Uniswap — Dominating the crypto DeFi market despite recent price declines
Uniswap is currently among the most popular DeFi projects in the crypto industry. Despite the recent decline in its token price it remains a dominant player in the DeFi space and is covered in many articles on crypto news pages. The objective of this publication is to analyse the Uniswap project & use case, its key differentiators from competitors and the main investors in the Uniswap project. The publication concludes with an outlook on the project’s future potential.
The decentralized exchange Uniswap created the very first automatic market maker (AMM) since Vitalik Buterin originally proposed the idea two years ago.¹ The idea of AMMs is to pool liquidity in smart contracts rather than to rely on an order book, like other decentralized exchanges (DEXs). The trader or investor (the user) trading on such an AMM platform trades against the liquidity pool and not via an order book. The first mover advantage of Uniswap combined with the start of the yield farming craze in DeFi, have let to large number of investors migrating from centralized to decentralized exchanges, making it the largest DEX.
In September, the team introduced a governance model, that led to Uniswap being among the most decentralized protocols in DeFi. With the launch of the UNI governance token on September 16th, Uniswap transformed from a tokenless protocol to a DeFi protocol governed by a governance token. Since inception of the UNI governance token, the DEX’s collateralized assets grew from c. $ 0.75 billion to $2.53 billion, according to leading crypto data aggregator DeFi Pulse.²
Source: DeFi Pulse
The large gain in collateralized assets results also in a deep liquidity for many ETH trading pairs, which outcompetes other DEX competitors and rivals centralized exchange (CEX) competitors.
At a current 23.50% market share dominance, investors wonder whether this is the top or just the start of Uniswap.³
What is the use case of Uniswap?
At its current stage, Uniswap V2, offers three specific features backed by its original AMM protocol. With the help of the AMM system, users take part in a decentralized trading experience by trading with other users via a liquidity pool (a smart contract), and not through a classical order book. Liquidity providers, often called yield farmers, provide liquidity to the DEX liquidity pool and are rewarded with a token swap fee.⁴ Yield farmers also contribute to the ecosystem by voting on the governance of the protocol.
Uniswap’s key objectives are to attract liquidity and enable trading of ERC-20 token, especially of new DeFi projects. To achieve the objectives the protocol incentivizes yield farmers by distributing token swap fees to them. Token swaps are key for the DEX, as most new listed DeFi projects can solely be purchased through token swaps. The supply of new DeFi project tokens and the demand for those tokens by traders and investors creates a positive feedback loop for Uniswap in a striving DeFi ecosystem.
Source: Uniswap
How does Uniswap work in detail?
As previously mentioned, the automatic market maker (AMM) makes the core of the protocol. Based on the Ethereum network, Uniswap relies on a ‘constant product formula’ where pooled reserves consist of two assets.⁵ Liquidity providers (LP) provide these two assets by maintaining a stable 1:1 ratio. Users (traders or investors) who swap token pay 0.3% in fees, which the protocol subsequently distributes to liquidity providers.⁶
The AMM acts as a smart contract, a coded automatization software that handles trades. On most centralized exchanges, users interact with the order book when trading. On Uniswap, users trade with other users via the smart contract. Based on a unique mathematical formula, the AMM calculates the relative ‘theoretical’ price of an asset based on the amount of pooled assets for each trading pair.⁷
In the beginning, Uniswap could only support trading pairs for ETH versus another ERC-20 token. After launching V2, the DEX now supports ERC-20 versus ERC-20 trading pairs and liquidity pools. Moreover, the team developed an accurate price oracle that calculates the average price of both assets at the start of a mined block. By doing so, other Ethereum contracts can estimate a time-weighted average price for the two tokens in a trading pair.
Uniswap ultimately acts as a decentralized intermediary. The DEX has an exchange contract with multitudes of token trading pairs and pools. Each user’s ETH address interacts with Uniswap’s contract, which then interacts with the liquidity provider on the other side of the trade.
Besides that, developers can also interact with the exchange contract. By calling a ‘createExchange’ function, developers can list their DeFi token on the exchange without paying a fee.⁸ Uniswap requires neither fees nor special ‘curator’ requirements for listing tokens. This may be by far the most important feature of Uniswap.⁹ The dominant centralized exchanges forced high fees and community requirements on developers for token listings. As a consequence of this feature, Uniswap can boost the flow of innovativeness within the developer community.
How are UNI tokens allocated?
With the recently introduced native UNI token, an additional layer of governance was introduced. In DeFi projects, governance is usually established to make a decentralized product or service owned by its community.
On September 16th, Uniswap launched the UNI tone and distributed 60% of the original genesis token supply to community members. The native UNI token is among the most distributed tokens in the history of cryptocurrencies. A majority of the tokens were distributed in the form of an airdrop to early community members. Following the tenets of the Ethereum community, Uniswap managed to create a strictly neutral and decentralized trading protocol.
