Most cryptocurrency trading takes place at centralized exchanges. Coinbase and Binance are the most popular. The company running the exchange controls and runs these platforms. The exchange must control the funds of users under its management by utilizing a traditional system for trading.
To trade successfully in price and quantity, order book trading requires a sell and buy order.
Before you could sell one Bitcoin (BTC), you would need to find a buyer willing to pay an amount equal to or greater than that.
This type of system has a major constraint in terms of liquidity. To put it into context, this refers to both the number and depth of the orders on the order books at any one time.
What is Uniswap ?
Uniswap is a decentralized exchange . It is fully decentralized and completely different because it uses a relatively new type of trading model called an automated liquidity protocol. First built in 2018 on top of the Ethereum blockchain, Uniswap is compatible with all ERC-20 tokens and infrastructure such as wallet services like MetaMask and MyEtherWallet.
Uniswap also is completely open source, which means that anyone can copy and paste the code in order to create a decentralized exchange. The exchange allows users to list their tokens for free. Uniswap is a DEX, which means that users can always have control over their funds. This allows them to be more secure than a centralized platform where the users’ private keys are stored in an internal database. Uniswap eliminates the risk of assets being lost if an exchange is hacked.
The Uniswap Liquidity Pool
Uniswap, Ethereum’s most popular market maker (AMM) exchange is a decentralized ERC-20 exchange, but it is not designed for tokens only; it also supports Ethereum. We can also see Uniswap as an exchange protocol that permits you to exchange ERC-20 tokens without fear. The smart contract is written in Vyper Smart Contract Language, and it allows for decentralization, security, censorship-resistance, and permissionless utility.
Uniswap Liquidity Pool gathers tokens into a smart-contract model and allows users to trade with the pool. By depositing tokens to a smart-contract and receiving tokens back in exchange, you or anyone else can provide liquidity or swap tokens. You can list a token on Uniswap.
You can exchange Ethereum to any ERC-20 Token in a completely decentralized way, without the need for KYC of company involvement.
Platforms that are Centralized Exchanges act as an intermediary over your money and charge commissions to facilitate transactions. Uniswap is exactly the opposite. Your money is always in your hands. After initiating a transaction the money is removed from your wallet, and returned in a different format. It is this way that it is ensured there will be no censorship.
Yield farming with Uniswap
Yield farming allows you to make more money with your crypto assets. How does this work? Like in traditional banks, where you can Provide your surplus cash for a fee in interest, you can get paid for depositing your tokens with crypto. Uniswap avails you the opportunity to become a liquidity provider.
Uniswap fees
On signing up on the platform and creating a liquidity pool, you share 0.3% of the transaction fees on the pools. You also have access to the percentage of liquidity you provide on the commission. For example, if you provide 60% liquidity to the liquidity pool, you will earn 60% of the transaction fee.
The following steps will help you track your income:
- Enter your email address on the Uniswap website.
- The system will process and show your current liquidity status on the table summary by clicking the “Analyze Return” button.
- Click the address to see ROI and KPIs.
How Uniswap Liquidity Pool Works
We will go further to explain how the Uniswap Liquidity pool works. The liquidity pools are an aggregation of tokens in smart contracts. There are many ERC-20 tokens in this liquidity pool for you to exchange – swap, send, and Pool- with another person, With Ethereum being the conduit. So, you can create a new exchange pair in a new liquidity pool for any token of your choice.
You can, for example, be a part of the ETH/DAI liquid pool. To participate, you will have to equalize the value of Ethereum with DAI. When someone decides to buy ETH/DAI from Uniswap and trade it, then your liquidity is reduced.
Your DAI’s liquidity may decrease if someone wishes to exchange Ethereum for DAI. However, the liquidity of Ethereum might increase. Your Ethereum will also increase if your DAI drops by a single dollar. The Uniswap Liquidity Pool works in this way.
How to do Yield farming on Uniswap Version 3
When you get on the exchange platform, You will see “clickable” buttons like Swap, Send, and Pool. When you click Pool, it means you want to
- Add liquidity,
- Remove liquidity, or
- Create your exchange pair.
Uniswap allows you to add and remove liquidity pools on your platform. How to carefully perform these tasks will be explained.
Create a liquidity pool in Uniswap Version 3
Creating a liquidity pool is similar to creating your exchange. This allows you to control your tokens. Here are steps on how to create a pool:
- Visit the official website. (app.uniswap.org)
- Click on the button Confirm to link Uniswap with your account when a Metamask Notification appears.
- Select the Pool Tab.
