Investor’s Guide to Uniswap: King of the DEXs

Executive Summary: Uniswap reigns as the undisputed leader of the DEX revolution. With no centralized order book, the exchange relies on a smart algorithm to set prices on hundreds of ERC-20 token pairs available on the platform for buyers and sellers.

With low trading fees and a growing user base, Uniswap remains the king of DEXs. But plenty of competitors want to claim the throne.

Is Uniswap’s UNI still a good investment? Who may unseat it? Read on to learn the answers to these questions and more.

Uniswap remains the largest decentralized exchange in 2023, handling the lion’s share of DEX trading volumes.

Here is a quick look at the recent DEX trade volumes:

Traditional centralized exchanges (CEXs) like Coinbase and Binance rely on an order book – a list of all the buyers and sellers for specific security – to set the prices on the exchange.

Decentralized exchanges (DEXs) like Uniswap rely on mathematical formulae to price the assets. This technology is called an automated market maker (AMM), and it removes the need for a middleman to set the prices for the market.

In the history of crypto, Uniswap was a significant step forward.

Where CEXs were slow to add new tokens (they had to carefully vet each one), Uniswap could automatically support any Ethereum-compatible token where there was enough supply and demand. The software-based approach let the company scale quickly.

The original version of the Uniswap protocol was launched on the Ethereum mainnet in November 2018. There have been several incremental upgrades since then:

• Version 1: Allowed users to trade between ETH and any ERC-20 tokens.
• Version 2: Launched in May 2020, this version added new features and functionality like increased decentralization, flash swaps, and ERC-20 pools, allowing direct exchange between different Ethereum-based tokens.
• Version 3: Launched in May 2021, it includes improved security and efficiency, with features like concentrated liquidity, range orders, NFTs, and flexible fees.
• Version 4: Currently under development, V4 is expected to be an incremental upgrade focusing on QoL changes like a better UI, built-in wallet, NFT aggregation, and possibly a batched auction system to combat MEVs.

The native token of the Uniswap protocol is also called Uniswap (UNI). Its stated purpose is to serve as the governance token of the protocol, though our thesis is that investing in UNI is like buying Uniswap “stock.”

UNI was launched without any ICO/token sale in September 2020. Instead, community members, protocol users, and liquidity providers were given free airdrops of the token, up to 400 UNI (worth approx $1500 at the time).

Synthetix founder Kain Warwick called the airdrop a “galaxy brain move,” since it rewarded early users for their loyalty. It was a bit like getting free stock in a company at its IPO, as thanks for being a loyal customer.

The airdrop was another Uniswap innovation that has since been copied by many new crypto projects, and today is expected of any new token launch.

Uniswap Fees vs. Revenues, Explained

As a DEX, Uniswap’s revenue/fee structure is different from those you find at centralized exchanges (CEX) like Binance and Coinbase.

Unlike most other centralized exchanges, Uniswap does not charge separate fees. Instead, Uniswap charges a flat fee of 0.30% per token swap.

The revenues generated by this fee are paid in full to the liquidity pools (i.e., the users providing the pairs of tokens to swap). The “company” itself and the holders of its governance token UNI, do not get any direct rewards from the Uniswap fees.

Uniswap V2 added the option for a “fee switch.” If switched on, this option would allow the protocol (i.e., the Uniswap company itself) to take a percentage of the fees collected from trades. (Like retained earnings, this could theoretically be paid out to UNI tokenholders.)

As of this writing, the fee switch has not been implemented. The decision to turn on the fee switch can only be taken through an open vote among the protocol governance forums (i.e., UNI token holders must approve it).

When Uniswap launched V3, they kept the fee switch option in place. The main change was the addition of different fee tiers, ranging from 0.01% to 1%. If they do switch on fee sharing, it is up to the liquidity providers to decide which fee structure they want to use.

Since the fee switch has not been implemented, all the revenues generated to date have been paid to liquidity providers. This means that the Uniswap “company” is currently not retaining any “revenue.” However, that may change in the future, if the fee switch is turned on.

The History of Uniswap Revenues

Uniswap started to take off after the launch of V2 in 2020, which allowed users the freedom to trade any ERC-20 token pairs. (Before that, V1 only allowed users to trade ERC-20 tokens against ETH.)

Monthly revenues for liquidity providers climbed from $4.8 million in July 2020 to $35 million by December that year. But the real spike in Uniswap revenues occurred in 2021, as V3 upgrades added further efficiency and features.

The protocol gained widespread acceptance, and monthly revenues quickly exceeded $100 million by March 2021. Uniswap hit a new peak in May, with revenues awarded to liquidity providers reaching an all-time high of $285 million.

Uniswap fees declined briefly in Q3 2021 before regaining steam in Q4, rallying to $180 million in November. In 2022, Uniswap broke several records in fees collected.

In June 2022, average daily fee earned on the protocols reached $4.87 million, surpassing even Ethereum which was at $4.8 million. By August 2022, Uniswap 7-day average fees were nearly double that of Ethereum ($8.7 million vs $4.07 million).

