OpenFi: Uniswap
In this edition, I couldn’t be more excited to be partnering with Flipside Crypto to bring OpenFi to the next level. As a leading business intelligence firm for crypto projects, Flipside Crypto brings valuable data and analytics to answer OpenFi’s key questions.
Armed with data provided by Flipside, we dive deeper than ever before to assess Uniswap, one of the earliest and most popular decentralized exchanges (DEXs) in the form of an automated market maker (AMM).
Disclaimer: The following piece is simply a summary of my opinions and should not be construed as investment advice or regulatory analysis.
O: Opportunity - How large is the Total Addressable Market? Does the project disrupt an existing market, or does it create a new market?
Score: 4/5
Decentralized exchanges (DEXs) and automated market makers (AMMs) have disrupted centralized exchanges (CEXs). In the future, they can potentially disrupt trading in traditional financial markets. By removing intermediaries and allowing users to trade directly with each other, trading becomes cheaper and more efficient. Total 24-hour exchange volume across centralized crypto exchanges average more than $210B vs. just the $1B of 24H volume that Uniswap typically sees - there is huge potential market share to continue grabbing.
Uniswap and other AMMs can be seen as alternatives to centralized exchanges (CEXs). The whole category saw huge monthly trading volume gains over the last year. In September 2020, volume on DEXs surpassed 5% of volume on centralized exchanges. According to DappRadar, Uniswap is the largest DEX by trading volume with almost $1B daily trading volumes. Sushiswap is a distant second with $130M. In comparison, the top 50 centralized exchanges all had daily volumes of over $1B. However, these volumes can be skewed heavily by exchanges that offer higher amounts of margin to their users.
At the time of writing, Uniswap is #4 on DeFi Pulse with $3.3B TVL with Sushiswap at #6 with $2.8B.
P: Product - How innovative and differentiated is the product? Is there product-market fit? How easy is it to use the product (i.e. good user interface and experience)?
Score: 4.5/5
Uniswap is hugely innovative, even in its v0 form at launch. It is one of the first trading platforms to take away the traditional order book model of CEXs and all the middlemen and processes that come with being a market facilitator. With daily volumes surpassing some CEXs and growing much faster, there is clearly a need for DEXs in DeFi. Uniswap’s onboarding process is much quicker and easier. Users always have access to their tokens and hold their private keys while using the platform.
Since Uniswap was built on the Ethereum network, swaps are limited to assets native to Ethereum token standards. The interface is more advanced than most DeFi applications. Newcomers can get lost pretty quickly. Here’s a breakdown of all the platform has to offer:
Swap: Exchange any ETH-based token with any other for which there is a trading pair. A lot of times, the “base pairs” are common tokens like ETH (or WETH), WBTC, and stablecoins like USDC and USDT.
Pool: Contribute liquidity to existing pools by locking up tokens in pairs per each pool’s predefined value ratios. Liquidity Providers (LPs) receive a share of Uniswap’s 0.3% transaction fee based on their percentage share of the total pool.
Governance: UNI native platform token holders can vote on platform proposals.
Charts: Not really a product but a data analytics engine where users can track basic metrics for each token pair including liquidity and volume.
As with all AMMs, users will have to deal with slippage and impermanent loss. Different platforms try to minimize slippage in different ways but impermanent loss is a fundamental limitation of AMM design in its current form.
Most users interact with the platform as swappers. To trade tokens, the experience is fairly straightforward. However, there are a few things to note. Any user on Uniswap can create a liquidity pool with a scam ERC-20 token, which can have the same ticker as an existing legitimate project. This confuses users and exploits their trust in the platform.
In addition to high Ethereum network fees, swappers on Uniswap are also subject to transaction fees of 0.3% per swap. This is high compared to other, more specialized AMMs, like Curve. Uniswap faces competition from competing AMMs, such as Sushiswap and Balancer, which are innovating at a quick pace and offering users more features.
There’s been a good amount of buzz regarding Uniswap V3. Although no official information has been released yet, many have speculated that V3 will utilize layer-2 rollup solutions. Each AMM project is innovating in a completely different direction and I’m keen to see what users end up adopting.
E: Experience - Does the team have any previous experience building software and technology? Is the team well-versed in blockchain? What previous experience does the team have to ensure success?
Score: 4/5
Hayden Adams is the founder of Uniswap and recently named the most influential person in crypto for 2020. This pretty much says it all. While he is young and didn’t have any coding or traditional finance experience before creating Uniswap, he has built one of the most well-known brands in DeFi. He bootstrapped the platform after being laid off from his mechanical engineering job and learning about Ethereum from a friend. In a November 2019 blog post, Hayden provides more detail around the early days. It’s worth a read.
Apart from Hayden, Uniswap seems to have anywhere from 10 to 20 other team members. For the most part, the team is decentralized and detailed bios are hard to come by. Regardless, what they’ve accomplished so far has been impressive. I’m looking forward to what the team has in store for the near future.
For Uniswap, fundraising has never been an issue. The project raised $11 million in a Series A round in June 2020, led by Andreessen Horowitz along with Union Square Ventures, Version One, Parafi Capital, Variant, SV Angel and A. Capital. Paradigm, which participated in Uniswap’s $18 million 2019 seed round, also invested in the latest round.
