May 25, 2020

An Introduction to Uniswap

Uniswap has tokens on it that you wouldn't even find on other dexs and has been getting attention recently after some very profitable runs. It can be considered "next gen" for a couple of reasons, although the protocol launched 1.5 years ago. Let's take a look what all the fuzz is about.

An Introduction to Uniswap

Over the past two weeks, a couple of micro cap tokens had very profitable runs on a decentralized exchange that a lot of people in crypto were not familiar with: Uniswap has tokens on it that you wouldn't even find on other dexs like Idex and it can be considered "next gen" for a couple of reasons, although the protocol launched 1.5 years ago.

So what's Uniswap exactly?

It's a decentralized exchange that has been around since end of 2018. It was inspired by a twitter thread from Vitalik and created by Hayden Adams. What sets Uniswap apart from traditional dexes is that the original dev doesn't own the smart contract (like it was the case with Etherdelta which later resulted in an SEC case that ended with a settlement) and there is no company behind it (like with Idex). Instead, the users can form liquidity pools for each pairing and they earn the transaction fee of 0.3% on each transaction made. This makes Uniswap a defi or "decentralized finance" application. (I have some thoughts on this and how to make the most out of Uniswap plays but more on this a little later.)

On Uniswap, you don't find any charts, just a very reduced UI that lets you either swap one token for another (ETH to an ERC20 or ERC20s among each other), swap and immediately send the swapped tokens to an address or provide liquitidy to a pool:

If there are no charts and displayed orders, how is price determined on the exchange?

Price is affected by every swap executed. However, there is no classical maker and taker interaction that you know from traditional exchanges. When you hit up the swap tab and input how much of a token you want to swap for another one, it gives you the amount of the new token you are going to get and displays an exchange rate at the bottom:

In this case I chose to swap one ETH for a stablecoin and it gives me a quote close to around current market price. However, users have to be very careful because the size of your swaps is going to have an impact on your quote. Look at what happens if I try to make a huge order all at once:

My price per ETH is lower by close to a full dollar. You can also spot the difference in exchange rate of DAI to ETH at the bottom. What happened here is that my order would bring the liquidity pool out of balance to a certain degree (every order does). The liquidity pools are created by each liquidity provider depositing the same amount of each token for the pool pair they want to provide liquidity to.

This is the ETH DAI liquitidy pool. The price is calculated by deviding between the two. If ETH makes big moves in either direction, Uniswap is most likely going to lag behind because arbitrage has to happen for the exchange rate on Uniswap to catch up.

So for Shitcoin plays this means you are going to have to be careful with your order sizing. This is most likely a reason why the pumps on this exchange are so out of control right now. 4chan/biz choses a coin to pump next and then you have a ton of uneducated users swarming in and one-upping each other with orders that bring the pools out of balance big time.

How to make the most out of a Uniswap play (an untested theory)

Given the architecture of Uniswap, if you manage to get into one of these plays early, it makes sense, imo, to keep half of your ETH around and become a liquidity provider for the token you are playing. You do this by, after making your purchase, going to the pool tab and adding your token and your ETH in a 50/50 proportion to the pool (could also do this with a stablecoin instead of ETH, depending on where the most volume is happening).

This is an untested assumption but since, in an ideal world, you are in before the frenzy starts, you could get your share of those 0.3% fees when the herd discovers your token. This hedges the play and creates all kinds of interesting opportunities. If/when BTC breaks out of the bear trend for real, having some of your ETH in a liquidity pool could be worthwhile. The same goes for a stable coin in a bear market.

However: THIS COMES WITH RISK so it is not advisable go all in on stuff like that. Don't move all your USD hedge into a Defi protocol because they do get hacked. Uniswap has been around for a while now so it has proven a certain resilience. The fact that it is on the extremely decentralized end of the defi application spectrum is good news in that regard as well. But the more action happens on there, the more the volume and the liquidity pools grow, the more attractive it is going to be as a target.

You can check on current annualized returns for each liquidity pool on this site which also offers educational material on how to make the most of and manage pools:

Results of a scan of the current Uniswap tokens

Is it time to rush over and buy everything that did not pump yet? Due to the nature of the interaction of orders and liquidity pools, some of the runs on Uniswap have been extremely powerful. Most prominently, $XIO pulled a 30x in a matter of four days. A couple of other tokens followed (with a bit less of an amplitute). A scan through all of the listed pairings showed however, that the pool of tokens that have an investment proposition to them and did not see a dramatic increase in price could be drained for now. These are examples of tokens/projects that looked very promising but, for various reasons, are not as obvious of a buy as it might seem at first glance. I want to start with $XOR - Sora, because it has been promoted very aggressively on Twitter and 4chan, mostly because of its low circulating supply and resulting market cap. It turns out that there is more to those numbers:

XOR - Sora

Marketcap: $350k in terms of ERC20 tokens but there are $650M (!!!) worth of tokens on the SORA mainnet

Daily Liquidity: high ($67k)

Rating: This one came down from a 10x to a 5x (although in terms of liquidity, most people should be maximum 2.5x on it. It's one of the more solid looking projects on Uniswap, not Defi but a Japanese App/Ecosystem. The issue is that only the ERC20 market cap is small. In reality there is a ton of mainnet tokens connected to the app. The Dev said they will only start dilluting the ERC20 market slowly (see screenshot below). The Uniswap market currently is especially irrational and uninformed so the price of the tokens could increase but in terms of the actual tokenomics, it is extremely overvalued. The ERC20 tokens can be viewed as a small test ammount before the full circulating supply is going to be bridged.

SCAI - Compound SAI

Marketcap: $490k

Daily Liquidity: very low ($100-300$)

Rating: Great potential but ended up being a governance token that's not supposed to be traded

Compound SAI looked amazing at first with a super low market cap and pretty insane fundamentals. Coinbase backing, adoption by major Fund custodians that are used by almost every fund in the crypto space, etc.

The issue is that it's not supposed to be an investment. The tokens probably shouldn't be trading at all and future distributions are even going to be released to users of the protocol:

TMV - Timvi

Marketcap: $5k (?)

Daily Liquidity: low/moderate ($2k)

Rating: Looked interesting at first but it's a stablecoin for the Timvi DAO

Yes, even a token that is meant to maintain a value of $1 has been moved 26% by overeager buyers:

OCDAI - Opyn cDAI Insureance

Marketcap: $9k

Daily Liquidity: low-moderate ($5k)

Rating: Fascinating project offering insurance for exposure to ETH and DEFI investments based on mechanisms similar to options. The token, however, is not meant as an investment and everyone can mint them at will. (4Chan made it 10x anyways, now back to a 2x).

Straight from the Opyn discord server

Aside from the fact that the tokens are easily mintable, the pumps actually had effects on some of the ecosystems:

Opyn is a super interesting project just in terms of what is possible in crypto now. Definitely enjoying this research and while all of these might not be Uniswap moonshots, somebody with a significant ETH holding might find useful edges here in terms of how to make the best of their investment and risk management.

Another reason to share these is to sharpen awareness for what people are actually buying on Uniswap at the moment. Only very few of the tokens that are exclusively available there have an investment proposition to them. I am sure that Uniswap is going to be a place to watch this year but be careful buying everything that is being promoted on 4chan and Twitter.