UniSwap v3: The Complete Guide

Uniswap v3 ranks among the top decentralized exchange (DEX) platforms— if not the best— on Ethereum. In just four years, it has achieved a trading volume above one trillion, $5B to $10B of total-value-locked (TVL), and 100K+ monthly users. All while offering the lowest possible fees for ERC-20 tokens.

This protocol is no longer a secret. By the time the new tokens appear in your centralized exchange, several early investors have bought them on UniSwap v3. As a decentralized exchange, it’s the fastest (and oftentimes cheapest) way to buy crypto.

By now, you might have heard of dozens of swap platforms. The first DEXs date back to 2013. So what makes UniSwap v3 so successful? And does that mean you should trade on DEXs instead of centralized exchanges?

Centralized versus Decentralized Exchanges

 In case these terms are new to you:                                                                                                                      

• Centralized exchanges (CEXs) are traditional trading platforms. You register an account (with KYC verification) on a regulated company, which will let you use their services/software for a fee. It’s one central authority in control of the pricing, services available, and your account.

*Not to confuse centralized with fiat-only exchanges. Most crypto-fiat exchanges founded before the invention of DeFi are centralized (~2018).                                                         

• Decentralized exchanges (DEXs) are decentralized applications (dApps) built as token peer-to-peer marketplaces. They’re 100% autonomous and trustless. This means anyone with a crypto wallet can trade safely without counterparties. 

DEXs are backed by decentralized, public blockchains that support smart contracts (like Ethereum or Pulsechain).

Difference Between Centralized and Decentralized Exchanges

Decentralized exchanges became so popular in the 2020 DeFi summer. Traders often ditch centralized platforms after trying DEXs like Uniswap. Even those with traditional preferences will likely use DEXs.

Here is why:                                                                                                                                                                                 

• Token variety: DEXs allow you to trade ANY token listed on explorers like CoinMarketCap or Etherscan. You can also trade unlisted tokens (like HEX) if you find the contracts on the official website, although it’s not always recommended. In regulated exchanges, you can only trade the coins approved by the company (which they could unlist later anyway). You’d be trading up to 500 (mostly old) coins. Thus missing out on new projects like PulseChain (PLS).

• Wallet custody: If you trade on regulated platforms for long enough, at some point you’ll get your account suspended. They’ll claim it’s for security reasons when instead it’s just the company protecting its business model. It’s no surprise withdrawals are “unavailable” during all-time highs, for example. By comparison, a DEX cannot manipulate how you use your wallet funds (other than network congestion). You always control your funds and account access.

• Governance: Centralized exchanges are autocratic and don’t prioritize communities’ interests. Unless their goal is gaining users, they’ll do everything to profit while offering a minimum viable offer. That doesn’t mean rates and services are mediocre, but you won’t be getting the best offer possible. DEXs are community-owned (also known as DAOs). People do what’s best for them (by consequence, you). You can also vote on how much your platform should charge and how to distribute revenue.
• Entry barrier: If you have a WEB3 wallet like Metamask (and funds), that’s all you need to use DEXs. You can use the same balance to interact with 100s of DeFi apps. On regulated platforms, there are geographical and legal entry barriers. It’s possible to trade without KYC, but your account will have low limits and unreasonable fees. Once they approve your identity and bank statement, you will unlock the “beginner-level account”. To access the best rates, as with banks, you need to stake or hold MILLIONS of crypto on their platform.

Even then, they can restrict accounts anytime.

If you’re thinking of trying DEXs, there are two warnings you should know:

• Liquidity: On DEXs, liquidity pools are essentials to facilitate trading. If you try trading micro-cap altcoins, the liquidity might be so low that you’re overpaying +20% in fees, spreads, or slippage. Make sure you double-check prices as DEXs have less liquidity than traditional exchanges.
• Risk Type: On conventional exchanges, the biggest risk is that the company disrupts your service. DEXs introduce different risks, such as impermanent loss, liquidity risk, network congestion, fake contracts, and smart contract exploits.

Let’s see what UniSwap v3 did right.

How Does UniSwap v3 Work?

Uniswap is a network protocol designed to automate transactions on Ethereum. While it seems all DEXs do that, not all automations are the same. Uniswap is special because of the “Constant Product Market Maker Model (CPMMM).” This variant ensures Uniswap always has liquidity, even for the largest orders and the tiniest liquidity pools.

Vitalik Buterin (ETH founder) came up with the name by combining Unicorn and Swap. Swap platforms are non-custodial exchanges and almost synonymous with DEXs. In finance, the unicorn represents the rarity of a billion-dollar start-up. Similarly, you can find the most exclusive tokens on Uniswap.