However, the meltdown in the wider crypto market in Q3 and Q4 2022 wiped out most of these gains. It took the crypto market several quarters to reverse the decline.

After the chaos of 2022, the wider crypto market has seen signs of recovery in 2023. While it is still too early for celebrations, there appears to be some space for cautious optimism.

With the successful Shapella upgrade, activity on Ethereum has gained momentum in 2023. According to CryptoFees data, Ethereum remains king of the hill:

Uniswap Fees vs. Other DEXs

In the last 3-4 years, several contenders have emerged, providing stiff competition for the DEX throne. Uniswap is no longer the only popular DEX in the market. Let’s take a quick look at some of the DEX competitors:

SushiSwap and PancakeSwap: Both are clones of Uniswap, built using the latter’s open-source source code and offering similar features and similar/lower fees as a competitive advantage.

Compound: Launched in 2017, this is a specialized DEX that creates tokens for assets locked on the platform. The tokens allow users to earn interest while retaining the freedom to transfer and use the assets on other platforms.

Curve Finance: Another specialized DEX, focused exclusively on stablecoins like USDT, USDC, DAI, and TUSD. Users can stake their stablecoins in liquidity pools or swap between different coins on the trading platform.

dYdX: Another DEX launched in 2017, dYdX gives additional options to users in the form of derivative trading. It briefly overtook Uniswap as the top DEX in terms of trading volume in September 2021.

Let’s compare Uniswap’s revenues against the contenders:

It is undeniable that the rise of clones like PancakeSwap and SushiSwap has eaten a chunk out of Uniswap’s business. Together, these clone DEXs accrued $1.5 billion in revenues prior to the 2022 downturn, despite launching after Uniswap.

When it comes to TVL, Uniswap is no longer the king of the hill. That honor belongs to Curve with $4.3 billion locked. Uniswap is second with $4.1 billion, with PancakeSwap a distant third at $1.6 billion.

And dYdX has been steadily eating away at the market share of Uniswap since 2021. With the advantage of an order book, derivative trading, and a massive airdrop of the dYdX token, the protocol has rapidly closed in on Uniswap over the last 2 years.

As of Q2 2023, it ranks second in the DEX tables with $621 million in trading volumes (daily). The other clones are far behind, with PancakeSwap V2 the closest at $139.68 million.

And in terms of crypto fees generated from trades, none of these DEX contenders come anywhere close to the numbers generated by Uniswap in early Q2 2023.

The nearest is Curve, with $283k in 7-day average fees. SushiSwap is further behind at $118k, just a fraction of the revenues generated by Uniswap for its liquidity providers.

Who Benefits from Uniswap Fees?

As we’ve mentioned, 100% of the revenues generated from trading fees on Uniswap currently go back to liquidity providers, through direct deposit into their liquidity pools.

Neither the team behind the protocol, nor the holders of the UNI governance token, earn anything from the revenue generated on Uniswap.

But all that could change in 2023, as GFXLabs, one of the contributors to the Uniswap project, advanced a proposal to turn on the fee switch and move a portion of the revenues to protocol treasury.

The proposal, if passed by the on-chain governance, would implement a protocol fee of 20% on the collected fees from V3 and also turn on the fee switch on V2.

Based on projections released by GFXLabs, the proposed 1/5th fee would generate over $52 million in revenues for the protocol across 6 months (based on average fees generated in May 2023). In theory, part or all of this revenue could be shared with UNI holders — like a stock dividend.

Of course, any such move would also have a direct impact on the revenue generation of liquidity providers, who could leave for competing exchanges. For UNI investors, that’s a risk that may outweigh the reward.

Uniswap Team Revenues

The protocol is managed by Uniswap Labs, formed by founder Hayden Adams. To date, the company has conducted two funding rounds, raising over $176 million.

The Series A round in August 2020 was led by Andreessen Horowitz (a16z crypto) and raised $11 million. There were 8 investors in total, including Union Square Ventures, A. Capital Ventures, SVA, and Variant Alternative Income Fund.

Uniswap launched its Series B round in October 2022. Conducted in the midst of the crypto winter, the initiative was a remarkable success, bringing in $165 million. The round was led by Polychain and featured SVA, Variant, and a16z as returning investors.

Since the company currently does not take any trading fees, the main source of value/revenue for the project is its native token, UNI. Although the majority of the tokens were airdropped to community members, liquidity providers, and protocol users on launch, 20% of the UNI supply has been kept in reserve.

The total supply of UNI is 1 billion. At the time of writing, UNI had a price of $5.32, putting the value of the 20% reserve at $1.06 billion which is set aside for the team behind the Uniswap project. Depending on UNI’s market price, they can sell these holdings for cash to run the business — but of course that will only last so long.

If the proposed activation of the protocol fee switch is passed, the revenues for the protocol and team behind Uniswap could increase by up to $50 million/year. The proposal seeks to spend these additional revenues to fund new projects and education programs.

