Uniswap Explained: Making Sense of the Leading Decentralized Exchange

When you start your web3 journey, it doesn’t take long until you run into Uniswap. Maybe you want to yield farm, maybe you’re exchanging an airdrop for ETH. But as the biggest decentralized exchange, it’s hard to not at least hear of Uniswap.

But if you’re new to crypto (or just new to decentralized exchanges), it can be confusing—especially because Uniswap has grown in the past few years and added many new features. In this article, we’ll explain What Uniswap is, how it works and how you can use it safely and efficiently to get the most out of your web3 journey.

You’re probably here to figure out how to use Uniswap and what it can do for you. In this article, we’ll explore:

• What is Uniswap and how does it work? 
• How to use Uniswap (both to swap and earn rewards)
• More than swaps: Uniswap’s other ventures
• Uniswap vs. other DEXs: Which is best? 

What is Uniswap?

Uniswap is a decentralized exchange protocol built on Ethereum. That might sound complex, but behind the abstract language is a simple concept: 

The Uniswap Protocol allows you to exchange one token for another without a middleman.

That’s why it’s called a decentralized exchange: Rather than holding huge amounts of each token themselves, Uniswap’s smart contracts facilitate transactions between users via liquidity pools (which we’ll explain below). 

In contrast, a transaction on a centralized exchange like Coinbase means you’re always interacting with the exchange and never with the funds of other users. 

How does Uniswap work?

Uniswap operates using an Automated Market Maker system. Users trade directly with the liquidity pool, and prices are determined by a formula considering the pool's balance of each token.

What is an automated market maker?

An Automated Market Maker (AMM) is a type of decentralized exchange protocol that relies on a mathematical formula to set the price of a token. Outside of crypto, a market maker holds massive amounts of assets and charges a fee to be the counterparty to trades placed on the exchange. 

An automated market maker pools assets from the community and uses the aggregate to facilitate trades. An AMM also charges a fee, but pays most of it back to the community. 

How does an automated market maker work?

In an AMM, liquidity providers deposit pairs of tokens in a pool. Traders then trade against this pool. The AMM uses a formula to automatically determine the price of the tokens based on the supply and demand for those tokens in the pool.

AMMs like Uniswap’s are vital infrastructure of decentralized finance (DeFi) because they enable trading tokens without intermediaries.

How does Uniswap make money?

Uniswap charges a small 0.3% fee on each trade, which goes directly to liquidity providers as compensation for their deposited funds.

How to Use Uniswap

While there are other parts of Uniswap, you’re most likely to come to Uniswap for one of two reasons: 

• Swapping tokens
• Providing liquidity to earn rewards

Let’s dive into both:

How to Swap Tokens on Uniswap

Swapping tokens on Uniswap is simple: 

1. Head to Uniswap.org and hit “Launch App” or navigate directly to app.uniswap.org
2. Connect your wallet
3. Choose the token you’d like to swap from. The default here is ETH, but it could be any token you own. 
4. Choose the token you’d like to swap to. If you can’t find the token via Uniswap’s search feature, you can paste its smart contract address. 
5. Uniswap will calculate the amount you’ll receive in exchange. 
6. If the amount is correct, click “swap” and follow the instructions. 
7. Assuming you’ve installed Fire to simulate transactions, you’ll get a pop-up showing you what’s entering and leaving your wallet. 

Uniswap Warnings/Errors

There are two common errors you might encounter while swapping: 

Not enough liquidity: If you’re trying to swap obscure tokens, you might see the “insufficient liquidity for this trade” error. This means Uniswap can’t perform the swap because not enough assets were deposited. This makes the swap impossible.

Price impact warning: When there are few deposits or a token is especially volatile, you might not receive an equal value of tokens in the swap. The “Swap” button will turn red and say “Swap anyway” and show you the loss you incur if you proceed with the swap.

Uniswap Liquidity Pools: Earning Returns on Your Crypto

As explained in our guide to yield farming, liquidity pools are at the heart of earning on Uniswap. The returns of these liquidity pools range from tiny (for large pools) to big (for lower-volume pools).

Here’s how to passively earn tokens on Uniswap:

1. Understanding Liquidity Provision: When you provide liquidity on Uniswap, you deposit an equal value of two tokens into a specific liquidity pool, such as an ETH/USDC pool. The pool allows users to trade these tokens with each other.

2. Become a Liquidity Provider: To start, you would select the 'Pools' option on the Uniswap interface and then choose ‘New Position’. You then pick the pair of tokens you want to provide liquidity for, ensuring you have equal values of each token in your wallet.