The initial genesis block minted 1 billion UNI tokens. The tokens will be evenly distributed over a period of four years in the following way. 60% of UNI is allocated to community members while the team receives 21.266%. Uniswap investors will receive 18.044% on a 4-year vesting schedule while advisors earn 0.69% on a 4-year vesting schedule. To ensure long-term activity, the protocol will implement a perpetual 2% inflation rate per year four years after launch.¹⁰
Source: Uniswap
According to the Uniswap team, 15% of UNI tokens were initially claimed by users who provided liquidity, traded on Uniswap, or redeemed SOCKS before September. Around 49 million UNI are eligible for claiming by historical liquidity providers who participated since Uniswap V1. Each address received 400 UNI while SOCKS redeemers received 1000 UNI.¹¹
From 16th of October users will have the first chance to initiate governance proposals. While users can go as far as to change the overall trajectory of the protocol, the community will limit itself, for the time being, to voting on new liquidity pools. Once UNI tokens are evenly distributed, Uniswap will become the 2nd most decentralized project after Bitcoin.
At the time of writing, UNI is priced at $3.34 according to CoinGecko. UNI reached an all-time high of $8.4 on September 18. It is therefore currently trading 60% below the all time high.¹²
What differentiates Uniswap from other DEX protocols?
A main potential of Uniswap’s success is, that it has an experienced developer team that worked on the product for years before the DeFi hype took off. With its first-mover advantage, the DEX received much more liquidity compared to other platforms The liquidity is deeper for trading pairs making it interesting for larger volumes. Moreover, the range of liquidity pools is wider, making it attractive for yield farmers to choose different tokens. Both reasons make Uniswap attractive for users but also liquidity providers.
Uniswap hosts more than $2.5 billion in collateralized assets, followed by DEX projects Curve Finance ($1.1 billion), Balancer ($0.31 billion) and SushiSwap ($0.3 billion).¹³
Security is another differentiator since smart contracts went through strict auditing processes, which enhances security for users significantly. The DEX also set fixed trading fees for all token swaps and pools, creating a standardized and transparent fee model. Competitor protocols such as Balancer let liquidity providers set fees. While this may offer a more competitive environment, liquidity providers are more prone to price manipulation. Besides those differentiators to other protocols, the evenly distributed governance to all stakeholders, which aligns the interests of different stakeholders and creates a strong alignment in the Uniswap community could be key to support the Uniswap growth and DeFi market dominance in the future.
Who has invested in Uniswap?
Uniswap was initially funded by major Venture Capitalists. According to data from Crunchbase, 8 investors participated in 2 funding rounds, raising $11 million in total.¹⁴ Uniswap held a seed round on April 17 this year while a series A funding round took place on August 7. SV Angel, A.Capital Ventures, Version One Ventures, Andreessen Horowitz, Parafi Capital, Variant Alternative Income Fund, Union Square Ventures, and Paradigm have participated.
Based on the previous tokenomics section, we know that investors received 17.8% of the UNI tokens. The team received 21.51%, and advisors 0.69%. Therefore, we observe a 60/40 ratio where the community holds 60% and investors, team and advisors 40%.¹⁵
A controversial topic analyzing the investors in the project is that vested UNI tokens are not truly vested. In a report by Glassnode, the firm reveals that the early investors have full control over their tokens.¹⁶ As a result, investors, team and advisors could submit a single proposal by delegating 10 million token. Despite the favorable distribution of tokens to the community, the team, investors, and advisors could have an advantage in the governance model in their submission of proposals through their full control over their tokens.
What does all of this mean for Uniswap’s future?
At $2.5 billion in collateralized assets and despite the recent sharp decline in UNI token price, Uniswap remains to be the number one DeFi project in terms of market share with 23.50% dominance. Uniswap is the first DEX to feature an AMM which removed the need for order books and enabled users to trade directly with other users. Developers have the chance to list the latest innovative DeFi tokens in the sector.
The UNI token is the consequence of the strong focus towards real decentralization. With the introduced governance model, UNI holders are now able to propose and participate in voting proposals and ultimately decide on the future strategy and development of Uniswap. Only the full control of key investors over their tokens may raise the question on true decentralization and may has implications on Uniswap’s governance going forward.
It remains to be seen if the DeFi DEX trend towards AMM systems will continue to strive or the classical order book DEX system will prevail. Uniswap is in a dominant position if AMMs are the prevailing DEX model and has a strong community alignment which is a major benefit for potential network effects which ultimately could result in strong growth rates of Uniswap.
Research by Tiuri Ventures
Follow us on Twitter: @Tiuri Ventures
Disclaimer: The information and publications are not intended to be and do not constitute financial advice, investment advice, trading advice or any other advice or recommendation. The author is not responsible for any loss arising from any investment based on any perceived recommendation, forecast or any other information contained in this publication.
[1] Link: https://vitalik.ca/general/2017/06/22/marketmakers.html
[2] Link: https://defipulse.com/uniswap
[3] Link: https://defipulse.com/
[5] Link: https://uniswap.org/whitepaper.pdf
[6] Ibid.
[8] Link: https://uniswap.org/docs/v2/protocol-overview/ecosystem-participants/
[9] Ibid.
[10] Ibid.
[11] Ibid.
[12] Link: https://www.coingecko.com/de/munze/uniswap
[13] Link: https://defipulse.com/
[14] Link: https://www.crunchbase.com/organization/uniswap/company_financials
[15] Link: https://uniswap.org/blog/uni/
[16] Link: https://insights.glassnode.com/uni-token-is-uniswap-really-decentralized/