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DeFi: Can Uniswap continue to dominate the market?

DeFi: Can Uniswap continue to dominate the market?

‍The decentralised exchange platform (DEX) has been crushing the competition for a few years, but its lack of a business model could gradually cause it to lose ground. Some players like Curve could benefit from this.

Uniswap, what is it?

Uniswap was launched in 2018 by American engineer Hayden Adams. Its function is simple: to enable the exchange of digital assets in a decentralised manner without the intervention of a third party, in other words not like a traditional stock exchange.

On Nasdaq, it is the eponymous company that ensures the proper execution of exchanges. On Uniswap, it's the technology itself that does it 💡.

Uniswap's major innovation is based on its model dubbed the Automated Market Maker (AMM). Instead of using traditional order books, Uniswap allows users themselves to provide liquidity to trading pools by adding funds to smart contracts (which automatically execute a trade when a pre-specified condition is met).

These liquidity pools are made up of asset pairs, for example, ether (ETH) and another token ERC-20 (the token of a project developed on Ethereum). In exchange for their contribution, liquidity providers receive the fees paid by traders.

What is Uniswap's market share?

Uniswap has seen rapid adoption and exponential growth since its launch 🚀.

Its MA model has been praised for its simplicity and accessibility, allowing anyone to become a liquidity provider and participate in decentralised exchanges.

Of all DEX available on Ethereum, its market share has reached 88%, ahead of Curve (11%) and Sushiswap (1%).

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Part of Uniswap's success is its relatively low fees compared to the competition: most other projects charge extra commission to fund a community cash fund 💰.

Over the last seven days, its trading volume has been close to $10 billion, according to Dune Analytics (all blockchain protocols combined this time).

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It is not uncommon for its market share to exceed that of Coinbase (the world's second largest centralised exchange platform) on certain pairs.

If we take total weekly trading volumes, Uniswap sometimes matches (which is considerable) the biggest.

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"Centralised platforms are simpler to use, cheaper and often offer more liquidity, but not all tokens are listed at Binance, Coinbase or their competitors," points out Stanislas Barthélémi, crypto expert at KPMG.

"The great advantage of Uniswap is that anyone can create a liquidity pool to enable the exchange of a token," he insists.

The other great strength of the application is its "non-custodial" aspect, meaning that nobody has control over your funds, unlike the centralised players to whom you hand over the management of your cryptos. "Many centralised intermediaries have been heavily heckled or even have disappeared by 2022 (FTX, editor's note). By using Uniswap, you protect yourself from an unexpected closure", insists Stanislas Barthélémi.

Since Uniswap requires you to manage your wallet yourself, the protocol is reserved for a more restricted audience than centralised players. "Despite its easy-to-use interface, Uniswap's biggest users are not individuals," explains Mounir Benchemled, co-founder of DEX aggregator Paraswap. "It's mostly centralised Exchanges or aggregators like us," he insists.

How has Uniswap evolved since 2018?

In May 2020, Uniswap launched its "version 2", introducing new features such as the ability to exchange ERC-20 tokens directly with each other, without needing ETH as an intermediary.

In 2021, Uniswap launched "version 3", bringing further improvements to capital efficiency and the customisation of liquidity pools.

"This update was very important, because before it, liquidity could be used on all possible prices of a token and this severely limited capital efficiency," notes Stanislas Barthélémi. "Now we can set a price range in advance, which makes the model much more efficient," he stresses.

The case of version 3 shows just how far Uniswap is at the forefront of innovation. A few days after the expiry of the licence that prohibited (for 2 years) anyone from exploiting the version 3 code, several competitors (Sushiswap and PancakeSwap) immediately picked it up and adapted it to their solutions.

"On the DEX side, Uniswap is definitely the undisputed leader in innovation and communication", agrees Mounir Benchemled.

It's not all rosy, however, as the players who provide liquidity are regularly exposed to capital losses when they wish to withdraw their funds from the liquidity pools (this is known as "Impermanent Loss").

A problem pointed out by Cyrille Pastour, co-founder of the Swaap protocol, which offers a system that eliminates this drawback:

"Numerous studies have shown that depositing liquidity on Uniswap passively on uncorrelated asset pairs implies negative returns on average, with very high variability. Put another way, depositing liquidity on Uniswap is closer to a gamble than to an investment strategy. This is due to the mathematical models used by Uniswap as well as the lack of use of oracles that cause the dreaded Impermanent Loss phenomenon."

