Uniswap

A case for UNI

Overview

  1. Uniswap (UNI) is an early pioneer of and largest Decentralized Exchange (DeX). A DeX allows users to trade cryptocurrencies without needing a company to act as a neutral third party to facilitate the transaction. Additionally, they allow users to exchange tokens directly from their chosen wallets without needing to first send them to an exchange. DeXs are currently among the most heavily used applications yet developed on the blockchain, already facilitating over 140 Billion dollars in swaps since its creation. More and more transactions are happening on DeXs vs on traditional exchanges.
  2. Uniswap is a smart contract protocol that currently runs directly on the Ethereum blockchain. It can be used to “swap” any ERC-20 (a token specification) token on Ethereum, which covers the majority of cryptocurrencies that speculators would like to acquire and trade.
  3. Uniswap is so heavily used that it has become among the largest individual sources of transactions on Ethereum. This unprecedented usage of ETH has driven up the cost of Ethereum transactions to astronomically high levels, which are currently driven primarily by Uniswap usage. The extreme fees on ETH have created a temporary crisis and accelerated the need for scaling solutions both for ETH and UNI.
  4. ETH is working on implementing ETH 2.0 to address scaling. However, ETH 2.0 is still expected to take at least a couple of years to deploy at best. Meanwhile, UNI is working on moving the bulk of their transactions off-chain (called layer-2) via a technology called Zero-Knowledge Proofs (or ZK Roll-ups). This is a technology that allows most transactions to occur outside of Ethereum and only writes a summary of the results to the blockchain. It is expected that UNI will come out with its layer-2 solution around May 2021.
  5. Uniswap has helped pioneer the concept of a DeX and kept pushing the limits of what’s possible in the space. Recently they have announced V3 of their protocol. With V3, UNI has solved many fundamental limitations of DeXs and brought many additional features that traders are used to in centralized exchanges. UNI has given their Liquidity Providers (or LPs, which are like market makers in traditional exchanges) fine-grained control over how their capital is used and the ability to deposit one token instead of matching pairs. These are called Concentrated Liquidity Pools. This is expected to make UNI the deepest (most liquid) and most efficient market of cryptocurrencies in existence. Additionally, the new flexibility for LPs also for the first time creates the ability for range orders - which are similar to limit orders in traditional exchanges.
  6. Other important features are also added to V3 including a bug bounty and a change in the license that makes it illegal for other projects to directly copy UNI’s source code, while still allowing anyone who wants access to see the full source code. Also, price oracles are greatly improved, allowing for more accurate pricing of assets.

Major Bullish Arguments

  1. With V3, UNI has again redefined the limits of what is possible in a DeX. UNI has provided features that are not available elsewhere. Even if competitors copy features, the liquidity of their LPs cannot currently compete with UNI. This means that orders and especially large orders are expected to execute better on Uniswap than any other platform. This means that UNI should continue to be very attractive for many users.
  2. One of the first things people tend to do after obtaining cryptocurrency is seeking out ways of gaining a yield on their holdings. With Concentrated Liquidity Pools, token holders have a new way that they can put their capital to work and earn reliable yield by supplying liquidity according to customizable market conditions. LPs in UNI should have good opportunities to make returns on their capital by adding it to Concentrated Liquidity Pools, without needing to trust third-party custodians.
  3. The combined effect of points 1 and 2 creates a virtuous cycle by adding even more liquidity to the already leading UNI pools and thus enticing even more users with even better order executions. These new users generate more fees for the LPs, which entice even greater participation in LPs, and the cycle continues.

Major Counterarguments

  1. UNI does not currently support trading assets that are not on the Ethereum platform.
    • This is somewhat misleading. Many solutions have been created to act as “bridges” for different cryptocurrencies and even non-crypto financial assets. For example, Wrapped BTC has created a way to own BTC on Ethereum, though perhaps not as seamlessly as could be desired. Coinbase has created its USDC as a reserve-backed US Dollar on the Ethereum network. Finally, much work has been done to facilitate “atomic swaps” of cryptocurrencies without needing to trust a party to hold reserves. It is expected that these and other solutions will continue to mature in time.
  2. No decentralized exchange can hope to compete with the efficiency possible in a centralized exchange.
    • For certain use cases, this may no longer be true. Centralized exchanges have many regulatory requirements that UNI does not as it is an open protocol. Coinbase has thousands of employees, yet UNI only had 10 when they surpassed them on daily trading volume. If layer-2 solutions can bring overall costs down, many trades will execute either on-par with or even cheaper than on centralized exchanges.
  3. Governments will shut down DeXs such as UNI that don’t comply with Anti-Money Laundering / Know-Your-Customer (AML/KYC) requirements.
    • It would be very difficult for governments to shut down self-executing code that the developers themselves can’t takedown. However, they can certainly make it difficult or illegal for their citizens to operate within. If they do so, they risk losing many of their most innovative companies and entrepreneurs to other countries that are more open to innovation. It is also possible that identity on cryptocurrency in time can mature enough to allow individuals to prove AML-KYC compliance without disclosing their specific identities.

Price Potential

  1. One place to look to in evaluating UNI would be centralized exchanges. Currently, UNI is used mostly with crypto-to-crypto exchanges. The largest exchange that shares that focus is Binance, which currently facilitates about $29 Billion in daily transactions on its centralized exchange. The semi-decentralized Binance Smart Chain currently supports around 3 million transactions per day. It should be noted that UNI cannot be used to service onboarding local currency (fiat) into crypto as centralized exchanges can. Also, UNI can currently only function with assets on the ETH ecosystem, meaning it is not currently suitable for trading all possible assets available in crypto. However, this divide may lessen over time with many cross-chain solutions.
  2. UNI has already been used to facilitate over $187 Billion in transactions since inception. UNI V2 currently services around $1.4 Billion in daily transactions. These numbers are expected to increase greatly when UNI launches its V3 upgrade in May, adding features not yet available elsewhere, and most importantly launching their protocol on Layer-2 of ETH very shortly afterward. When Layer-2 is launched, fees should go down to pennies instead of $50-$100 that they can currently be. This should entice even more usage of the platform. UNI is well-positioned to become the overwhelmingly dominant DeX if both releases go quickly and smoothly.

Major Risks

  1. UNI V3 was expected to launch at the same time as its layer-2 scaling solution. UNI has announced that its layer-2 will occur a few weeks after the V3 upgrade but has not yet given a date. Some have interpreted this as a warning of potential problems with the layer-2 solution as it is not at the same time. However, this minor delay can help ensure a successful launch of V3 on layer-1. As long as it is quickly followed by another successful launch of layer-2, UNI will likely do well. But, if layer-2 delivery becomes truly delayed it would remain a negative issue for the entire UNI and ETH community.
  2. UNI V3 pioneers several new concepts that have never before been combined in a single protocol. There is a chance that some of its innovations may have unforeseen or unintended consequences. However, the UNI team has proven their ability to deliver with two previous versions so the likelihood of such a failure seems relatively low.
  3. Many DeXs have previously copied features or even the entire Uniswap codebase as it is open-source. With V3, UNI has introduced a commercial license of its code to reduce copy-cats. Even so, other DeXs will still be able to re-implement many ideas pioneered on UNI. However, DeXs can only facilitate trade when enough liquidity is available in the pool to execute a given trade at a good price. If UNI retains the largest liquidity, it will be able to provide the best overall order execution price regardless of copy-cats.

Additional Resources

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