Learn more about the concept behind liquidity pools and check out the review of today's top 5 DeFi liquidity pool providers.
This guide provides a detailed explanation of the Uniswap mode of operation and its rise to becoming an in-demand diversified exchange.
Uniswap is an exchange protocol that enables consumers to purchase and sell ERC20 tokens easily without initiating a transactional request. It is a protocol that is already pre-programmed to alter the values of digital tokens, depending on how well it is bought or sold.
Decentralized exchanges have provided numerous solutions to issues such as capital mismanagement, unethical server penetration, and other third party on-carriage fees which usually arise from centralized corporations. While they resolve a lot of problems, these corporations personally struggle with generating capital to trade quickly and effectively which is what makes Uniswap its knight in shining armor.
The digital protocol aims to provide diversified exchanges an avenue to exchange tokens by eliminating the role played by consumers who want to buy or sell to generate liquidity. It also sets up a free-for-all policy, by allowing the public to make use of their tool to swap tokens at no cost.
Uniswap separates itself from its counterparts with its “Product Market Model” that lists prices. Uniswap’s variety of offerings include tokens that can be bought using Ethereum or ERC20 tokens and they must have the same prices.
For instance, a unique transactional trade is set up for the token as well as an avenue for users to generate revenue through swapping. This implies that a $10 valued token is traded for an Ethereum with equivalent monetary value. The main distinctive feature for Uniswap is the ability to automatically determine how much a token is worth using arbitrary constants in an equation rather than two parties in a transaction. The equation is x * y = k
The equation holds up variable constants x and y as the available units for exchange that can be traded on the Uniswap platform where k remains the same all through the solution. The rate at which the token is demanded is a major factor in calculating how much each unit can be sold.
Let’s say a token is called Creek Token and it is then purchased with Ethereum, the availability of Creek Token is reduced while the availability of ETH is increased which leads to Creek Token getting higher market value. Making a transaction in a liquidity pool This implies that the value of tokens will only be altered when there is an exchange or swap. So, what Uniswap aims at is to automatically analyze market demands and produce a value for the tokens.
Uniswap displays several tokens on their website without restrictions and a contract is placed on each of them along with their liquidity pool if it has already been set up. Once all regulations for smooth transactions have been put in place, consumers can put a bid or ask price on currencies and generate a 0.3% liquidity interest in the process. The value of a liquidity pool is increased when ERC20 tokens and ETH of the same price are added to the pool.
Uniswap offers two separate contracts on its interface. The first type is called an exchange contract and it is typically known for its token and Ether uniqueness that can be traded for the other. The second type is called a factory contract which is designed to develop exchange contracts and add ERC20 tokens to its diary or log address.
Uniswap doesn’t request management fees to include tokens to its platform and it is easily done by dialing a feature on the factory contract to include a new one. To explain further, a user can accomplish this by using the CreateExchange feature in the DAI contact registry owned by the Factory contract. The contract currently used then verifies that an Exchange contract is already initiated for the token registry. If this hasn’t been done, an exchange contract is created and the exchange registry is logged for future reference.
Ethereum’s main type of token is the ERC20 token. They possess a fungible essence which means each token produced bears many similarities with the last one. For instance, if 70 marbles are placed down, they will all have the same size and shape.
However, the ERC721 tokens are different and are not similar, as such they are referred to as non-fungible tokens and a very good example is the crypto kitties. The ERC20 is usually regarded as the basic unit of payment for a wide array of uses. Some of which are; getting incentives, debt bonds, interest slips, and a host of others. They can be further reduced to smaller units and sent or received and since the price value changes constantly, it is advisable to trade them every once in a while.
Uniswap’s main specialty comes from its ability to generate prices automatically without the need for an order book which is way different from the process employed by centralized exchanges which require users to place a bid and ask price for a sell or buy and the lowest and highest prices in both scenarios are the basis of price determination. For example, if a bid for Bitcoin (BTC) reaches a high of $9300 and a minimum of $9200, $9300 becomes the selling price by the bitcoin company.
Initiating a contract for swapping a token starts the values of both token and Ether at zero and a quick deposit from a user into one of the units provides the user the ability to determine the price ratio between the two units. Including a ratio that doesn’t match the current market allows the user to make a quick profit from selling or buying to meet the market price. Ensuring enough tokens and Ether for trade or swap will give room for more liquidity without having to expend the ratio way more than the curve.
Contributors who add tokens to a liquidity pool generally earn incentives known as ‘’pool token’’ which have ERC20 values. These incentives are generated by increasing the ERC20 tokens in a liquidity pool and these tokens can be traded or used for other purposes in a decentralized app. Withdrawing cash in exchange for tokens voids the token and they become useless. Users are allowed to hold a stake in Uniswap and each share is held in the form of tokens which is a fraction of the entire shares available in the liquidity pool.
Uniswap’s open-source and accessibility to the public without users incurring management fees allow several individuals to create a webspace in it. For instance, InstaDApp allows users to escape the rigorous process of going through the main Uniswap interface to add tokens by funding their accounts directly.
Upcoming platforms like DeFiZap allow funding from a single unit of payment instead of two. For example, an ETH can ensure payment without adding a token as well. One-touch payment is also included for adding tokens to a liquidity pool and purchasing token strategies.
Uniswap seems to be showing signs of growth and its new and innovative features allow easy swapping and trading opportunities. It however remains to be seen how well they would hold up in years to come as there have been reports of fraudulent transactions on the platform with fake coins.
In the meantime, users hope for token trading and collaboration with DeFi and many other companies