What Is the Uniswap DEX and How Does It Work?

Uniswap is currently the leading decentralized exchange (DEX) by trading volume. It was the first DEX on the Ethereum network, allowing you to swap any ERC-20 token on the Ethereum blockchain.

Now, there are multiple versions of Uniswap. Given the decentralized nature of the protocol, it is not possible to just do away with other versions after an upgrade, so there are currently three versions, with V3 being the latest.

So, let’s take a look at Uniswap and see how this decentralized exchange actually works.

What Are Uniswap’s Tokenomics?

Uniswap uses the UNI token for paying transaction fees on the network.

The UNI token was initially distributed to the community through yield farming. Only 60% of the total supply was actually distributed through this method, with 15% of these tokens given to historical users.

Liquidity mining refers to a method of rewarding network users who contribute liquidity to the various trading pools in the DEX. It’s an incentive to ensure that users support the network.

In Uniswap V3, token creators can specify which token liquidity providers (LPs) are awarded in a pool. LPs are awarded swap fees from the pool. Unlike the older Uniswap versions where the swap fee was fixed to 0.3%, Uniswap V3 now has three fee tiers that are set at initialization: 0.05%, 0.30%, and 1%. Additionally, more fee tiers can be added using on-again governance.

Uniswap V3 also incorporates protocol fees. These are supposed to be a given percentage of the swap. However, protocol fees are by default set to zero & can be set on or off through on-chain governance.

How Does Uniswap Governance Work?

Uniswap has both an on-chain & off-chain governance system. The on-chain system allows UNI token holders to propose & vote for changes in the protocol. However, the discussion for such changes begins off-chain.

The off-chain governance is mainly handled through Snapshot and Uniswap’s governance forum.

A community member that wishes to propose changes begins by asking an unbiased question on the forum. This is referred to as a “temperature check”.

After gaining enough support from the temperature check, the individual can move on to step two. In this next step, the community members discuss with the community the options on how to proceed that gained support in the temperature check.

As a final step, the option that has the most support can now go on-chain, thereby becoming a governance proposal. Any address that has at least 2.5m UNI tokens delegated to it can participate in voting for a governance proposal.

When a governance proposal is made, UNI holders are given a period of seven days in which they can vote for or against it. A simple majority is necessary for the proposal to pass through, with at least 40m tokens voting in favor of it.

After the proposal has been approved, it goes through a time lock of not less than two days before the proposed changes are implemented. This waiting period is managed by a Timelock contract which can modify aspects such as system parameters and contracts.

Swapping Coins

Uniswap is a decentralized automated market maker (AMM). It allows you to swap any supported ERC-20 coins.

To swap one coin for another, simply head over to Uniswap’s official site and press the “Launch app” button. This will take you to a page where you can connect your crypto wallet and specify the coins you wish to swap.

As mentioned earlier, there are transaction fees when making swaps on Uniswap. One big problem with Uniswap is that it has very high transaction fees. At the time of this writing, the average gas cost was about $7.5 on the Ethereum network, which is high compared to other networks that charge a few cents (or even much less). However, there are numerous other popular crypto exchanges, many of which feature cheaper transaction fees!

Can Uniswap Keep Its Place as the Largest DEX?

As pointed out earlier, Uniswap has high transaction fees & this is not suitable for retail investors. It is a big problem that has led to the rise of other DEXes such as Pancakeswap.

However, the Uniswap community has taken active steps to ensure that the network retains its position at the top. In December 2021, the Uniswap protocol was also deployed on Polygon. The Polygon network has very high transaction speeds and very low fees (a fraction of a cent), ensuring Uniswap can compete with other cheaper DEX alternatives.