Uniswap is a breakthrough technology that has resolved the problem of liquidity and pushed the usage of DeFi to new heights. It allows exchanging any Ethereum-based tokens directly while leaving all the issues of centralized exchanges behind and allowing users to interact with each other in a completely decentralized manner.
As part of the work we are doing at Numbrs regarding crypto, we decided to review this technology in detail to find out what is so special about it and how it managed to show such incredible results in such a short time.
The biggest pain of the early DeFi
Before we go anywhere further, it’s important to understand the phenomenon of DeFi first.
This is an abbreviation standing for Decentralized Finance which represents an analogy to traditional financial tools powered by banks and other centralized institutions. These publicly available tools are powered by smart contracts and they enable taking loans collateralized by cryptocurrencies, earning interest on deposited coins, and performing many other types of financial operations.
MakerDAO can be named one of the most well-known DeFi services in the early years of the industry. Launched in 2017, it allows borrowing stable coins DAI while pledging ethers as collateral. Ever since that date, many other projects have tried to ‘make a revolution’, but hardly any of them can be named the industry mover. How so?
The lack of liquidity is, perhaps, one of the biggest issues that early DeFi services struggled with. Big exchange platforms and stock markets were solving this problem with the help of the market-making services by artificially pumping the liquidity. However, small projects did not have sufficient budgets for that. To get their tokens listed at least somewhere, they had to fall back on decentralized exchanges that could never have boasted of high popularity.
It all has changed with Uniswap.
Uniswap’s revolutionary approach
Liquidity pools introduced by Uniswap have become the holy grail that has resolved the liquidity problem and helped startups break this vicious cycle. They represent smart contracts where any project can upload its tokens along with a bunch of ethers of the same value (ether is liquid, no one would doubt that, agreed?). With that said, users can exchange any ERC20 tokens directly between each other within a single smart contract.
Thus, we finally have a decentralized tool that allows instant exchange of Ethereum-based assets with guaranteed liquidity. To explain the logic of this approach and its advantages more scrupulously, let’s review a couple of real-life examples.
1. Example #1. Listing a coin
Suppose you’ve decided to launch a new cryptocurrency (one more in addition to 10k that are already listed on CMC, omg).
You send your tokens to the liquidity pool and an equivalent sum in ethers for anyone to exchange them in both directions. As you have deposited ethers, the situation when users have tokens with zero trading volume and no way to get rid of them becomes impossible.
Whenever someone buys your tokens, their amount in the pool decreases while the amount of ethers increases. This makes the token price grow. And vice versa: when someone sells your tokens, the amount of ethers in the pool decreases, the amount of tokens increases, their price falls.
Example #2. Earning fees
Suppose you’ve decided to take another path and make passive income on transactional fees (USDT/ETH).
You deposit 4,000 USDT and the equivalent sum of 1 ETH that hovers at approximately the same level at the time of writing. Uniswap commission makes up 0,3% and is distributed across contributors in proportion to the deposited sum. Thus, if the pool reaches the level of 100 ETH and the cumulative fee makes up 1 ETH, your reward would be equal to 1/100 ETH. Surely, the numbers may vary from day to day, but the reward is guaranteed in any way.
These two primary use cases have opened up numerous possibilities for cryptocurrency enthusiasts. Token holders rushed to deposit their reserves to the liquidity pools to make a guaranteed profit while blockchain projects started integrating the new technology to ensure the liquidity of their tokens.
As a result, the amount of locked assets has been steadily growing since its release. Now the total sum has already reached $8 billion and it still continues to grow!
DefiPulse: the amount of assets locked in Uniswap liquidity pools has been growing exponentially during the past year
Problems of Uniswap
However, don’t hurry to cheer up and raise a glass for the bright decentralized future yet. Uniswap faces a number of challenges that have to be resolved. The list of its key problems includes the following:
High network fees
With Uniswap, everything works on smart contracts which means pretty high network fees on Ethereum. From the technical perspective, the exchange process occurs not between two users directly, but through an additional layer of a smart contract. Therefore, users will have to pay the fees twice: when sending tokens to the contract and when forwarding them further to the second party.
Ethereum will surely reach the Serenity stage one day, implement sharding and finally resolve this issue. Until then, Uniswap cannot be a fit for microtransactions and therefore, can’t be adopted at scale.
Expensive panic sell
In the times of big market movements, the number of transactions in the network grows and so do the network fees. If the assets you’ve deposited to the liquidity pool have started plummeting, the losses you will bear in case you sell them would be much higher.
Lots of them. It’s sad but the blockchain industry has always been a honeypot for malefactors due to the lack of regulation and a plethora of technical loopholes. Uniswap has not become an exception to this rule. The platform is filled with fraudulent projects that list their worthless tokens under the tickers similar to real coins and fool users into buying this rubbish.
Not a real BADGER! CoinMarketCap warns about Uniswap scams and gives some advice on how to avoid them
The lack of legalization
Uniswap does not work with fiat currencies at all and the chances of its legalization in the nearest few years are pretty low. Therefore, law-abiding projects and individuals must think twice before using any associated tools.
No cross-chain compatibility
Uniswap works with Ethereum only and there is no information in the project’s roadmap on whether other chains will ever be supported. The service blocktivity.info, at the same time, shows that only 2.7% of all transactions across all blockchains are conducted on Ethereum.
Blocktivity.info: As of May 2021, Ethereum’s contribution to the overall blockchain activity is still very low in comparison to other platforms
Uniswap’s influence on the industry
It’s obvious that problems are aplenty, even though Uniswap has released a truly viable product that resides on the blockchain and doesn’t depend on any centralized party. However, despite all these inefficiencies, the project has indeed managed to stir up the whole industry after a long crypto-winter.
As of now, one can say for sure that Uniswap has significantly pushed the adoption of DeFi upward. The forks have started to emerge and even dedicated services to facilitate this process for developers while the amount of tokens staked in the pools grows exponentially.
And, what’s especially important, blockchain startups have gained a new method of attracting investments. With ICOs having almost gone extinct and IEOs being affordable only for the big guys, Uniswap is a much better alternative for small but ambitious projects.