What is Uniswap?
Uniswap is a decentralized finance protocol used to exchange cryptocurrencies. It also represents the company behind the Uniswap protocol. This protocol has garnered significant attention for how it works. Essentially, it facilitates automated transactions between cryptocurrency tokens on the Ethereum blockchain. The protocol uses smart contracts to achieve that. This feature has become prevalent in the crypto industry.
Uniswap started its operations in November 2018 under Hayden Adams. However, the protocol was founded over a year ago. Before launching Uniswap, Adams worked as a mechanical engineer at Siemens. He was a Stony Brook University graduate with a degree in the same field. However, Adams left his job at the company due to layoffs. This event happened in July 2017, three months before he launched the protocol.
At the time, Adams contacted a friend, Karl Floersch, a blockchain engineer at ConsenSys. From there, he got introduced to the Ethereum blockchain. Soon, he realized the potential for the platform and designed a working prototype of a protocol. Later, he renamed it Uniswap, which is also its current name. However, Floersch introduced the platform to others through a developer conference.
After that conference, Adams continued working on the platform with Floersch. However, they also enlisted the help of another friend named Uciel Vilchis. In 2018, they released a fully-featured demo of the Uniswap protocol. During the time, Adams struggled financially due to his Ethereum investments in the market. Despite that, he reached out to Vitalik Buterin, Ethereum’s founder, at a South Korea conference.
Buterin encouraged Adams to apply for the Ethereum foundation grant, which Adams later received. This grant was worth $100,000. Buterin was also the person who came up with the name Uniswap. Initially, Adams named the protocol Unipeg. In November 2018, Adams released the first public version of the Uniswap protocol. At the time, it faced significant competition from Bancor, which had raised $153 million in fundings.
However, Uniswap had significant advantages over Bancor. Furthermore, Uniswap used a tokenized platform, which made it more favourable in the market. In April 2019, Uniswap had locked $10 million in liquidity pools. Through these funds, the company also received its first seed investment. Uniswap continued to grow during 2019. Due to this growth, the company has become a well-known name in the industry.
In May 2020, Uniswap also released its first update to its protocol, known as V2. While V1 was still functional, V2 provided better features and interfaces. However, it faced some security issues. The company continued growing in size during that time. The company also released a V3 update to its platform. This update came in May 2021, which is currently the company’s latest version.
How does Uniswap work?
As mentioned, Uniswap is a decentralized exchange protocol. It primarily works with the Ethereum blockchain. Uniswap allows users to swap tokens using its ERC20 standard. In practice, however, it works on a complicated model. Understanding how Uniswap works require differentiating between centralized and decentralized exchanges. The former is more prevalent in the Ethereum circle. The latter, in contrast, is synonymous with Bitcoin or Binance.
In a centralized exchange, sellers must find a buyer to exchange tokens. However, it creates a liquidity issue. Essentially, the amount of buying and selling orders at any given time may not match. When the liquidity is low, traders may not find buyers to buy their currencies. On top of that, the centralized exchanges charge high fees for providing that liquidity.
With centralized exchanges, users face issues with liquidity and high expenses. However, users can also choose decentralized exchanges to tackle those issues. With these exchanges, users can cut out the intermediary in the process. Uniswap also works on the same premise, allowing users to conduct their transactions directly. The company uses an automated liquidity protocol to achieve that, known as the “Constant Product Market Maker Model.”.
The Uniswap protocol incentivizes marketplace participants to become liquidity providers. They use their money to create a fund that supports trades on this exchange. Every token gets listed on the platform. Therefore, Uniswap creates a liquidity pool to which participants can contribute. Uniswap uses a constant equation to determine the price of the underlying token. However, other factors may dictate the price given for the token.
Among those factors are the size of the liquidity pool and the proportionality of the trade. These ultimately determine how much the price of the underlying token will fluctuate. For small transactions compared, the prices will be unaffected. Therefore, most participants with low-value transactions are unlikely to suffer significantly. This way, they can tackle the issues with centralized exchanges.
In exchange for providing liquidity, users get a “pool token”. This token represents their staked contribution to the pool. Later, they can redeem the pool token for a share of the trading fee charged by Uniswap. This way, the company provides an incentive to participants to boost the liquidity of its decentralized exchange. While these participants use their own money, they can get discounts later due to their pool tokens.
Aside from the decentralized exchange, Uniswap also has its token called UNI. However, it is not a tradeable token like others. Instead, it acts as a governance token. The owners of these tokens can get various rights. For example, they can vote on new developments and changes to the platform. In that regard, it acts similar to a share for companies. The more tokens a user owns, the higher their voting power is.
What is Uniswap’s business model?
Uniswap uses a platform-based business model. As mentioned above, it is a decentralized finance protocol that allows users to exchange cryptocurrencies. The primary currency which this platform uses is Ethereum. Therefore, it does not provide the product itself. Instead, it acts as an exchange platform for users to trade in this cryptocurrency.
Uniswap primarily operates under an e-commerce business model. The protocol uses the internet to reach out to users and attract them. Furthermore, it may also classify under a C2C business model. As mentioned, sellers cannot find sellers for the right price under the centralized exchange protocol. In those cases, they may lose money and liquidity.
However, Uniswap allows buyers and sellers to interact without hassle. Therefore, it provides a platform for those users to exchange cryptocurrencies without those issues. On top of that, it rewards other users for providing liquidity. By doing so, it incentivizes those users to power its platform. Without these users, the platform will not be effective.
Lastly, Uniswap uses a fee-based structure to make money. However, this charge may be optional based on the decision by its owners. Under the fee-based business model, the company charges for every transaction it helps the process. Although these fees are insignificant, they help Uniswap make money from every transaction.
How does Uniswap make money?
As mentioned, Uniswap primarily makes money from its protocol fees. With these fees, Uniswap charges its users for every transaction they make. This feature is optional and turned on by the UNI governance. As mentioned above, this governance is related to the UNI tokens offered by the company. Therefore, the owners can turn on the protocol fee.
However, the optional feature is only available in V3 of the Uniswap protocol. In V2, the UNI token governance mechanism did not exist. Uniswap makes money directly from every transaction in that version. In August 2021, the company made over $1 billion from the combined protocol fees from V2 and V3.
When a liquidity pool gets created, the protocol fees are zero. As transactions occur in that pool, it generates protocol fees. From these fees, Uniswap only receives a fraction of the total. Usually, this may fall between 0.05% and 1% of the total fees. These charges apply to V3. However, the V2 protocol fees may differ.
However, these protocol fees do not apply to every pool. The company only turns on these fees for some pools. Nonetheless, the income generated from those pools can be significantly higher. On top of that, the company can also make money from its internal tokens. However, they are not publicly tradeable like other cryptocurrencies.
Conclusion
Uniswap is a decentralized finance protocol used to exchange cryptocurrencies. At the time, it had a revolutionary mechanism that helped it garner significant attention. Uniswap’s business model includes a combination of various e-commerce-based models. The company primarily makes money from the protocol fees it charges on pools.