- Select “Connect wallet” from the dropdown menu. This may mean that you need to create an exchange.
- You can copy the contract address of your token (for example, from Etherscan or coinbase wallet).
- Copy the address and paste it in the Token Address box. Select the option from the dropdown.
- Join the pool by clicking on “join pool”.
- Click on Confirm to confirm the Metamask Notification.
Add Liquidity To Uniswap Liquidity Pool
To add liquidity to a Uniswap Liquidity pool, there are a few steps you’ll need to follow. Firstly, bear in mind that you’ll need to have an ERC-20 wallet.
- Log on to the Uniswap site (app.uniswap.org). Once you have clicked on ‘pool’, select “Join Pool”.
- Find pools. You can choose from TEND, KIMCHI or Dai.
- The next step is to click “Add Liquidity”. This will appear on your screen. Its position may vary depending on whether you’re using the desktop or mobile versions. Uniswap shows you your balance in all wallets connected (Eth, and any other ERC-20 Tokens). Also, you will see the current exchange rate as well as the percentage of liquidity.
- After entering the ETH/DAI value, Uniswap automatically fills in the amount for the remaining assets based on the current rate of exchange.
- Click on the details of the transaction to view more details, including the number and value of the liquidity tokens that you intend to mint. Details will include the amount of tokens that you wish to mint.
- Click the “add liquid” button. If you are using MetaMask, adjust your gas before clicking “confirm.”
- After the Ethereum transaction is confirmed, you will be able to see the updated DAI and ETH balances as well as your share in the total liquidity pool for the trading pair.
This guide is as explanatory as it can be. We hope it is of great help to understand how Liquidity pools in Uniswap work and perhaps in helping you decide if Uniswap Liquidity pools suit your investment style. You can try to invest with a little sum before opting to up your investment stake if you wish to.
FAQ
What are Liquidity Pools❓
Liquidity pools are pools of tokens locked in a smart contract to aid liquidity. The main aim of liquidity pools is to allow traders to trade their digital assets and, at the same time, earn rewards on their asset holdings.
What is Uniswap V2❓
On the 19th May 2020, Uniswap released its second version on the Ethereum Mainnet to coincide with the core contract v1.0.1 release after series of testings on the Rinkeby testnet. So far, The protocol has been used on the Mainnet, and no major issues regarding breakages have been recorded. This further strengthens the claim of the smart contract’s integrity.
Uniswap V2 is superior to its predecessor, Uniswap V1, in the following regard.
???? ERC20 to ERC20 token swaps: with the V2, ETH is no longer needed to be an intermediary token for the swap process. A term known as “ETH bridging.” No intermediary means the transaction count is cut in half, and more money is saved on gas fees.
???? Flash swapping: This refers to the ability to “borrow” tokens from a Uniswap pool, make some arbitrary transaction with external services, and repay your initially borrowed funds, all in one transaction. The atomic nature of the transaction makes for full reversal if the transaction fails at any stage. The major use for such a feature is to execute arbitrage trades leveraging a liquidity pool and closing a Maker Vault.
???? Helper Architecture
???? Technical Improvements
???? Sustainability
Difference Between Uniswap V2 and V3❓
⚡️Uniswap constant product curve
Unlike the Uniswap V2, in the Uniswap v3, Liquidity providers do not only put their assets in liquidity pools and spread them evenly along the price curve. They also have the privilege to choose the price range they want to allocate their assets to and earn from fees when the price is within the selected price range.
Imagine that you put 1 ETH and 2,000 DAI in the ETH/DAI liquidity pool, and you choose to put it in the $1,950-$2,050 price range. What you are saying is this:
“Take these assets and put them in the Pool. Whenever someone buys ETH for any amount of DAI between 1,950-2,050 DAI, I get the fees from that swap. If ETH price is outside that range, I don’t get the fees.”
⚡️Higher Capital Efficiency for Uniswap v3 LPs
In V2, there is a minimal chance that the price of your stablecoin Pool, e.g., DAI/USDC, would go out of the $0.99-$1.01 price range, even though your assets would be evenly distributed along the price curve. This causes you to have only a tiny percentage of the total amount of funds as earning fees. In Uniswap v3, it’s different. You deposit 100% of your assets in that $0.99-$1.01 range. This way, it’s not only a fraction of the assets you deposited that is making returns for you but the whole amount.
For non-stablecoin pools, like the ETH mentioned above/DAI pool, you can’t predict the price range as accurately as you can for the DAI/USDC pool. However, you can select a wider price range to account for ETH price changes – such as $1,950-$2,050. You would not always earn fees, but when you do, you will gain much, much more than in v2 because you are using 100% of your assets, not just a small portion. That’s how concentrated liquidity makes higher capital efficiency possible.