Uniswap LP Revenues

Anybody with available crypto assets can become a liquidity provider, or LP. A decentralized exchange cannot function without LPs: they make the trades possible. Thus, Uniswap wants to encourage as many people as possible to become LPs.

To understand the revenue potential for being a Uniswap LP, let’s take a quick detour to explain how Automated Market Makers work.

In an order book system at a traditional exchange like Binance or Coinbase, we have trading pairs. (For example, BTC/ETH, ADA/DAI, or any other pairing of two currencies.) On these traditional crypto exchanges, a transaction occurs between a buyer and a seller, i.e., peer-to-peer.

However, in an AMM exchange, the counterparty is not one person, but a pool of funds supplied by many different users, with the smart contract setting the price and executing the trade.

This is where LPs enter the equation: the cryptos they lock into Uniswap provide the liquidity to the smart contract. Instead of a buyer and seller, you have a buyer and a liquidity pool. People make up the pool.

In Uniswap, these pools are usually based on token pairs like ETH/BTC or SOL/DAI. To participate in a liquidity pool, you deposit equal amounts of the two tokens in a 50:50 ratio (for example, 50% ETH/50% BTC).

Since they are so integral to an AMM, liquidity providers are rewarded handsomely by the company. Uniswap earned $612 million in fees between May 2022 and April 2023, all of which was paid out to the LPs.

It can pay to play in the pool. This is why turning on the fee switch could be problematic: LPs may simply go to competitor DEXs, where they can make more money.

Why Uniswap is Important for Investors

Uniswap is the most successful DEX based on the AMM model. Moreover, if it maintains high revenues and stability, it’s the proof of concept that a crypto exchange can work, without a centralized order book or market maker.

The entire concept of blockchain is based on decentralization: trusted transactions on a transparent yet highly secure network. Uniswap brings that vision to the crypto exchange market — like handling your money yourself.

Conversely, mainstream crypto exchanges use centralized architectures to provide a better user experience and more user safety — like trusting a broker or banker to handle your money for you.

While 2022 was a tough year for everyone in the crypto market, developments in 2023 have shown that there is still room for hope and optimism.

Trading volumes on Uniswap have increased dramatically and the DEX continues to pull in over $1.5 million in 7-day average fees. LPs are earning more on this DEX than other exchanges due to its generous fee structure.

But if Uniswap votes to implement platform fees, it could have some impact on investor confidence. At least a few LPs could opt to leave the protocol as the fee would directly be taken from their share of the revenues.

Investor Takeaway

Uniswap faces an uncertain future. Though it still has a huge user base, it is losing market share to competing DEXs that do not have the AMM model. Many LPs face an uphill battle to retain profits in AMMs due to “impermanent loss.”

There is also considerable opposition to the “fee switch” proposal, since changes in revenue generation could attract increased attention from US regulators, as Uniswap is located in the USA.

Still, Uniswap has a history of innovation, and delivering on significant protocol upgrades. (Uniswap ships.) It is also far easier for the average user to understand and use than tech-heavy sites like dYdX.

With the rise of knockoffs and non-AMM alternatives, Uniswap has its work cut out: it must continue to innovate, adding new features and improving its user experience, all areas where it has traditionally performed well.

Of course, much will also depend on the future trajectory of the crypto market. Overall, Uniswap remains our top pick for the long-term DEX winner, which is why we continue to hold UNI as part of our Future Winners Portfolio.

FAQs

Is Uniswap a good investment?

The Ethereum blockchain is the most popular and vibrant crypto ecosystem in the world. It is also likely to receive significant upgrades to efficiency, gas fees, and transaction times over the next several years, making it hard for other Layer 1 chains to overtake it.

As the pre-eminent decentralized exchange on Ethereum, with access to over 1,600 trading pairs, Uniswap still has a lot to offer investors interested in staking their assets in liquidity pools.

Our investment thesis is that buying and holding UNI is like a long-term investment in the Uniswap company. Despite the challenges listed above, we believe in Uniswap’s ability to execute, and currently have the token as a part of our Future Winners Portfolio.

How does Uniswap make money?

Uniswap makes money by charging a 0.3% fee for each trade on the platform. Currently all of this is paid out as a reward to liquidity providers in proportion to their token contributions. The company also earns revenue via its holdings of the governance token UNI, which can appreciate in value with changes in the crypto markets.

However, in the present scenario, nearly 50% of LPs on Uniswap are losing money due to impermanent loss [read our guide here]. In a highly volatile crypto environment, loss in the value of a token is not compensated by the fees of a transaction on the DEX.

This causes a loss in dollar value to investors on the platform. In the future, this may change with an improved algorithm. But as long as they fail to address impermanent loss, Uniswap will remain a sub-optimal investment option for liquidity providers.

Should you trade on Uniswap?

DEXs like Uniswap require some technical expertise: you must own a crypto wallet like Metamask, and understand how to navigate gas fees. In addition, the interface may not provide much hand-holding, unlike centralized exchanges. With those caveats, if you want to buy or sell any ERC-20 tokens, Uniswap is one of the best DEXs on the market.

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