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Without the liquidity-providing market makers, the trading world would come to an abrupt halt. In traditional markets, involvement in the market making process is inaccessible to the average investor. In the DeFi space, Uniswap is changing that, allowing everyday investors to get a slice of the market pie.
In this guide you will learn how Uniswap works and how you can use the decentralized application to earn investment income.
What is Uniswap?
Uniswap is an automated and open source liquidity protocol that runs on the Ethereum blockchain. Users can use Uniswap to engage in decentralized trading without having to worry about an intermediary or order book.
Centralized exchanges have played an important role in digital asset markets. They have long offered an affordable and familiar source of liquidity. However, mirroring the reliable infrastructure of digital currency transactions to form decentralized exchanges (DEXs) has long been a real, but elusive, goal.
Uniswap seems to have become the “unicorn” of decentralized exchanges: a completely trustless liquidity pool.
How does Uniswap work?
Uniswap differs from traditional digital exchanges in that no order book is involved. It uses a protocol called Constant Product Market Maker, which is another form of file Automated Market Maker (AMM).
Automated market makers are smart contracts designed to maintain liquidity pools, and traders can trade against these pools. The pools are funded by people who choose to invest in the system by providing liquidity.
To invest, you just need to deposit two chips into the pool. Traders pay commissions to the pool for each transaction they make. The proceeds from the proceeds are distributed to those who are in the pool, according to what each individual has made available to the reserve.
The two tokens deposited by liquidity providers can be an ETH and an ERC-20 token or a pair of ERC-20 tokens.
After liquidity providers have made a deposit to the pool, they receive liquidity tokens, which can be redeemed based on the percentage of the pool they represent.
The formula “k”
The calculation of “k” is central to Uniswap’s evaluation system. Trades made on a pair get their price from a constant product formula. The result is regardless of the number of tokens that are added or removed from the pair’s reserves, the product of the reserves remains the same.
The value of “k” changes only after cash has been withdrawn or deposited. This is an important detail because it helps in the calculation of commissions. When the amount that is paid in a Uniswap pair is reduced by 0.3% commission, before checking the consistency of the value of “k”, the commission is added to the reserves.
Additionally, each liquidity provider earns UNI tokens as an incentive to provide liquidity.
How to use Uniswap to earn investment income
On Uniswap, a 0.3% commission is taken from every transaction made on the platform. The more you trade, the bigger the pool. One way to make money with Uniswap is to invest in the liquidity pool. As Uniswap gains popularity, more and more traders can get in on the action and the amount you earn can increase proportionally.
The amount of income you earn is determined by your pool percentage. For example, if you provide 10% of the liquidity in the pool, you receive 10% of the fees that are collected. This fee is put back into the liquidity depth of the pool. Consequently, the amount actually obtained will depend on how each token involved in the exchange accumulates against the USD. Also, the price between two tokens fluctuates based on trading activity on Uniswap and this will also affect your ROI.
To get started on Uniswap:
- Go to the Uniswap main page and select Launch App
- Select Pool
- Select Add liquidity
- Choose a pair, from a list or manually, and enter the amount you want to add to the pool
Withdraw your earned commissions
With Uniswap, when you withdraw your commissions, you also withdraw your liquidity. However, you don’t have to remove all cash every time you cash out. You can choose to withdraw only part of your cash and keep the rest in the cash pool. When you make a withdrawal, the amount you take includes both the commissions you have earned as a liquidity provider and the amount you are withdrawing from the pool.
Additionally, since the end of September, liquidity providers are also earning UNI tokens as an additional incentive.
Uniswap also allows you to keep track of the commissions you collect. Within the platform, you have access to a dashboard that shows data related to your ROI, including Net, ROI, Price ROI and Uniswap ROI.
Uniswap presents a simple digital asset investment solution. The platform enjoys a significant market share of well over $ 500 million at the time of writing, which could be a testament to the growing trust generated by trustless exchanges.
Further reading:
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