How Uniswap outperformed the most popular american crypto trading platform?

Uniswap was born out of an idea proposed in 2016 by Vitalik Buterin for a decentralized exchange (DEX) that would employ an on-chain automated market maker with certain unique characteristics. A year later Hayden Adams began working on turning this idea into a functional product.

DeFi-fever has become a big time for decentralized exchanges. One of the first DEX with the use of smart contracts was Uniswap, which introduced the technology of automatic market maker (AMM). The site was created with the support of the Ethereum Foundation and Vitalik Buterin. Up until this summer Uniswap could not boast of impressive trading volumes, but only during June this figure has increased by 10 times — from $1.75 to $17.5 million, and by the end of August exceeded $425 million, overtaking the most popular American crypto trading platform Coinbase. Here’s the story behind Uniswap and its long way to success.

From Siemens to Ethereum

The idea behind Uniswap has a specific point of origin — Vitalik Butterin’s post at Reddit in October 2016. At that time, he said, the problem of all decentralized exchanges was too big spread in trading. Buterin proposed to solve it with the help of smart contracts, which would manage the reserves of different tokens and balance their prices against each other depending on supply and demand.

This idea was realized by Hayden Adams, a young computer engineer from New York. He joined the crypto industry after he was fired from Siemens in summer 2017. After he was fired, he was contacted by his friend Carl Floersch, who suggested that Adams should retrain as a programmer and start writing smart contracts on Ethereum. Adams agreed and started to create an “automatic market maker” (the author of the idea he calls Alana Liu from Gnosis, who described AMM in the same 2017).

Floersch introduced Adams to the “party” of Ethereum developers and in the spring of 2018 introduced Vitalik Buterin (he came up with the name “Uniswap” — first Adams called his project “Unipeg”).

Already in August 2018 Uniswap received its first funding — a grant from the Ethereum Foundation in the amount of $100 000. According to Adams, Uniswap is based on “Ethereum core values”.

The official launch took place in November 2018. Presenting the platform, Adams listed its main features:

“No central token or platform commission. There is no special attitude towards early investors, users or developers. The token listing is free. All smart contract features are open and can be improved”.

How does automatic marketing work?

In Uniswap, the AMM principle is implemented by means of liquidity pools, which are trading pairs and consist of users’ funds blocked in the smart contract. The ratio of tokens in a pair determines the price of a token. Realized supply and demand for tokens changes the volume of tokens in the pool, therefore, and the ratio between them, that is, the price.

Any user can participate in the pool — he just needs to bring both tokens from the pair into the pool in the ratio at the current rate. Such users become “liquidity providers”, who receive 0.3% of the amount of transactions with the trade pair of the pool for their contribution. Thus, the users themselves earn fees, not the platform.

Providing liquidity in protocols reminds the work of currency exchangers anywhere in the world. Imagine that you can lend your nearest exchanger $100 and €84.95 in exchange for a fee of 0.3% of the transaction amount from each dollar to euro exchange and back. In doing so, you assume the risks of volatility of the euro to the dollar. The same amount of dollars and euros (excluding commissions) you can return only if the rate returns to the value of the moment you borrowed the funds.

If the exchange rate of the euro to the dollar changes a lot, you lose some money because of the volatility. In the existing financial system, exchangers and banks use their liquidity to carry out such operations, they take risks and earn on it. In decentralized finance, anyone with internet access has the opportunity to take these risks and earn on fees. In order to achieve the best exchange rate and reduce volatility risks, a bank and a decentralized exchange must have as much liquidity as possible. To attract as many people as possible who are ready to borrow their money, the Uniswap and Balancer decentralized exchanges give them a portion of their tokens. Banks cannot give out their shares to each customer because of the high cost and legal complexity of such transactions, for this they can use essentially attractive deposit rates.

Possible price deviations from the spot market are smoothed out by arbitration. Another feature of the platform is that anyone can add a trading pair with a new token.

Road to success

Uniswap did not conduct ICO. The project raised money from professional investors. Over $1 million Uniswap received in 2019 from the fund called Paradigm, and in 2020 it has already raised $11 million.

The absence of an ICO is one of the reasons why Uniswap did not have its own token from the beginning.

For a long time Uniswap was inferior to centralized exchanges, and in the field of DeFi — credit protocols such as MakerDAO. Everything changed when the market began to flood DeFi products that provide passive earnings for liquidity providers.

