How does Uniswap work?

The Uniswap protocol enables crypto trades without the reliance on a centralized intermediary. The protocol achieves this through decentralization, liquidity pools, and automated market maker.

 

Decentralized

The Uniswap protocol is an open source peer-to-peer decentralized exchange.

Immutable, persistent, non-upgradable smart contracts on the Ethereum blockchain define the Uniswap protocol. This makes the protocol censorship resistant, secure, and self-custodial. The protocol’s services are open for public use. No one has the ability to restrict who can or cannot use them. The result is anyone can swap tokens, list a token, or provide liquidity in a pool to earn fees.

 

Liquidity pools

Liquidity pools are token pairs stored in a Uniswap pool contract. They allow users to swap against the tokens within a pool.

These pools rely on users for funding. Users create market liquidity by providing token pairs to a pool. To incentivize pooling liquidity, there is compensation for liquidity providers. The incentivization of providing liquidity is different in V2 and V3.

 

Automated Market Maker

This smart contract manages liquidity pools. It allows for automated and permissionless token swaps. It is also known as an AMM or a Constant Function Market Maker.

The AMM analyzes a token pairs’ supply and demand within a liquidity pool. This is how the AMM determines the real time value of a token, and provides efficient token prices for each swap. This system replaces the traditional order book used by centralized exchanges. Instead, users interact with the liquidity pool using the AMM.

These are high-level overviews of how Uniswap works. If you would like more detailed information, please visit the Uniswap Docs.

 

 

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