⚡️Active Liquidity
As earlier stated, two people in a pool would get the same amount of fees; so far, ETH’s price stays within the $1,808-$2,215 range. What happens if it goes beyond that?
In this case like this, your liquidity becomes effectively removed from the Pool and is no longer earning fees until you decide to update your range to account for the price change.
There are three main options in this case
You choose multiple price ranges.
You choose one wide price range, settle for lower capital efficiency but reduce the risk of price fluctuations.
You pick one narrow range, get super-high capital efficiency, and risk being exposed to a much higher risk.
⚡️Flexible Fees
Uniswap v1 had a flat 0.30% fees, of which 100% goes to the LPs. Uniswap v2 introduced a 0.05% protocol fee which could be turned on/off.
Uniswap v3 brings a lot more community-governed flexibility through multiple fee tiers:
0.05% – expected for stablecoin pools like DAI/USDC
0.30% – for standard non-correlated pools like ETH/DAI
1.00% – for exotic non-correlated pairs
The Uniswap team added even more flexibility by allowing the governance to include additional fee tiers. Protocol fees are also there, but they are put off by default. However, the governance will be able to turn on the protocol fees on a per-pool basis and set them between 10%-25% of LP fees.
⚡️Non-Fungible Liquidity
This might be one of the most important uses of NFTs. The liquidity positions of Providers in Uniswap v3 aren’t fungible because they come in different price ranges. ETH/DAI positions at $1,950-$2,050 and $1,900-$2,100 are not the same. The first one comes with higher capital efficiency but also more risk and the possibility of inactive liquidity. This is the main reason why LP positions in Uniswap v3 cannot be represented as ERC20 tokens in the core protocol but rather by non-fungible ERC721 tokens (NFTs).
What is Uniswap V3❓
Uniswap is undoubtedly the leading Decentralized Exchange and one of the world’s most popular DeFi platforms. Innovative with every new iteration without retaining the bugs of the previous ones. With Ethereum’s scalability issues being a major problem generally, Uniswap v3 puts more trust in its underlying infrastructure than previous versions. It enables a higher return on capital for its users and brings new possibilities for the development of an ecosystem around it.
The new features on Uniswap v3 are quite complex and are not so easy to understand by ordinary crypto holders. However, we expect to see developers working on their solutions to make Uniswap v3 more user-friendly and strategy inclusive.
How to make money with Uniswap pools❓
You can earn o Uniswap as a liquidity provider. For instance, for every liquidity you provide, you earn 0.3% of the Pool.
How do you calculate pool liquidity❓
Use X*Y =K to determine the pool liquidity. X, Y, and K represent the value of ETH, ERC-20 token, and Constant, respectively. The above equation represents the demand and supply of ETH/ERC-20 tokens, and it uses that to balance the price of the pooled token.
How to find the most profitable Pool❓
For more profitable pools, metrics such as volumes, pool ROI, and so on come in handy.
How Yield Farming Can Offset Impermanent Loss❓
Impermanent loss is defined as the difference between holding tokens in an AMM and holding them in your wallet. It is a result of token price divergence. The more the divergence, the greater the impermanent loss.
Supplying liquidity on Uniswap is profitable, but you can lose money in some situations if the price moves too much compared to when you hold the underlying assets.
How Trading Fees Can Offset Impermanent Loss❓
To reduce the effect of impermanent loss within the decentralized finance ecosystem and give users incentives to supply tokens to liquidity pools, Uniswap provides a 0.3% fee for every trade. For liquidity providers, more trading and more volatility mean more money. With enough trading volume on the platform, liquidity providers can accumulate fees to reduce the effect of impermanent loss.
How Price Changes Impact the Value of LP Tokens on Uniswap and Other Such Exchanges❓
Let’s take an example of an imaginary Mr. Ayo who provided liquidity of $1k Bitcoin and $1k USDC.
If Bitcoin were to double in price, the total assets in your Pool would total $3k. With $2k in bitcoin and $1k in USDC. If you think this is the case, you are a bit wrong. What Uniswap does that it will constantly rebalance the assets, so it would have to sell bitcoin for USDC to reach the equilibrium again, meaning you will have $1.5k Bitcoin and USD 1.5k (not considering transaction fees). In simple words, the change in the price of any of the tokens will cause a rebalancing.
Since the price of both tokens is not the same, you could lose out on huge gains Because of the rebalancing.
