Uniswap is an Ethereum-based decentralized exchange (DEX) that allows anyone to swap ERC20 tokens. In September 2020, Uniswap launched its UNI governance token with an airdrop to anyone who had used the protocol before September 1. Uniswap is trying to solve decentralized exchanges' liquidity problem, by allowing the exchange to swap tokens without relying on buyers and sellers creating that liquidity here. Uniswap is also the name of the company that initially built the Uniswap protocol. The protocol facilitates automated transactions between cryptocurrency tokens on the Ethereum blockchain through the use of smart contracts.
Getting started with Uniswap is relatively straightforward, however, you will need to make sure you already have an ERC-20 supported wallet setup such as MetaMask, WalletConnect, Coinbase wallet, Portis, or Fortmatic. Once you have one of those wallets, you need to add ether to it in order to trade on Uniswap and pay for gas – this is what Ethereum transaction fees are called. Gas payments vary in price depending on how many people are using the network. Most ERC-20 compatible wallet services give you three choices when making a payment over the Ethereum blockchain: slow, medium, or fast. Slow is the cheapest option, fast is the most expensive and medium is somewhere in between. This determines how quickly your transaction is processed by Ethereum network miners.
Uniswap leaves behind the traditional architecture of digital exchange in that it has no order book. It works with a design called Constant Product Market Maker, a variant of a model called Automated Market Maker (AMM). Automated market makers are smart contracts that hold liquidity reserves (or liquidity pools) that traders can trade against. Liquidity providers fund these reserves. Anyone can be a liquidity provider who deposits an equivalent value of two tokens in the pool. In return, traders pay a fee to the pool that is then distributed to liquidity providers according to their share of the pool. Let’s dive into how this works in more detail.
Liquidity providers create a market by depositing an equivalent value of two tokens. These can either be ETH and an ERC-20 token or two ERC-20 tokens. These pools are commonly made up of stablecoins such as DAI, USDC, or USDT, but this isn’t required. In return, liquidity providers get “liquidity tokens,” representing their share of the entire liquidity pool. These liquidity tokens can be redeemed for the share they represent in the pool.
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