At the same time, yield farming became popular. By this time, Uniswap was already the most reputable project in the DEX segment.

In addition, the developers of Uniswap prepared for the hype from the technical point of view — in May there was a major update of the protocol. It eliminated the weakest points — in particular, introduced direct exchange between tokens of ERC-20 standard (before that, all exchanges took place via ETH), instant swaps for trading and improved control over trading pairs.

From the beginning of July till the end of August the volume of funds blocked in Uniswap pools increased by almost 5 times — from $47 million (July 2) to $831 million (August 31).

However, the success of the SushiSwap fork, launched in late August, contributed to a record inflow of funds into the protocol.

SushiSwap offered a record yield due to distribution of its own governance token among all participants of its pools. Thanks to this proposal, the project pools initially launched on Uniswap received $1.4 billion in just a few days. It became clear that exactly such an incentive as a token was not enough for decentralized exchanges to accelerate.

At first, SushiSwap quickly poached the lion’s share of Uniswap users’ funds, but after reducing the distribution of tokens SUSHI quickly lost them. They returned to Uniswap with the release of UNI control token, which was announced on September 16.

What has UNI changed?

Uniswap learned its lessons.

Firstly, the issue of new tokens turned into a big advertising campaign: 15% of all tokens were distributed for free to all platform users, including those who have not used Uniswap for a long time. Minimum amount of tokens was 400 UNI.

Such an impressive distribution instantly attracted the attention of a huge audience.

Secondly, the developers have changed the approach to inflation. In SushiSwap, the first two weeks the emission of SUSHI tokens was increased by 10 times compared to the standard value. Oversupply of new coins led to the price decrease. In UNI, the inflation mechanism (2% annually) will be included only after four years.

Thirdly, the approach to collective management of the project has been changed. The SushiSwap protocol provides for a development fund, where 10% of all issued SUSHI coins are directed. Uniswap also has a fund, the so-called “community treasury”. Over the next four years, it will receive 43% of all coins (430 million UNI). The fund is designed to provide grants, encourage community initiatives, liquidity management and other areas.

One month after the release of UNI, on October 18, the Uniswap community will have control of the fund. During this time, UNI holders must choose a board of representatives from “protocol delegates”. In six months the community will establish control over the main lever of Uniswap — the fee.

The creators of Uniswap urged the community to choose from its ranks “a diverse and high-quality list of protocol delegates”, as well as to start discussions and communication about specific decisions to be taken. And the community responded.

Thus, a “union” has already been formed, attracting small UNI holders to its ranks. It aims to unite small stakes of coins to defend the interests of small users and to have a comparable share of votes with the whales.

Will Uniswap become more decentralized?

The development team, which owns 21.5% of UNI’s emissions, will continue to improve the protocol code and conduct audits. At the same time, team members will not be directly involved in management, although they “may delegate their votes without the intention of influencing future decisions.

Another almost 18% of coins were given to investors. Therefore, there is indeed a possibility of whales owning large UNI amounts.

Creators of Uniswap strive for further decentralization of the project by transferring the levers of exchange management to the community. But it is not that simple.

Investors, advisers and team members of Uniswap are entitled to receive 40% of all tokens issued, which should be distributed through “hosting”. This procedure involves blocking this number of tokens in smart contracts and the issue of small amounts of tokens on a certain schedule.

However, as Glassnode highlights in its research, now these funds go to ordinary Ethereum addresses (43 in total), while the coins “community treasury” are distributed in a special smart contract with a specific unlocking period. That is, technically, the team and investor funds can be used now.

UNI is already listed on Binance, Coinbase Pro, Bitfinex and other top exchanges. At the time of writing, 131.6 million coins have already been distributed. Industry participants are concerned that the success of UNI and SUSHI may result in similar platforms without a viable business model producing useless management tokens, which could turn into a new ICO boom.

One way or another, but thanks to the implementation of UNI, the amount of blocked funds (TVL) on Uniswap has not only returned to the previous values, but even exceeded them — and at the time of writing it is $1.92 billion. Fork of Uniswap tokens has already been introduced by the payment company, and Binance has launched two DeFi projects at once. This shows that the centralized exchanges are ready to challenge Uniswap’s leadership in DeFi, and with their resources this is more than real. Whether the project will be able to maintain its leadership is an open question.

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Jeffrey Hancock

Blockchain enthusiast developer and writer. I love video games, blockchain and the hot symbiosis of these two worlds.