N: Network Effects - Will more people in the network benefit when others join? Are there high switching costs and stickiness in using the platform?
Score: 3.5/5
By nature, DEXs have close to zero switching costs. Swappers are free to use whichever platform offers the lowest prices for tokens and lowest fees for trades. Liquidity pools, on the other hand, have more natural network efforts because users have to lock up their tokens to earn transaction fee income.
That being said, similar products or even clones can be spun up relatively quickly because the code is open source. We saw Sushiswap drain almost $1B in liquidity from Uniswap when it offered a platform with yield farming rewards and other features. Looking at the following chart showing total TVL, this drop is very apparent in mid-September. Unfortunately for Sushiswap, the UNI incentives program launched soon after, which led to Uniswap regaining more than the TVL they lost (more on this in the incentives section below).
Sushiswap’s incentive program drained nearly $1B of liquidity from Uniswap in September 2020 but Uniswap has reclaimed more than that after launching its own incentives program.
Being a first mover and the largest player in the DEX space, Uniswap has a community with over 175k followers on Twitter. When combined with over 100 applications using Uniswap’s functionality, the line between the platform and other DeFi applications on Ethereum gets very blurry. Uniswap’s brand also has value. Its liquidity pools are trusted and independently audited. These together create stickiness in a platform that inherently has none.
F: Fundamentals: Do the underlying unit economics make sense within the current network? How quickly are users growing? How much value has been transacted or locked up?
Score: 5/5
What is most interesting about Uniswap is how well it has been able to continually grow users (both LPs and swappers) and activity (trades). But because Uniswap uses smart contracts to execute trades, it does not need to spend large amounts of capital to host servers or hire operational personnel like traditional exchanges. Instead, those fees can be shared with its users: the liquidity providers.
Uniswap charges 0.3% fees on all transactions. This fee is currently distributed straight to LPs only. There is an option via community vote to divert 0.05% of the fee to fund the platform’s development costs but that is currently not enabled.
While this fee structure is applied to all liquidity pools, most of the platform’s liquidity is concentrated in the top 10 or so pools. As such, most of the fees are generated by the largest pools.
Each bar above represents one pool. We can see that most of the liquidity on Uniswap is concentrated in the top 10 pools or so.
On Uniswap, there are two major parties: liquidity providers (LPs) and swappers. We saw a dramatic increase in swap volume in the top 95% of pools after Uniswap’s incentive program launched in September 2020. Once volume normalized after the program ended, we’ve seen a recent uptick in volume again in 2021.
Total swap volume across the top 95% of pools has continued to grow after volume normalized once the UNI incentives program ended.
As DeFi development on Ethereum ramps over the next few months, we should expect to see activity on Uniswap increase even more.
I: Incentives - Are there proper cryptoeconomic incentives in place for network stakeholders and users to support blitzscaling?
Score: 4/5
While there aren’t staking rewards, Uniswap offers incentives in other ways. For traders, there are arbitrage opportunities to profit on imbalances across pools. For liquidity providers, there are non-regular UNI liquidity mining opportunities to receive more UNI.
It’s worthwhile to take a closer look at the first and only time Uniswap offered these liquidity mining incentives. Between September 18th and November 17th of 2020, Uniswap allocated 20 million UNI tokens for additional LP rewards for WBTC/ETH, USDC/ETH, USDT/ETH, and DAI/ETH pools. So how did this program do?
While many will refer to just TVL, we took a closer look. The next chart shows the number of liquidity provider addresses for the top 6 pools. As expected, the number of LP addresses increased more than 200% at the start of the program. What’s surprising is that the number of newly acquired LPs never seemed to go down, even after the rewards ended. In fact, the number of individual LPs has climbed higher and higher since the promotion period ended.
The number of active LP addresses in the top 6 pools exploded after UNI incentives were introduced. These new LPs stayed even after the incentives ended.
We also saw knock-on effects when looking at swapper addresses in the same top 6 pools. The availability of the UNI token in trading pools spurred a large spike in swap activity. While levels normalized very quickly, Uniswap gained 30-50% more swap addresses than it started with.
The availability of UNI pools helped Uniswap grow active swap addresses by 30-50% after its liquidity mining rewards program began.
This is further confirmed when we take a deeper look at average swap volume (in USD) per LP. Over the last four months, we’ve seen a broad trend of higher swap volume per active LP address.
Average swap volume (in USD) per LP address has increased over the last four months.
Overall, with this incentive program, I’d say Uniswap accomplished what it set out to do: grow users and trading activity.
Total Score: 25/30
Uniswap set out to create a decentralized AMM for swapping Ethereum-based assets. To date, it has succeeded with flying colors. While we are used to using TVL as the defining metric for DeFi applications, the data from Flipside sheds more light into the inner workings of the Uniswap platform. I look forward to sharing more detailed analysis like this moving forward. Let me know what you guys think in the comments below or feel free to shoot me a message. I’m always looking for ways to improve our assessment and look forward to hearing your feedback!