most cryptocurrency exchanges being centralised, they also often struggle with liquidity.
Most exchanges operate order book-based trading. Order book-based trading is essentially a database of what is being sold versus what is being bought. It works seamlessly if the scales are balanced but cannot even operate if it is too unbalanced. For example, if too many people are selling a cryptocurrency but not enough people are buying it, the exchange would end up with a surplus amount of the cryptocurrency but not enough fiat money to reimburse those who are selling. That’s why order book-based trading requires liquidity.
Liquidity ensures that even if the scales aren’t balanced, there is still a stash of currency that can be dipped into in order to ensure the exchange can still operate. But liquidity on a large scale is difficult to source. Even if an exchange had an impressive amount of liquidity, the cryptocurrency market is so volatile that problems could still occur.
Even most DEXes use an order book system, so they also struggle to have enough liquidity to operate successfully. Most commonly, a DEX system pairs up sellers with buyers of the same value, so the liquidity problem still prevails.
In contrast, Uniswap has no order book. Uniswap operates with an infrastructure called a Constant Product Market Maker. In this protocol, any ERC20 users can trade some of their coins for liquidity tokens. Their ERC20 coins effectively become the liquidity that is so hard to come by. The users that do this are called liquidity providers and their coins form what is called a liquidity pool. By putting their coins in a liquidity pool, liquidity providers are essentially freezing their assets, so they receive a fee in order to reward them and incentivise this service. Then, when they need to use the coins that were exchanged for liquidity tokens, the tokens can be returned and the original stake can then be collected. The coins are still yours to own, and they are still accessible at any given time, but these liquidity pools provides exchanges with an insurance policy to fall back on.
It sounds like a complicated and somewhat dubious process, but it is a process that happens every day in the real world. When you take out a loan from a bank, the bank isn’t digging in to their own pockets to give that money to you. Instead, they are moving money between all their different account holders all the time in order to maintain liquidity. Liquidity pools offer the same benefits to a fiat savings account. Essentially, they both offer investors an opportunity to earn an income on their holdings.
If nothing else, Uniswap is evidence of how cryptocurrencies are not just coins. Uniswap is one example of how coins like Ethereum are becoming ecosystems in their own right. Without Ethereum, Uniswap simply wouldn’t exist. But Ethereum has facilitated Uniswap’s incredible growth, allowing them to create their own loyal community and network.
Uniswap could also be a catalyst for further growth in the cryptocurrency world. Because any ERC20 coins can be traded on Uniswap, fledgling coins have the opportunity to grow and gain more attention and investment. In an industry that is totally dominated by the top dogs like Bitcoin and Ethereum, Uniswap could level out the playing field and provide promising opportunities to young and exciting developers. In many ways, that is as key to cryptocurrency ethos as decentralisation is. Uniswap could provide a more equal set of opportunities and allow innovation to trump reputation.
Since their launch in 2018, Uniswap has been steadily building up momentum, with huge successes materialising after the release of Uniswap V2. With version 3 also in the pipeline, investors are hoping this momentum will continue to build.