Growspace Research (UNI)
Updated: Dec 13, 2022
Introduction
Uniswap is a decentralized exchange (DEX). Basically, it’s an automated platform/exchange for trading cryptocurrencies. It has a distributed governance (i.e., decisions are made through voting by UNI token holders and the platform's control is not concentrated in the hands of a few entities), thus the term ‘decentralized’.
How does it work?
DEXs like Uniswap do not use the order book approach employed by traditional centralized exchanges, rather they are fully automated and use an Automated Market Making system (AMM) to enable trading. Basically, in AMMs, traders trade against liquidity pools which are pairs of 2 cryptocurrencies each (eg: ETH/USDC liquidity pool). These cryptocurrencies are priced based on their relative quantity in the pool. As one of the assets (eg: ETH) is traded against the other (eg: USDC), their relative prices shift as now there is less of one asset (ETH) and more of the other (USDC) compared to the initial composition, leading to a new exchange rate for the assets based on new composition of the liquidity pool. Individuals who supply cryptocurrencies (liquidity) to these pools are called Liquidity Providers (LPs). In return for supplying liquidity, LPs earn the trading fees paid by traders to the platform.
A brief overview of how exchange rates are set in Uniswap:
Exchange rates are based on the ‘constant product’ formula:
x*y=k,
x= quantity of asset1, y= quantity of asset2, k= invariant (constant)
The core principle of this approach is that at any point in time ‘k’ must be constant.
Eg: Let’s assume a hypothetical world where 1 ETH(x) = 50 OMG(y) for simplicity. We are creating a liquidity pool with 10 ETH and 500 OMG, setting the initial exchange rate at 50 OMG per ETH. With these values, k becomes 5,000 (this will now be constant irrespective of the amounts of ETH and OMG in future). Now let’s assume a trader wishes to swap 1 ETH and receive OMG. We will assume the trading fees of 0.25% per trade. When 1 ETH is deposited, 0.25% of 1 ETH (= 0.0025 ETH) will be the fees and 0.9975 ETH (1-0.0025=0.9975) will go into the liquidity pool. So now, the total amount of ETH in the pool will be 10.9975ETH (10+0.9975=10.9975). Based on the constant product formula, the amount of OMG that should be in the pool is:
x*y=k => (10.9975) *y=5000 => y= (5000/10.9975) => y=454.65
So, the amount of OMG released in exchange of 1 ETH will be equal to 45.35 OMG (500-454.65= 45.35)
Value Proposition
For traders looking to swap their crypto, Uniswap provides an on-chain way to effortlessly do that.
For individuals who wish to earn yield on their cryptocurrencies, they can become LPs on Uniswap and earn the trading fees.
For the overall ecosystem, it enables composability with other DeFi apps, provides on-chain liquidity and a way to trade in a non-custodial manner.
Tokenomics
UNI is the native token of Uniswap. It provides holders the right to vote in Uniswap’s governance decisions like fee structure, deploying treasury and more.
Source: https://uniswap.org/blog/uni
At genesis (September 2020), 1 billion UNI tokens were minted and were planned to be made accessible over 4 years. The decided allocation was as follows:
60.00% (600M UNI)- Uniswap community members
21.266% (212.66M UNI)- Team members and future employees with 4-year vesting
18.044% (180.44M UNI)- Investors with 4-year vesting
0.69% (6.9M UNI)- Advisors with 4-year vesting 6,900,000 UNI
There is also going to be a perpetual inflation rate of 2% annually post the 4 year period.
The UNI token has an interesting (currently not functional) feature for value capture called the ‘fee-switch’. It would enable UNI holders to receive a % of the trading fees generated on Uniswap (currently all of it is going to LPs). The ‘fee-switch’ needs to be unlocked through a governance voting by the UNI holders. The reason it hasn’t been approved yet is the fear of LPs pulling out their liquidity from the platform due to a reduction in their earnings post the fee-switch, causing Uniswap to lose its market share.
Competitive Analysis
1. Trading volume
Source: https://www.theblock.co/data/decentralized-finance/dex-non-custodial
Uniswap has the highest trading volume among all DEXs, and it has held that position for quite some time.
2. Fees generated
Source: https://tokenterminal.com/terminal/projects/uniswap#competitive
Uniswap is the highest fee generator in the DEX category and among the top ones in the whole crypto ecosystem.
3. Total Value Locked (TVL)
Source: https://tokenterminal.com/terminal/projects/uniswap#competitive
Uniswap has the highest liquidity (overall) in the common-purpose DEX vertical (Curve is a specialized DEX for assets with similar value eg: stETH/ETH and USDC/USDT).
Metrics
1. DEX Market share
Source: https://www.theblock.co/data/decentralized-finance/dex-non-custodial/share-of-dex-volume-monthly
Uniswap has been (almost consistently) growing its market share among DEXs.
2. Uniswap vs Coinbase and Binance Trade volume (7DMA)
Although Binance (centralized) clearly dominates the crypto exchange space, Uniswap is the only DEX large enough to compete with established centralized exchanges and it has been neck-to-neck with the centralized behemoth Coinbase in trading volume.
Investment Thesis
Uniswap is one of the most dominant players in the crypto ecosystem.
1. It is a foundational element for DeFi, providing on-chain liquidity and composability with other DeFi applications.
2. With 1.2 trillion+ cumulative trading volume, 112 million+ trades, 300+ integrations, and 4400+ community delegates Uniswap is clearly a dominant dapp.
3. Uniswap holds the highest market share (over 60%) of the in the decentralized exchange space.
4. Uniswap is the highest fee generator among DEXs and ranks second only to Ethereum in the whole ecosystem.
5. It ranks at top in terms of liquidity among DEXs (2nd highest TVL as of 10th October 2022).
Uniswap is the industry leader in a DeFi vertical (DEX) that has achieved an exceptional product market fit and is positioned to grow significantly with rise in crypto’s adoption.
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