How Does Uniswap Make Money? Analyzing Its Business Model

Executive Summary:

Uniswap is a decentralized exchange that is powered by Ethereum and allows users to swap tokens using its ERC20 standard.

Uniswap makes money via protocol fees that can be optionally turned on by UNI governance. On top of that, it generates income through the issuance of its own UNI token.

Founded in 2017, Uniswap has grown to become one of the world’s leading cryptocurrency exchanges. It has raised $11 million throughout its existence.

How Uniswap Works

Uniswap is a decentralized exchange that is powered by Ethereum and allows users to swap tokens using its ERC20 standard.

To understand Uniswap, we first need to contrast it against centralized exchanges. For instance, if you intend to sell one bitcoin (BTC) on a centralized exchange like Binance, you need to find a buyer who is willing to pay the price you ask for.

The major issue with a centralized exchange like that is liquidity, namely the amount of buy and sell orders at any given time. If there is low liquidity, then traders will have a tough time executing their orders.

On top of that, some centralized exchanges also impose high fees in exchange for providing liquidity themselves (or simply for just facilitating orders).

Uniswap, by contrast, gets rid of the middleman concept through the use of an automated liquidity protocol dubbed the “Constant Product Market Maker Model.”

This protocol incentives marketplace participants to become liquidity providers themselves. They use their own money and create a fund that is used to facilitate the trades taking place on Uniswap.

Every token that is listed on the platform, therefore, has its own liquidity pool that participants can contribute to. The price of said token is determined using a constant equation x*y=k, in which k is a constant value (that doesn’t change) and x as well as y are the numbers of tokens in the pool.

Let’s assume Peter wants to trade Dogecoin (DOGE) for ether (ETH) using Uniswap’s DOGE/ETH pool. He then adds a large amount of DOGE to the pool which increases the ratio between DOGE and ETH. Since k must remain constant, it means that the cost of ETH goes up while the price of DOGE declines.

However, the size of the liquidity pool, as well as the proportionality of that trade, will ultimately determine how much the price of a given token will change. If your trade only makes up a small fraction of the pool’s size, then prices will likely remain unaffected.

In exchange for providing liquidity, marketplace participants will get a “pool token” that represents their staked contribution to the pool. For instance, if the participant provided $2,000 of the $10,000 a pool holds, then he or she would receive a token for 20 percent of that pool. This token can then be redeemed for a share of the trading fees that Uniswap charges.

Apart from its decentralized exchange, Uniswap has also introduced its very own token called UNI, which is used as a governance token. That means owners of the token can, for example, vote on new developments and changes to the platform. The more tokens a user owns, the greater his or her voting power.

Uniswap Company History

Uniswap, which is headquartered in New York City, United States, was founded in October 2017 by Hayden Adams.

Prior to launching Uniswap, Adams, who graduated from Stony Brook University in 2016 with a degree in Mechanical Engineering, was working as an engineer at Siemens.

Unfortunately, in July 2017, he was laid off from that job, which in retrospective proved to be the best thing that could’ve ever happened to him.

Saddened by the layoff, he got in contact with Karl Floersch, a friend of his who went to the same university. Karl, at the time, was working as a blockchain engineer at ConsenSys, which is known for building Ethereum-based products for companies like Microsoft, Procter & Gamble, Hitachi, and more.

Floersch was ultimately the person who introduced Adams to the world of Ethereum. Amazed by its potential, Adams began to code away. In October 2017, he released a first (barely) working prototype of what would end up becoming Uniswap.

During a talk at Devcon 3 (the Ethereum Foundation’s yearly developer conference), which took place in November, Floersch showcased a demo version of Uniswap, which raised the interest of attendees.

One of them, Pascal Van Hecke, reached out to Adams directly and even provided him with a grant that lasted about a month. At the time, Adams was living off of his crypto investments, which he was fortunate enough to purchase at the beginning of 2017, right before the rally that took place later that year.

Over the coming months, Adams, Floersch, and a high school friend named Uciel Vilchis continued to work on Uniswap. In March 2018, they released a fully-featured demo of Uniswap. Unfortunately, market downturns had destroyed Adams’ portfolio by more than 75 percent, which significantly altered his personal runway.

Despite his financial struggles, he booked a last-minute flight to Seoul, South Korea, to attend Deconomy 2018. Floersch, who had been hired by the Ethereum Foundation months prior, then introduced Adams to Vitalik Buterin, the founder of Ethereum.

Vitalik encouraged Adams to apply for an Ethereum foundation grant (worth $100,000), which he ultimately received in July. Ironically enough, it was also Vitalik who came up with the name for Uniswap. Adams initially named it Unipeg, a mixture between Unicorn and Pegasus to which Vitalik responded: “Unipeg? it sounds more like a Uniswap.”

On November 2nd, 2018, during Devcon 4, which took place in Prague, Adams finally released V1 of Uniswap to the public.  

Wayback Machine

By no means was Adams the first one to launch a decentralized exchange. Bancor, another competitor, had raised $153 million during the ICO craze in the summer of 2017. However, Uniswap offered a variety of advantages over Bancor right from the get-go.

Not only was its design much more user-friendly and intuitive but trading on the platform was just much cheaper. Lastly, unlike Bancor, Uniswap had not tokenized its platform, which provided it with a much more noble reputation. Bancor, on the other hand, had faced repeated criticism over its decision to tokenize.

By April 2019, roughly six months after launching, Uniswap had already $10 million locked in its liquidity pools. This earned Adams and his small team a first seed investment of about $1 million from investors such as crypto hedge fund Paradigm.

Throughout the remainder of 2019, Uniswap continued to grow at a steady clip. In May 2020, now with dozens of employees under contract, Uniswap was able to release its first-ever update by launching V2 of its exchange.

