What is the Uniswap protocol?
Traditional financial services and exchanges are centralized, meaning that an intermediary (for example, a bank) manages the exchange process and custodies the consumers’ assets on their behalf. In response to the risks and operational challenges posed by custodial exchanges, the crypto community invented decentralized, non-custodial exchanges. These exchanges don’t require you to relinquish access to your cryptocurrencies and are governed, in part and increasingly so, by their communities. Uniswap is one of the top DeFi protocols currently on the market, having grown significantly since its launch in November 2018 by founder Hayden Adams.
Uniswap is a so-called “automated market maker.“ Instead of an exchange composed of an orderbook on which traders buy and sell crypto (which is how most crypto exchanges operate), Uniswap lets you swap cryptocurrencies by leveraging its algorithmically-managed liquidity pools.
Uniswap’s algorithm automatically swaps tokens through these pools to get the best price. For instance, if you wanted to swap ETH for AAVE, Uniswap would reroute your token from ETH -> WBTC -> USDT -> AAVE. Notably, while this process is designed to be cost efficient, any exchange relying on ETH will run into high gas fees, or at least until Ethereum improves its mining process.
While Uniswap is non-custodial, meaning that it never takes control of your assets and does not request any personally identifying information about its users, the founding team and a small team of coders were, until recently, in control of the platform and dictating its development roadmap. But that changed in the autumn of 2020, when Uniswap launched its eponymous token, UNI, and created its own decentralized governance framework.
What is UNI?
UNI is a so-called “governance token,” meaning that those holding the tokens can use them to vote on proposals to upgrade the network. Part marketing drive, part loyalty reward, the Uniswap team decided to airdrop 15% of all UNI tokens to a little more than 50,000 addresses. That amounted to about $2,800 shortly after launch when its price peaked to $7 on September 19. Its price then dipped, but in January 2021 hit highs of $15. That meant that anyone who had received those 400 UNI tokens would have $6,200 in their pockets.
Uniswap’s team claimed 21.51% of the tokens, investors another 17.8% and a further 0.69% to advisors (with vesting periods.) The rest of UNI supply will go to Uniswap’s “governance treasury,” a community-run chest distributed according to the wishes of those holding UNI.
However, it’s very expensive to suggest a vote (you need 1% of the total UNI supply to submit a proposal, and most of the community needs to be on your side to pass the proposal.)
As of May 2021, UNI has a market cap of over $22 billion and around $1.2 billion of the token is traded on crypto exchanges each day, according to metrics site CoinMarketCap. That makes it the 11th largest token by market capitalization (but this ranking changes often as the DeFi sector matures.)
How is UNI different than Bitcoin?
UNI differs from Bitcoin in a few key ways.
First, Bitcoin is a “coin” and UNI is a “token.” That is because Bitcoin powers the Bitcoin blockchain, and it is mined by a decentralized network of computers that solve complicated maths puzzles to verify transactions. By contrast, UNI is a token that runs on the Ethereum blockchain. On Ethereum, ETH is the only coin that can be mined. And miners mine ETH to process UNI transactions. It is what is known as an ERC-20 token, the name applied to the generic token standard for the Ethereum blockchain.
Being an ERC-20 token has perks. Blockchains aren’t great at speaking to each other—you can’t get an Ethereum contract to work with a Bitcoin smart contract without some complicated engineering. However, it’s very easy for ERC-20 tokens to speak to one another, which means that UNI can be used in most other decentralized finance applications. You can take out loans of UNI on decentralized finance lending market AAVE for instance, or lend it out and earn interest of 0.03% a year. But you can’t do that with Bitcoin: To do that, you’d have to convert your Bitcoin into something like “Wrapped Bitcoin”—a synthetic representation of Bitcoin that is based on the Ethereum blockchain. And that’s… complicated!
Second, Bitcoin is far larger than Uniswap, and far older, too. While Bitcoin, the largest cryptocurrency by market capitalization, has a market cap of roughly $1 trillion, UNI has a market cap of over $22 billion (May 2021.) Put another way, while Bitcoin accounts for 62% of the global crypto market cap, UNI accounts for 0.4%. And while UNI was created in September 2020, and its purpose—governance—is very much in its infancy, Bitcoin has been around for over a decade.
Third, UNI’s value is secured by very different things than Bitcoin. Bitcoin is secured by its miners, who, as mentioned, solve complex equations to verify transactions. The UNI token is backed by Ethereum miners, who do much the same. But Uniswap’s protocol—the decentralized exchange bit—is entirely the Uniswap team’s own making. Its protocol is audited, but the types of bugs and vulnerabilities it could be exposed to are very different than those faced by the Bitcoin or Ethereum blockchain.
Vulnerabilities in DeFi protocols are exploited often, resulting in hundreds of millions of dollars worth of losses. Hackers have exploited vulnerabilities in other DeFi protocols to mint an infinite amount of new tokens or drain pools of investors cryptocurrencies, for instance. The point is not that UNI is necessarily at risk, but has different kinds of risks that users, and UNI investors, should be aware of.
Before trading any crypto assets it is important to understand the risks. This overview is a starting point for you to perform your own research prior to investing in a crypto asset. First and foremost:
No Canadian securities regulatory authority has expressed an opinion about Uniswap, including an opinion that UNI is not itself a security and/or derivative.
Wealthsimple has performed a legal assessment of Uniswap prior to making it available on Wealthsimple Crypto and has concluded that UNI is not and is unlikely to be deemed a security or derivative. However, there is a risk that this conclusion could change in the future and the impact of this on an asset’s value is outlined in our Product Disclosure.
We evaluated Uniswap based on publicly available information, including (but not limited to):
- The creation, governance, usage and design of Uniswap, including the source code, security and roadmap for growth in the developer community and, if applicable, the background of the developer(s) that first created Uniswap;
- The supply, demand, maturity, utility and liquidity of UNI;
- Material technical risks associated with Uniswap, including any code defects, security breaches and other threats concerning Uniswap and its supporting blockchain (such as the susceptibility to hacking and impact of forking), or the practices and protocols that apply to them; and
- Legal and regulatory risks associated with Uniswap, including any pending, potential, or prior civil, regulatory, criminal, or enforcement action relating to the issuance, distribution, or use of the UNI.
Like all other crypto assets, there are some general risks to investing in Uniswap. These include short history risk, volatility risk, liquidity risk, demand risk, forking risk, cryptography risk, regulatory risk, concentration risk, electronic trading risk and cyber security risk. Each of these risks are described in more detail in our in-app Product Disclosure. Specifically, we note that the UNI token was only released in the fall of 2020 and thus has a limited history. Further, the Uniswap community is not under any legal or regulatory obligation to disclose material information to the public regarding community activities. Holders of UNI have no recourse to the Uniswap community or Wealthsimple if the cryptocurrency declines in value for any reason.
We emphasize that this Crypto Asset Statement is not exhaustive of all risks associated with trading Uniswap. Investors should perform their own assessment to determine the appropriate level of risk for their personal circumstances.
WDA is offering Crypto Contracts in reliance on a prospectus exemption contained in the exemptive relief decision Re Wealthsimple Digital Assets Inc. dated June 18, 2021. Please be aware that the statutory rights of action for damages and the right of rescission in the securities legislation of each province and territory of Canada would not apply to a misrepresentation in this Statement.
Last updated: July 26, 2021