Uniswap is one of the most important projects in the decentralized finance (DeFi) space. It is a decentralized exchange (DEX) of tokens that uses an Automated Market Maker (AMM) on the Ethereum blockchain. Users don’t have to deposit their funds or go through the process of know-your-customer (KYC). The project is deployed as a set of smart contracts and was created by Hayden Adams in November 2018. After the DeFi Summer in 2020 total value locked in Uniswap has risen gradually. At the time of writing, Uniswap is boasting over $4.8 billion total value locked (TVL).
The UNI token is the key to participating in Uniswap’s governance. By voting on different proposals or delegating their votes to a third party, UNI holders are the true owners of the protocol.
If you are familiar with stock exchanges or centralized exchanges, most of these exchanges use an order book. The order book brings buyers and sellers together in a system where buyers try to buy a certain asset at the lowest price possible while sellers try to sell the same asset at the highest price possible. For trades to happen, buyers and sellers should meet at the same price point. But what happens if there is no one willing to place their order at a fair price or if there is not enough liquidity in the pool of the asset? That’s where market makers come into action.
The term market maker in traditional finance(TradFi) refers to a firm or individual who actively quotes two-sided markets in a particular security, providing bids and offers along with the market size. Market makers provide liquidity and depth to markets and profit from the difference in the bid-ask spread.
Automated Market Makers allow for automated cryptocurrency trading, via smart contracts. Unlike order book exchanges, where users must wait to have their limit orders fulfilled, AMMs process all transactions automatically, without relying on third parties to make the trades.
The AMM model uses liquidity pools, or collections of crypto tokens, to make trading possible via an algorithm that sets the token prices based on the changing ratio of tokens supplied. Liquidity providers (LPs) or market makers are those who supply liquidity to pools in the form of digital assets. In return, they’re rewarded with trading fees, charged to the trader, proportional to how much liquidity was initially contributed.
However, there are some negatives to using AMMs. With AMMs, users incur higher slippage if they want to swap large amounts because they are changing the liquidity pool balance by selling one asset and buying another. Also, users do not have the option to create limit orders which are provided by order book-based models.
Uniswap DAO — Treasury
- The Uniswap DAO is the heart of Uniswap. It is where all the decisions are made by UNI holders.
- Uniswap holders govern over UNI community treasury, protocol fee switch, uniswap.eth ENS name, and SOCKS liquidity tokens.
- The Treasury does not receive revenue from the protocol itself. Swap fees all go to liquidity providers and gas fees go to miners. The treasury contains only what was allocated during token generation.
Uniswap DAO — Governance
- Token holders can submit proposals by locking UNI.
- Token holders must own a minimum of 1,000 UNI to participate in off-chain governance discussions. And 2.5 million UNI must be staked to make a formal on-chain proposal.
Value creation and value capture
As pioneers in the DeFi space, the Uniswap team is always trying to improve the protocol. Most investors are counting on Uniswap’s team, and some may see UNI as an investment because UNI was one of the first AMMs in the market. Aside from being first, Uniswap is the highest liquidity DEX in the Ethereum ecosystem giving users lower slippage rates compared to other DEXes.
So what makes Uniswap unique and what adds value to protocol? In May 2020 before the start of DeFi Summer, Uniswap launched its second version V2. V1 only allowed liquidity pools with ETH/ERC20 tokens, V2 users can add liquidity and swap their assets between ERC20/ERC20 pairs. With that improvement, Uniswap became the best-known and the most used automated market maker in the DeFi ecosystem. In the graph below you can see that Uniswap is the largest DEX by trading volume since deploying both V2 and V3.
Source: The Block Research
The main focus of V3 is the maximization of capital efficiency compared to V2. The Uniswap team decided to deploy V3 on both Ethereum and Optimism which is a Layer 2 protocol built on Ethereum. With V3’s improvement in capital efficiency, liquidity providers (LPs) will earn more fees with the liquidity they provide. Moreover, V3’s new algorithm improves trade execution by speed and gas fees.
In December 2021, Uniswap’s total value locked had reached $10.5b, and its monthly volume reached almost $70b. At that time it was more than most of the centralized exchanges such as Coinbase and Kraken.
V3 is all about concentrated liquidity. This allows users to provide liquidity in a custom price range that is selected by the user. In the previous version of Uniswap, liquidity was evenly distributed along the price curve between 0 and ∞. This caused liquidity providers to incur heavy impermanent losses and have capital inefficiency.
