Challenge #3| The Best Exchange | Part 4 | Uniswap : Decentralized Exchange
Cryptocurrencies as a whole came into existence to defeat the flawed centralized system. These digital assets have been able to achieve this purpose to a great extent. However, one area which still requires a centralized system is the centralized crypto exchanges that we have used for several years now.
Since most popular exchanges out there are centralized, to unleash the full power of blockchain and cryptocurrencies as a whole, we needed a decentralized exchange that is not controlled by anyone. Over the years, we have had several decentralized exchanges.
However, none of them were able to enter the mainstream exchange market. Most of the decentralized exchanges were unknown to the majority of traders. This was due to the complex workings of the decentralized exchanges and the low liquidity that they had to offer.
All decentralized exchanges tried to replicate the behavior of centralized exchanges which is why most of them failed. There are a few that did succeed. In this article, we will have a look at Uniswap which is one of the most successful decentralized exchanges out there.
Before we get into the details of Uniswap, let us first see what you should look for while choosing an exchange.
Factors to consider while choosing a cryptocurrency exchange:
Whenever I decide to start using an exchange platform, I look for a few factors that they have to offer. By considering these factors you would be able to easily weed out the bad exchanges from the lot. These factors are:
1- Liquidity: This is one of the first things that I search for in an exchange. Choosing an exchange that offers good liquidity helps you get better offers while trading. You would be able to easily buy or sell cryptocurrencies quickly.
2- Cryptocurrency support: When the crypto space was born there were just a few cryptocurrencies. Mainly because of the ERC20 protocol, we now have over 7,400 different cryptocurrencies out there. Choosing an exchange that has many of these cryptocurrencies listed would definitely increase your chances of investing in a great crypto project.
3- Reputation: I always look for the reputation a particular exchange has on the internet. Bad reputation, be it for poor security practices or poor customer support should all be considered as red flags.
Many exchanges out there have a poor reputation because of their inability to handle high-frequency trades. Coinbase is one of the prime examples of this.
I have given a few decentralized exchanges a go. However, they failed to meet my expectations. This all changed when Uniswap released version 2 of its decentralized exchange this year.
Uniswap in a nutshell:
Uniswap is a decentralized exchange that is hosted on the Ethereum blockchain. This has allowed this exchange to leverage all the benefits that the Ethereum blockchain has to offer. Uniswap was initially released in 2018. However, it wasn’t until 2020 that this exchange gained a lot of popularity.
The whole idea behind decentralized exchanges is not something new in the crypto world. However, the existing ones suffered from problems such as high fees, large spread, or simply just low liquidity.
Uniswap solves all this with its unique approach to the problem. As the name suggests, you simply swap tokens on the Uniswap dex. Since it is based on the Ethereum blockchain, you will be able to find all ERC20 tokes as well.
To use Uniswap, you need to first connect your existing Ethereum wallet to the web app. You will then be able to swap your existing tokens for other tokens on the Ethereum platform. This entire system is free from any centralized intervention. So, you don’t have to pay any fee to them.
However, when you swap tokens, in real-time, you are moving tokens from one wallet to another. To confirm this transaction, you will need to pay the gas fee on the Ethereum network. Additionally, a small fee should also be given to the person who is swapping the token with you. Such a person is called the liquidity provider and the fee that you pay is called the liquidity fee.
This is Uniswap in a nutshell. Let us now understand the main problems that decentralized exchanges prior to Uniswap faced and also see how Uniswap was able to solve those problems.
How did Unswap sole the DEX problem:
Early DEX(Decentralized exchange) platforms try to mimic exactly what centralized exchanges did. This is why they failed so badly. One of the problems that I would want to highlight is the large spread that used to exist.
This is also a problem that some of the lesser-known centralized crypto exchanges out there also face. One of the Indian exchanges that still suffers from this problem is Unodax. At the time of writing this article, the price of one Ethereum is $377. An exchange that suffers from a large spread would probably have a taker who would place an order close to $377 per ETH. Whereas the maker might make an offer to sell his Eth for $450. This large difference between maker and taker price is definitely unsetting and a problem that even the early DEX platforms faced.
Another problem faced by early DEX was the low liquidity wherein your order would sit idle for several days before someone filled it up.
Uniswap solves all these problems with its unique approach. Since a decentralized exchange is very different from its centralized counterpart, Unisqp decided to get rid of the entire order book. On Uniswap, we have liquidity providers who are traders just like us. They pool the tokens that they have in the Uniswap smart contract.
With hundreds of thousands of users pooling various tokens on the Uniswap platform, the liquidity that each asset possessed was very good. By removing the order book feature, Uniswap got rid of the large spread problem as well. The liquidity providers don’t have a say in the price of tokens that they provide.
At the time of order placement, the Uniswap protocol checks for the latest price and swaps the tokens accordingly. This ensures that everyone gets the fair price for the cryptocurrency that they possess.
To bring in more liquidity providers, the Uniswap protocol incentivizes these users by offering a small fee for every completed order. With users now being able to earn extra in the form of fee, it wasn’t very hard to find so many liquidity providers.
To top things off, Uniswap is based on the Ethereum blockchain which is one of the most secure blockchains out there. Thus, making this smart contract very secure as well.
