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How does a decentralised exchange like Uniswap work?
Uniswap is a decentralised crypto trading exchange that enables trading of ERC20 tokens on Ethereum and is also a financial marketplace for DeFi apps. Uniswap is the largest crypto project built on top of Ethereum.
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What is a decentralised exchange?
In a centralised exchange such as Binance, Coinbase or Kraken, there is a central authority - the owners. Trading is based on an order book system, meaning that buy and sell orders are listed. Buy and sell orders at the same price need to be matched. If there are no matching orders, it is referred to as a ‘low liquidity’ situation and may make it difficult for traders to execute buy or sell orders. Uniswap is a completely different type of cryptocurrency exchange, and enables trading using liquidity pools that automatically create a ‘market’.
Uniswap is different from other exchanges as there is no centralised control or order book. There is no listing process or fees for ERC20 tokens on the Uniswap exchange. Any token can be launched if there is a liquidity pool. This is a refreshing change from most other exchanges that charge a high listing fee for new tokens.
Decentralised exchange volumes grew rapidly in 2021, and Uniswap led with the highest 24 hour transaction volume. This platform is now rivalling some of the large centralised exchanges based on daily volume.
How to use Uniswap?
Liquidity pools and liquidity providers
To understand how the Uniswap exchange works, you need to be familiar with liquidity pools and liquidity providers. There are some users who provide their tokens to an Automated Market Maker protocol (AMM) for people to trade with. These people are called Liquidity Providers (LP). Liquidity pools are pools of two cryptocurrencies. Traders can buy and sell from the pool even if there’s no person on the other side. The Automated Market Maker uses a mathematical algorithm to set the prices of assets rather than supply and demand.
Connect through a Uniswap wallet to trade
To trade, you need to connect through a Uniswap wallet and own ETH or any ERC20 standard token. You don’t need to provide any personal details or verification for this, so your privacy may be better protected than with most other exchanges.
Choose the token pair to trade
When you’re ready to trade, choose the token pair you’d like to trade in from among the available ERC20 tokens. You choose the token you’re selling and the one you want to buy. You can specify the transaction deadline; that’s the maximum time you’re willing to wait for the swap to execute. Once you click ‘swap’, you get a chance to verify all the details, then you receive the tokens in your wallet automatically.
The Uniswap token is called UNI. One billion UNI were minted when it first started in 2020, to be made accessible over the following four years. Of these, at least 60 per cent have already been assigned to community members.
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