While Uniswap V1 continued to exist (as it cannot be shut down to not interfere with existing liquidity pools), its successor offered a better interface, mostly greater liquidity (although that ultimately was depending on the coin pairing), faster execution (thus lower spreads), as well as an onslaught of new features like direct token-to-token swaps or flash loans.

However, with increased relevance also came greater scrutiny. By July 2020, Uniswap was facing a growing problem with regard to so-called scam tokens. Scammers would essentially create copycat versions of existing and reputable coins and then cash out once a pool had enough liquidity.

Uniswap remained inactive as it stated that it didn’t want to act as the arbitrator of truth, a stance the platform would later reverse (but more on that in the coming paragraphs).  

Meanwhile, the release of V2 did exponentially increase the adoption rate of the platform. Over the summer of 2020, which later became known as “DeFi summer”, Uniswap’s trade volumes surged from $2 million a day to over $500 million. On August 30th, 2020, Uniswap even surpassed Coinbase in terms of daily trading volumes.

The platform’s astonishing growth was rewarded with another round of funding, which was announced a few weeks prior (early August). World-class backers like Andreessen Horowitz, SV Angel, and Union Square Ventures invested $11 million into Uniswap.

Interestingly enough, the platform’s success also brought in an onslaught of new competitors, which weren’t always playing by fair rules. In late August, a copycat DeFi exchange named SushiSwap went live and managed to attract over $1.3 billion in value within five days.

Not only did its founders essentially use the same code Uniswap does (since Uniswap is open-sourced, its code is freely available for anyone to use) but it created its own token (called SUSHI) which they used to offer extremely enticing yields.

On top of that, a few whales (participants with high amounts of disposable capital) created artificial liquidity by moving a significant number of coins from Uniswap to SushiSwap. However, soon after launching, SushiSwap had to adjust its unreasonable rewards, which prompted a lot of users to return to Uniswap.

Furthermore, interest in Uniswap was also boosted due to the launch of its governance token UNI in September. Four billion tokens were minted for the launch and would be made available over a four-year span. 60 percent of the tokens would be allocated to community members (the more liquidity a member provides, the more tokens he/she receives), 21.51 percent to team members and future employees, 17.80 percent to investors, and 0.069 percent to advisors.

Hackers and spammers also continued to take advantage of the platform’s relevance. In November, a copycat mobile application, named Uniswap DEX, was launched in Google’s Play Store. One of its users lost around $20,000 and many more were affected.

Despite these hiccups, Uniswap capped 2020 off by solidifying its leading position in the decentralized exchange space. On December 15th, the platform surpassed $50 billion in all-time trade volume.

And just two months later, in February 2021, Uniswap already doubled that figure by hitting $100 billion in cumulative trade volume. A problem that came with that growth was the overload that platforms like Uniswap and OpenSea were causing on the Ethereum blockchain. As a result, trading fees could get as high as $100 during overload periods.

Despite the overload, other exchanges continued to embrace their native UNI token. After Binance, Coinbase, and FTX added support for the token right after its launch, eToro followed in May.

Days later, on May 5th, Uniswap also introduced V3 of its platform. The update gave liquidity providers greater control over what price ranges their capital is allocated to, added multiple fee structures (allowing liquidity providers to earn varying fees depending on the level of risk they take on), as well as more efficient computation.

Within a few weeks, V3 managed to overtake the trading volumes of its predecessor. Not everyone was convinced, though. In mid-July, the Uniswap-funded DeFi Education Fund liquidated half of its donated funding, namely 500,000 UNI tokens, into stablecoins (USDC). While some called into question the transparency and motives of the fund, others were concerned about the attractiveness of its UNI token.

A few weeks later, Uniswap finally reversed its course on monitoring by delisting various tokens from its platform. The strategic shift was motivated by the firm’s desire to legitimize itself in the eyes of financial regulators. Coinbase, especially in comparison to Binance, which is banned in the US, had made a name for itself by building its platform in close communication with regulators.

Despite Uniswap’s adjustments, reports in early September stated that the United States Securities and Exchange Commission (SEC) allegedly began to investigate the platform with regards to its marketing and investor services. Uniswap, as a result, hired Hari Sevugan, former President Barack Obama’s senior spokesperson for the 2008 presidential campaign, as its Head of Public Relations.

How Does Uniswap Make Money?

Uniswap makes money via protocol fees which can be optionally turned on by UNI governance (and thus owners of the token).

The governance mechanism was added in V3 of the protocol, which was introduced back in May 2021. A previous, less sophisticated version, has already existed in V2 (since Uniswap had not launched its governance token when V2 was already released).

Whenever a liquidity pool is created, protocol fees are set to zero by default. Uniswap then receives a fraction of the fees, which on V3 are equal to either 0.05%, 0.30%, or 1%.

However, Uniswap, even if only a few pools have protocol fees turned on, will likely be able to sustain its operations for many years to come.

This is because more than 20 percent of the four billion UNI tokens issued will be assigned to employees of the company.

Consequently, the token will continue to increase in value as the trading volume un Uniswap continues to ascend.

Uniswap Funding, Investors & Valuation

Uniswap, according to Crunchbase, has raised a total of $11 million across four rounds of (venture capital) funding.

Notable investors include Andreessen Horowitz, Union Square Ventures, Paradigm, SV Angel, Version One Ventures, and many others.

Both valuation and revenue figures were not disclosed during any of the firm’s funding rounds.

Hi folks, Viktor checking in! Years of experience in various tech-related roles have led me to start this blog, which I hope provides you with as much enjoyment to read as I have writing the content.