How to use Uniswap:
1- To get started with trading on Uniswap you need to have some Ethereum.
2- Once you have your Ethereum in your wallet, download a supported wallet to use. I would recommend you to go with Metamask as it is a browser extension that works well with Uniswap.
3- Now transfer your Ethereum to your Metamask wallet.
4- Head over to uniswap.org and launch the web app. Ensure that you go to the official page of Uniswap DEX. You don’t want to be a victim of phishing attacks.
5- On the web app, click on the connect wallet and connect your Metamask wallet to Uniswap.
6- You can now easily swap your ETH with any ERC-20 token that you can find from the drop-down list.
7- The token that you choose to swap with will then be transferred to your wallet.
Pros:
1- High liquidity: Due to Uniswap’s approach to incentivizing the liquidity providers, this decentralized exchange was able to record trading volumes that were at times greater than that of Binance, the largest cryptocurrency exchange.
2- Coin support: A new project running on the Ethereum blockchain can easily get listed on Uniswap by simply offering liquidity for that particular token. In a centralized exchange, the token goes through several rounds of scrutiny before getting listed.
3- Simple to use: Getting started with Uniswap is actually a whole lot simpler than some of the exchanges out there.
Cons:
1- Fake tokens: Since getting listed on Uniswap is extremely easy, there have been instances where several fake ERC20 tokens were listed on Uniswap. When these tokens were swapped by other users, they received worthless tokens from fake projects.
2- Gas fees: This has been the main reason why I stopped using Uniswap for the time being. Earlier in 2020, we could easily make micro trades on Uniswap without having to cough up many fees. However, this has now changed with the Ethereum network fee spiking up due to the large usage. Now, micro trades on this platform are out of the picture. Today alone, over $189,000 was spent on Uniswap in the form of gas fee.
Uniswap token:
In September, Uniswap launched the Uniswap token. During its release, 400 tokens were provided to every user who used Uniswap before September. This was a welcome present for everyone who used this platform as this acted as a rebate to the high prices that we were all paying.
The Uniswap token went as high as $8.5 after its release. It has since then consolidated to $3.2 today.
Conclusion: The Future of Uniswap:
Currently, the large fee is the major set back for all Uniswap users. Fortunately, this fee is not charged by Uniswap but by the Ethereum network. With Ethereum 2.0 getting closer to its launch, we should see a decrease in the gas price. This should definitely help bring more people to the Uniswap platform. Uniswap paved the way for more such decentralized exchanges to get started.
With Dex’s now on different blockchain’s we can easily find on that does not suffer from the fee problem that Uniswap did.
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The liquidity issue of DEX can be solved either by making all the DEX interoperable with each other or by making it semi-centralized, meaning critical elements to be decentralized, and the non-critical elements to be centralized to enjoy low latency. But interoperability between heterogeneous blockchain is still an issue.
Uniswap wins it by Automated Market Maker model.
In an order-book-based exchange, even if a pair exists, there is no guarantee to the liquidity and hence a trader may not get the desirable/competitive price to trade, excessive slippage does not make it feasible for the trader.
In contrast, in the Automated Market Maker model-based exchange, the only condition is that an exchange pair should exist to enable a trader to trade at a desirable price at par with the broader market. That means the liquidity is guaranteed by the AMM. Does not even matter if the liquidity is high or low.
So there is no such concept like high or low liquidity in an AMM based DEX like Uniswap.
There is no such one-fit exchange for all, in my opinion, it all gets defined by what is your requirement and priority.
For a trader to get the best exchange value in Uniswap the trade size should contain within 1% of the liquidity pool size, otherwise, there will be excessive slippage. You can refer to the AMM Mechanism xy=k
The current gas fee scenario is a tax on swapping in Uniswap. I need at least 20 to 25 USD worth crypto to make it count. For a micro trader(20 to 40 USD), the net effective exchange fees could go as high as 50%. Uniswap no more cost-effective exchange fees at this juncture. However, its AMM mechanism is really popular and solved the issue of liquidity that all the DEX were plagued with.
Thank you.
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Yup! That's a great thought about interoperability. Maybe in the future, we might actually see a DEX which leverages a feature like atomic swap or if some other better feature comes out by then, to achieve DEX interoperability.
The AMM model is great for DEX. For Uniswap, Ethereum 2.0 is highly essential for the reduction of gas price.
Atomic swap has also its own limitation, that can only be used for swapping, it can not be utilized in AMM . Atomic swaps take a long time out to execute properly; that is where it gives an edge to the malicious players to participate slowly, making the price unfavorable for the other party.
That is why the AMM based DEXs are going with the tokenized representation of heterogeneous blockchains (pegged 1:1).
Thank you.
Just my own thought regarding tokenized representations..... Tokenized representations such as Wrapped Bitcoin, do mimic the price of Bitcoin. However, at its core, it is still an Ethereum based token which cannot be Bitcoin. So, that's a bummer in my opinion.
We need something more concrete which allows the blockchain interoperability for more people to start moving towards DEX.
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This thing make uniswap unique exhange and there are lots of other things. But i don't like the higher fees. It's not by uniswap but it's harming uniswap a lot. when they will get a rid from this issue, more users are on the way.
#twopercent #india #affable