Uniswap v3 ranks among the top decentralized exchange (DEX) platforms— if not the best— on Ethereum. In just four years, it has achieved a trading volume above one trillion, $5B to $10B of total-value-locked (TVL), and 100K+ monthly users. All while offering the lowest possible fees for ERC-20 tokens.
This protocol is no longer a secret. By the time the new tokens appear in your centralized exchange, several early investors have bought them on UniSwap v3. As a decentralized exchange, it’s the fastest (and oftentimes cheapest) way to buy crypto.
By now, you might have heard of dozens of swap platforms. The first DEXs date back to 2013. So what makes UniSwap v3 so successful? And does that mean you should trade on DEXs instead of centralized exchanges?
In case these terms are new to you:
*Not to confuse centralized with fiat-only exchanges. Most crypto-fiat exchanges founded before the invention of DeFi are centralized (~2018).
DEXs are backed by decentralized, public blockchains that support smart contracts (like Ethereum or Pulsechain).
Decentralized exchanges became so popular in the 2020 DeFi summer. Traders often ditch centralized platforms after trying DEXs like Uniswap. Even those with traditional preferences will likely use DEXs.
Here is why:
Even then, they can restrict accounts anytime.
If you’re thinking of trying DEXs, there are two warnings you should know:
Let’s see what UniSwap v3 did right.
Uniswap is a network protocol designed to automate transactions on Ethereum. While it seems all DEXs do that, not all automations are the same. Uniswap is special because of the “Constant Product Market Maker Model (CPMMM).” This variant ensures Uniswap always has liquidity, even for the largest orders and the tiniest liquidity pools.
Vitalik Buterin (ETH founder) came up with the name by combining Unicorn and Swap. Swap platforms are non-custodial exchanges and almost synonymous with DEXs. In finance, the unicorn represents the rarity of a billion-dollar start-up. Similarly, you can find the most exclusive tokens on Uniswap.
The Uniswap ecosystem is broader than it seems:
If you just want to trade, the website and protocol are enough. But before showing the swap process, there are a few basics to cover:
Unlike traditional platforms, DEXs are fragile financial ecosystems. These need a near-perfect balance between liquidity providers and traders to prevent the inherent risks of DeFi. To automatically regulate both, DEXs use AMMs, an alternative to order books.
The largest centralized exchanges receive tens of orders every second. The order book records all of them by amount, price, and type. The exchange will partially or completely fulfill matching orders (e.g., Buy 30 PLS from someone selling 30 PLS at that same price).
With market orders, you get instant exchanges on almost any coin because there are hundreds of orders waiting. But unless it’s Uniswap, most DEXs don’t have that liquidity.
The AMM ensures traders can always fulfill their orders within seconds, anytime, even when there are no buyers or sellers. These smart contracts follow an algorithm (in Uniswap it’s x*y=k) to regulate token prices on liquidity pools. These “pools” are funded by users in exchange for fees, and AMMs use these to automate orders.
According to the CPMMM, prices and token amounts must equal the same product (k) as originally set:
Meanwhile, the real market price is still $1 for each. In other liquidity pools, it might be $0.25 and $4, or $0.9 and $1.1. These differences can put liquidity providers at risk of impermanent loss.
Impermanent loss refers to the price ratio change of your liquidity pool tokens. During sharp price movements, holding tokens would be more profitable than providing liquidity. If prices revert and you withdraw at the same deposit price ratio, losses won’t be realized.
Instead, you could also buy the underpriced token and sell it somewhere for more. Or buy tokens from an exchange and sell them higher to the pool. Which is essentially an arbitrage business.
If you’ve used DEXs, you might have never noticed major price differences. That’s because there are arbitrage bots balancing the pools every minute. By balancing the pool, liquidity providers prevent losses, traders get accurate prices, and they make profits.
By definition, arbitraging involves finding markets with price differences. Arbitrage users aren’t value investors nor day traders. They buy and sell exclusively for price variations, which they find with trading bots, databases, and DEX aggregators.
Traders swap these repeatedly until the AMM increases their price.
