Recently, I had a chance of visiting my hometown and meeting my grandparents. In one of our dinner conversations, he told me that the primary aim of having a business about 60 years ago was to feed the family. There was no concept of luxury per se. As a result, he would quite often accept wheat/groceries etc. in return for his services (He owned a type writer repair shop). And that sort of brought me back to thinking about the good old barter system. But why am I suddenly talking about barter system to talk about something as complex as Uniswap? Well, at a very basic level, that’s what Uniswap does. So, in today’s blogpost, we talk about what is Uniswap? What problems does it solve for? And what’s the hype around it’s native token UNI. As always, it will be done in a non jargony so that even your grandfather can enjoy the next dining table conversation regarding this.
How did Barter System Work?
Imagine that you are a farmer growing potatoes in the 17th century. Even though potato is considered to be a king of vegetables, you are now sick of it and want to explore something else. So you look out for someone who is selling apples. Turns out, someone from your village, knows a person who is growing apples. You decide to reach out to that person and strike a deal regarding apples in exchange of potatoes. There is no intermediary, fee or taxes involved here. There was no concept of KYC back then. You simply traded a raw material with another raw material and that was it.
The Money System:
Fast forward a little and let’s come to the present times. If you are a farmer wanting to exchange your potatoes for apples, you would first exchange them for cash. You can get this cash from government marketplaces etc. Later, you could go to a grocery store and purchase Apples with that money.
Benefits you ask?
Cash won’t go bad unlike potatoes. So you can sell your potatoes and hold cash instead without having to worry for storage.
And why apples only? You can purchase almost anything with that cash. Any other fruit of your choice.
This also gives you reach. You can purchase these fruits from the store, even if they are grown miles away, even on the other side of the world.
There’s no wait time involved, these grocery stores have a stock of apples, pineapples, coffee beans etc. You can simply use this cash to purchase them any time you like.
But there is a downside as well:
Since now you are used to the comforts as stated above, the grocery store is commanding a premium. They know you are unlikely to travel to the other side of the world to fetch your favorite fruits, so they can charge a higher margin for them.
What is Uniswap?
Now you want to find the original seller. Instead of converting your potatoes to cash and then to apples, you want to directly swap it for apples. This is basically what Uniswap does. It is a decentralizes exchange to swap Ethereum based cryptos (ERC-20 tokens). They do this by charging you a minimal fees of 0.3%.
Leading from our example, Uniswap is the grocery store that we discussed above but without the cash. You can directly pay your potatoes to buy apples.
How Does Uniswap Work?
Think of it like this. Uniswap has a huge warehouse which has apples and potatoes. You can simply deposit either of these items in that warehouse and get the other one in return. What happens if someone comes along and buys a lot of apples? Since there won’t be much apples left after that, the store would simply charge more number of potatoes per apple. This would continue to happen until someone comes with a lot of apples to buy potatoes, at which point, the price (potato) per apple may fall.
If you want to dive deeper into how these calculations work and the price of an apple and potato is determined, please read our blogpost on Automated Market Makers (AMMs). Just like this one, it uses analogies to explain how the decentralized market works.
Let’s get a little real now. So in the example that I have used so far, think of apples as Ethereum and potatoes as BAT (basic attention token). Just by basic supply demand that we discussed so far, prices of Ethereum and BAT will fluctuate. Oh, and the grocery store? Let’s call it what it is, a liquidity pool. One could also leverage arbitrage opportunities. How? Say you buy Ethereum for $2000 on CoinDCX and sell it for $2100 on Uniswap. Totally possible.
The Liquidity Provider:
One question that should’ve popped up in your head is that where does this warehouse or liquidity pool get tokens (apples and potatoes) from? Well, the answer lies in investors called liquidity providers. These investors lock in there funds so that other people can trade in these markets.
They do it for free? Absolutely not. Remember I told you about the fees that is levied for every exchange? The fees doesn’t go to any government or company. It is rather distributed amongst LPs or liquidity providers.
This also means that you can either use Uniswap to exchange tokens for a small fee OR you could become a liquidity provider to earn passive income for your investment.
Problems Solved By Uniswap:
A. Quick Exchange:
If there were no Uniswap, you would have to sell your Ethereum for a dollar equivalent like USDT and then purchase BAT. There would be a high chance that these two tokens are listed on separate exchanges. So you would have to go through a lot before completing this transaction.
B. No Tax/KYC:
Since there are no governments involved here, there is no tax or KYC required for swapping. This makes the entire process quick smooth. Compare it with traditional exchanges that convert your INR to dollar when you are travelling. There is so many details required along with a hefty fees.
C. Decentralized:
Above that, all of this happens in a totally decentralized manner. A piece of code is governing every transaction.
Uniswap Token or UNI:
And then there is a native token of this ecosystem as well. The UNI token is being traded at $26 as I am writing this. Let’s understand the drivers of value of this token.
UNI is a governance token. Right now there is no mechanism for voting but in future, the hodlers of token should be able to vote for key changes in the ecosystem. Imagine there is a proposal to increase the fee from 0.3% to 0.5%, token holders will be able to cast their vote and decide.
Secondly, these token holders can also be incentivized in the form of a percentage of trading fee. This is again a speculation only, but people who are bullish on Uniswap believe that this might happen.
In a nutshell, Uniswap has no intrinsic value as of now but it represents a very popular and valuable decentralized exchange, thus giving it the value it has today.
Conclusion:
From stones, shells, salt, gold, paper money to Uniswap, money has completed a full circle. What a time to be alive isn’t it?
Btw, did I do a good job of explaining what Uniswap is?
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Until next time..
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Yes, I love how you explained yield farming too.