With V3, users can select the price range they want to provide liquidity to and earn fees only within this range. This means that users are now earning more while putting smaller amounts into the pools. To better understand V3, check this article which is written by Finematics here.
UNI’s only value capture is governance rights. Users who hold UNI can participate in governance discussions and vote on the future of Uniswap. But it does not capture the value related to its unique selling point. There are still ongoing discussions about UNI’s future and its benefits to holders.
To sum it up, due to concentrated liquidity, V3 helps reduce the risk of impermanent loss and is more capital efficient since it helps users to earn more by putting a smaller amount of capital into the liquidity pools and subsequently at risk. But also, it is harder to use compared to V2 because users have to manage their liquidity for the price changes in the market.
Supply: Distribution and Vesting
Uniswap Labs announced the UNI governance token to become a more decentralized and community-owned protocol on 16 September 2020. Tokens were distributed to users of the protocol, historical liquidity providers, and SOCKS NFT redeemers/holders based on a snapshot ending September 1, 2020. Everyone who had used Uniswap before the snapshot date was rewarded with 400 UNI tokens worth around $1200 that day with a price of $3 per UNI.
As seen in the graph above all of the UNI which is a total of 1 billion will be distributed at the end of 2024 September. At first, Uniswap airdropped 15% of the total supply of UNI tokens which is equal to 150 million tokens to historical users including liquidity providers. The remaining 430 million tokens allocated to the community will be distributed on an ongoing basis through contributor grants, community initiatives, liquidity mining, and other programs. In the table below, you can see the yearly vesting schedule of UNI tokens allocated to the community.
Also, an initial mining program was live for 2 months after the UNI token release within the ETH/USDT, ETH/USDC, ETH/DAI, and ETH/WBTC pools. During the mining program, 5,000,000 UNI was allocated per pool which accounts for a total of 20,000,000 UNI.
The total supply of 1 billion UNI has been minted at the genesis and will be vested over 4 years. Currently, 46% of the total supply accounts for 460 million UNI tokens in circulation.
The initial four-year allocation is as follows:
- 60.00%(600,000,000 UNI) to Uniswap community members
- 21.266% (212,660,000 UNI) to team members and future employees with a 4-year vesting period
- 18.044% (180,440,000 UNI) to investors with a 4-year vesting period
- 0.69% (6,900,000 UNI) to advisors with a 4-year vesting period
After 4 years of reaching a total of 1 billion UNI tokens, there will be a perpetual inflation rate of 2% per year to ensure continued participation and contribution to Uniswap at the expense of passive UNI holders.
Most of the investors, advisors, and team members — usually not the core team members — tend to sell their tokens to realize their profit. The selling pressure usually ends up lowering the price of a token. 40% of UNI tokens went to team members and investors as mentioned above, meaning that UNI could face high sell pressure in the future.
The allocation is an important point but what determines the value of a token is measured by its utility and the demand side. UNI token’s utility comes from the governance rights it provides on the future of Uniswap such as deciding to deploy the protocol on other chains, grants, fundings, fee tiers, proposal submission thresholds, etc. Token holders must own a minimum of 1,000 UNI to participate in off-chain governance discussions. And 2.5 million UNI must be staked to make a formal on-chain proposal.
Holding UNI tokens does not allocate a portion of the fee revenue accrued by the liquidity mining to the token holder or even to the treasury. Some of the protocols such as SushiSwap, Curve, and PancakeSwap let users stake their tokens and that generates passive income in the protocol’s tokens. In the upcoming improvements, we suggest that bringing a fee share mechanism will help UNI to create added demand for investors to buy and hold UNI tokens. This may create a shortage of UNI tokens and lead to price appreciation.
Uniswap’s value comes from its long-standing background, first-mover advantage, and continuous development. The team behind Uniswap is always finding things to improve on and V3 is one of the most important developments in decentralized finance.
As discussed above Uniswap is probably one of the most extraordinary decentralized exchanges on the market with its low slippage and market fees. Also, with its competitive advantage, its liquidity is more than some centralized exchanges. Uniswap shows how to achieve greatness with decentralization.
As people learn more about blockchain and how to use DeFi, most of the successful projects in the ecosystem will become more valuable. The protocol can continue to grow by expanding its product to other chains, Layer 2’s, and supporting swaps/pools for more tokens.
As mentioned above Uniswap has no sustainable inflow to the treasury. The protocol itself may have hard times when the market is down because its only source of income was the token allocation to the treasury at genesis. Aside from governance, Uniswap should add more utility to the token, or as a consequence users may invest in other DEX’s tokens which provide more utility.