Arbitrage is a common business model outside crypto too. You can flip retail products, real estate, domains, cars, and collectibles. In DeFi, arbitrage traders look for small liquidity pools, volatile tokens, and low-fee DEXs like Uniswap.
Suppose you want to swap ETH for HEX on UniSwap v3. Let’s see what happens from the user and developers’ perspectives. Once you’re on the website:
Remember to add each token contract to your wallet or you won’t see any balances.
While you wait a few seconds to complete the transaction:
Most forks follow similar steps. But what Uniswap version should you use?
When it comes to volume and TVL, these three exchanges rank among the top 10 highest. Both Pancakeswap and Sushiswap are Uniswap forks, and so are most ERC-20 DEXs. That’s why we’ll start comparing it first.
Uniswap has a $5.2B TVL, a $4B market cap, and a 0.76 Mcap/TVL ratio. The highest stats recorded were $22.5B in market cap and $44.97 per UNI token in 2021. This 2022 they’re 4-8x lower because of bear market cycles, but Uniswap continues leading DeFi exchanges.
Here’s an overview of UniSwap’s evolution:
For example, providing USDC-ETH liquidity would give you UniSwap USDC-ETH LP tokens. These are proof that you own a share of the pool assets. LP tokens allow you to withdraw without anyone’s intervention, and they use up when you do. Alternatively, you can use these for yield farming.
When reinvesting all capital saved, the new UniSwap pools would have eight times more liquidity for high-volume prices. For example, a $1 token might have most funds allocated between $0.95 and $1. There’s minimal liquidity outside this range, but this concentration prevents prices from deviating in the first place.
That’s how UniSwap became the most efficient DEX and cheaper than SushiSwap.
SushiSwap launched as a fork of UniSwap in 2020 (before UNI tokens were launched). The goal: a more decentralized UniSwap that rewards the community, not just the largest LPs. Before UniSwap v3, it might have been the best DEX to date.
In SushiSwap, liquidity providers get revenue of 0.25% fees instead of 0.3%. But the other 0.05% goes to SUSHI holders instead. As token prices rose above $10, yield-farmers rushed from UniSwap to SushiSwap (essentially stealing +$1B of liquidity).
When v3 launched, UniSwap flipped the tables. Today, SushiSwap remains relevant because it’s feature-rich. It offers several DeFi services besides the DEX, supports 14+ networks, and is cheaper in some cases:
However, SushiSwap doesn’t inherit v3’s capital efficiencies. Which makes it the most expensive of the three.
New traders are likely to choose PancakeSwap because the BNB chain is more cost-efficient. Even though we see ETH fees falling rapidly below $10, $0.20 on BNB is too much difference. If the same project has contracts on both chains, most trading volume will go to PancakeSwap (native CAKE token).
This DEX launched in 2020 in the Binance Smart Chain (now BNB Chain). Ironically, it’s a UniSwap fork that doesn’t trade ERC-20 tokens. You’ll need an ETH-BNB bridge to convert them to BEP-20, and many new tokens aren’t BNB compatible.
On the flip side, you can trade any token with BNB contracts 4x faster and 10x lower fees. PancakeSwap charges a 0.25% fee, 0.17% of which goes for liquidity-providing smart contracts.
All three DEXs have similar interfaces and rates. The biggest difference is token availability:
Since most projects are ERC-20, the ideal DEX should be Ethereum-based with the efficiency of the BNB Chain. PulseChain (PLS) is the Ethereum fork that increases speed four times and reduces fees while increasing network rewards. PulseX aims to become the Uniswap of PulseChain, as it also trades ERC-20 tokens in PRC-20 format.
The PulseChain hard fork will happen soon. If you hold any tokens on Ethereum before the launch, you could get free copies to swap on PulseX (ETH -> PLS, LINK -> PLINK, and so on). Learn more about PulseX here.
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Max is a European based crypto specialist, marketer, and all-around writer. He brings an original and practical approach for timeless blockchain knowledge such as: in-depth guides on crypto 101, blockchain analysis, dApp reviews, and DeFi risk management. Max also wrote for news outlets, saas entrepreneurs, crypto exchanges, fintech B2B agencies, Metaverse game studios, trading coaches, and Web3 leaders like Enjin.