What is Uniswap's business model?

Unlike many decentralised finance protocols... there are virtually none 😅.

When you use Uniswap to exchange tokens, the transaction fees you pay are returned in full to the liquidity providers.

👉 No remuneration is provided to feed the reserve of the DAO (decentralised autonomous organisation) at the head of Uniswap, unlike what is practised on decentralised lending applications such as Aave or Compound.

In the short term, Uniswap's low cost of use is a real advantage, but it still has the disadvantage of limiting, in the long term, its revenues and therefore its means of development.

"Uniswap has impressive volumes, but has never earned a single cent," notes Marc Zeller, a specialist in decentralised finance and head of Aave Chan Initiative, a delegation platform within the governance of the Aave decentralised lending protocol. "Yet it's essential to earn money, because the revenue earned by a DAO helps to fund the protocol and also the service providers", he notes.

There is no perfect solution: if Uniswap decides one day to allocate part of the fees to its reserve, this will reduce the share reserved for liquidity providers. The latter will then be encouraged to go elsewhere and the protocol will mechanically lose market share.

What is the UNI token used for?

The UNI token is the utility token for the Uniswap protocol. It was launched in September 2020 as part of a community distribution (airdrop).

Everyone who had used Uniswap at least once in the past was eligible. The airdrop corresponded to 400 UNI, which at the time was around 1300 euros Today, it would be around 2000 euros.

This token offers a right of governance. Its holders can propose improvements to Uniswap, vote on other people's proposals, and overall take part in decision-making about developments to the protocol. Each UNI token holder has one vote to express his or her preferences.

Over time, one billion UNI tokens will be in circulation. Here is the vesting timetable, i.e. when the tokens will be released:

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How is it governed?

Uniswap differs from many other protocols in that its governance is "on chain". Each vote involves a transaction on the blockchain and, when a decision wins, it is automatically implemented in the code.

This system is rare enough to be highlighted, because for many protocols, it is necessary for managers to take responsibility for applying the result of votes "by hand".

Who controls Uniswap?

This is the big problem with the project: its governance is concentrated in a few hands, notably American venture capital funds, including Andreessen Horowitz (a16z) and Paradigm. It's worth noting that, without their backing, nothing moves! 👀

With the fear of tough US regulation on cryptos, these players are being pushed into a wait-and-see attitude and many strategic decisions cannot be implemented.

"Many would like to add transaction fees to remunerate the protocol, but no proposal is able to get through," bellows Marc Zeller. "Uniswap is clearly under American influence and the members of its governance are more akin to shareholders in companies quoted on the stock exchange", he insists.

According to the American legal system, a decentralised autonomous organisation (DAO) is legally akin to an association. Etched in the marble of the law, this premise would have profound implications for its members 😅.

"If a governance vote resulted in Uniswap being reclassified as an issuer of illegal financial securities (as could potentially be the case if fees were levied to fund a reserve), voters could be exposed to US sanctions," says Mounir Benchemled.

Hence the reluctance of funds to move on governance votes; this situation affects many other crypto projects.

"This situation clearly shows that Uniswap is still far from being a truly decentralised DAO. Even though the UNI token has been distributed, there are few proposals for improvements and it can be considered one of the least active DAOs in the ecosystem", Marc Zeller points out.

Who are Uniswap's big challengers?

In the absence of economic fundamentals, with sustainable revenues, Uniswap is going to have to move. And in the meantime, other projects, whose governance is less subject to US regulatory fears, will be able to continue to innovate and try to take market share.

"In terms of traction and innovation, Curve has been a serious contender since the arrival of its version 2, which allows tokens other than stablecoins to be exchanged," notes Mounir Benchemled. In March, Curve recorded daily volumes of $10 billion over a few days.

"It's a much more complex protocol than Uniswap, but it allows you to do a lot of additional things", he insists.

Balancer or Maverick are also looking like challengers.

"Uniswap's monopoly should erode over time and that's a good thing", argues Mounir Benchemled. "For the moment, they are crushing volumes because they were the first to launch in the DEX sector, but if tomorrow a player has a superior value proposition, users will have no trouble migrating", he stresses. "In any case, having a single dominant player is not healthy."

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