3. Earn Trading Fees: As a liquidity provider, you earn a pro-rata share of the trading fees accrued in the pool. For Uniswap v3, this fee is 0.3% per trade. These fees are automatically added to the pool’s reserves, so your portion of fees is claimable only when you withdraw your liquidity.

4. Liquidity Tokens: Upon depositing your tokens, you'll receive a liquidity NFT that represents your share in the pool. This token can be used to exchanged your share of the pool, along with any fees earned.

5. Additional Incentives: Besides trading fees, liquidity providers could also earn additional rewards. For example, certain projects incentivize liquidity provision in their token pools by offering additional token rewards.

But Uniswap isn’t the only DEX in web3. Let’s see how it compares to others in the space:

Uniswap Comparison: Which DEX is the best?

Sushiswap vs. Uniswap

Because Uniswap is open source, anyone can build a rival exchange. That’s exactly what Sushiswap did: It’s a fork of Uniswap with added features.

While Uniswap remains the market leader, Sushiswap has established itself on multiple chains, including Avalanche, Binance Smart Chain, Optimism and others.

1inch vs. Uniswap

1inch is a DEX aggregator, not a DEX itself. It sources liquidity from various DEXs, including Uniswap, to provide users with the best possible trading rates. While interacting with 1inch, you might trade through Uniswap without knowing it.

Uniswap vs Coinbase

Coinbase is a centralized exchange, offering a different user experience. It provides customer support, a user-friendly interface, fiat on/off-ramps, and custodial services but lacks the decentralization and permissionless nature of Uniswap.

Coinbase also doesn’t offer any way to yield farm by becoming a liquidity provider.

Curve vs. Uniswap

Curve, like Uniswap, is an AMM. However, it specializes in stablecoin and wrapped asset swaps, optimizing for minimal slippage in these markets, while Uniswap is more general-purpose. Curve, in general, is more experimental and exotic. Yields for providing tokens can be higher, but Curve is definitely for more adventurous DeFi enthusiasts.

Is Uniswap safe?

Uniswap's protocol itself has been audited and is known to be one of the most secure and reliable DeFi dApps. But there are a few risks when using Uniswap:

• Smart contract bugs in the tokens you’re trading could lead to you receiving no tokens.
• When trading memecoins or other volatile tokens, you could lose tokens to slippage, which is when prices change between you submitting and executing the trade.
• Fake tokens are one of the most common crypto scams, so always make sure you’re interacting with the right smart contract.
• Impermanent loss (a complex technical subject) can temporarily cause a loss of tokens in your balance.

Uniswap does a good job of warning you of trades with high slippage and deactivates trades with too little liquidity, but always make sure you’re making the right trade.

But the biggest risk with Uniswap isn’t Uniswap itself, it’s scammers who replicate or impersonate the DEX.

Bad actors sometimes imitate web3 dApps that look just like the real thing, but steal all of your assets. That’s why using Fire to simulate transactions is important.

Besides simulating transactions to show you what’s entering and leaving your wallet, we also verify domains. Look at the screenshot below. See the checkmark next to the app.uniswap.org? That means we’ve verified it as the authentic Uniswap—meaning it’s safe to interact with.

More than swaps & pools: Everything Uniswap

While we’ve explored how to use Uniswap swaps, pools and AMMs, Uniswap is more than that. If you’re curious about the rest of Uniswap, here’s the rest of it:

• Uniswap’s app is the decentralized exchange that lets you exchange tokens.
• Uniswap Labs is the software development studio that builds, maintains and grows the Uniswap protocol, founded by Hayden Adams.
• Uniswap v2 was an update to the Uniswap protocol in May 2020. It included features such as direct ERC20/ERC20 pairs and price oracles.
• Uniswap v3, launched in May 2021, brought concentrated liquidity, providing LPs (Liquidity Providers) with more control over the price ranges in which their capital is used.
• Uniswap v4 is set to launch in 2023 or 2024 promises various upgrades to make the architecture more efficient and introduce more customized liquidity pools.
• Uniswap NFT is an NFT aggregator. Uniswap Labs acquired NFT aggregator Genie, which collects listings from major NFT marketplaces to help find the best prices.
• Uniswap Wallet is an iOS Ethereum wallet which supports Polygon, Arbitrum and Optimism in addition to Ethereum.
• The Uniswap token (also called $UNI) is the governance token of the Uniswap protocol which lets holders vote on decisions regarding the Uniswap ecosystem.