The Uniswap ecosystem is broader than it seems:                                                                                   

• There’s the Uniswap Protocol, which includes all smart contracts that form the CPMMM (explained later).
• The website interface, including uniswap.org and uniswap.org/#/swap
• The Uniswap Governance, where users can use UNI tokens to vote and suggest governance decisions
• Uniswap Labs, the company that developed the website and original Uniswap v1
• The 300+ Uniswap dApp integrations
• The 260 Uniswap forks. Notably, PancakeSwap (BNB), Sushiswap (ETH), QuickSwap (MATIC), and TraderJoe (AVAX)
• Uniswap Oracles to reliably record historical prices and liquidity data

If you just want to trade, the website and protocol are enough. But before showing the swap process, there are a few basics to cover:

What are Automated Market Makers (AMMs)?

Unlike traditional platforms, DEXs are fragile financial ecosystems. These need a near-perfect balance between liquidity providers and traders to prevent the inherent risks of DeFi. To automatically regulate both, DEXs use AMMs, an alternative to order books.

The largest centralized exchanges receive tens of orders every second. The order book records all of them by amount, price, and type. The exchange will partially or completely fulfill matching orders (e.g., Buy 30 PLS from someone selling 30 PLS at that same price).

With market orders, you get instant exchanges on almost any coin because there are hundreds of orders waiting. But unless it’s Uniswap, most DEXs don’t have that liquidity.

The AMM ensures traders can always fulfill their orders within seconds, anytime, even when there are no buyers or sellers. These smart contracts follow an algorithm (in Uniswap it’s x*y=k) to regulate token prices on liquidity pools. These “pools” are funded by users in exchange for fees, and AMMs use these to automate orders.

According to the CPMMM, prices and token amounts must equal the same product (k) as originally set:

• Suppose a liquidity pool has (x) 10K ETH and (y) 10K PLS, and both cost $1. That means X*Y equals 100K, and the relation is 50/50.
• If users decide to over-buy PLS, the AMM will adjust its price relative to ETH. If there are only 5K PLS left, there will be 20K ETH to equal 100,000 (the constant).
• AMMs try to maintain the token relation (50/50). If there first was $10K worth of Ethereum, whatever amount is left in PLS should be $10K too. $10K divided by 5K PLS makes $2 per Pulse.
• Inversely, 20K ETH tokens are now worth $0.50 each.

Meanwhile, the real market price is still $1 for each. In other liquidity pools, it might be $0.25 and $4, or $0.9 and $1.1. These differences can put liquidity providers at risk of impermanent loss.

Impermanent loss refers to the price ratio change of your liquidity pool tokens. During sharp price movements, holding tokens would be more profitable than providing liquidity. If prices revert and you withdraw at the same deposit price ratio, losses won’t be realized.

Instead, you could also buy the underpriced token and sell it somewhere for more. Or buy tokens from an exchange and sell them higher to the pool. Which is essentially an arbitrage business.

What is Arbitrage?

If you’ve used DEXs, you might have never noticed major price differences. That’s because there are arbitrage bots balancing the pools every minute. By balancing the pool, liquidity providers prevent losses, traders get accurate prices, and they make profits.

By definition, arbitraging involves finding markets with price differences. Arbitrage users aren’t value investors nor day traders. They buy and sell exclusively for price variations, which they find with trading bots, databases, and DEX aggregators.

Traders swap these repeatedly until the AMM increases their price.

Arbitrage is a common business model outside crypto too. You can flip retail products, real estate, domains, cars, and collectibles. In DeFi, arbitrage traders look for small liquidity pools, volatile tokens, and low-fee DEXs like Uniswap.

How to Use UniSwap v3: Step By Step

Suppose you want to swap ETH for HEX on UniSwap v3. Let’s see what happens from the user and developers’ perspectives. Once you’re on the website:                                                       

1. Click on Enter App and then Connect Wallet
2. If you don’t have a Web3 wallet, you can visit Metamask.io to get one. Once you do, UniSwap will request permission. Before you click Confirm, make sure you’re on the real UniSwap domain.
3. If your wallet has no funds on the ETH chain, you could bridge from other networks. Otherwise, you can buy crypto from regulated exchanges and send it to your wallet address. It’s recommended to have $50 – $100 for Ethereum fees.
4. From the app, select the tokens you want to swap. If you can’t find it, search it on CoinMarketCap and copy the ERC-20 contract address (next to the price stats). Paste it on Uniswap.
5. Once selected, rates will update every few seconds. Select the amount to trade and confirm. If you never swapped a token before, you’ll find a small, one-time approval fee on your WEB3 wallet. Confirm to enable the swap.
6. Click Swap on Uniswap to preview the order on your wallet. You can leave network fee fields as default. Click next and confirm.
7. In a few seconds, you should see the new tokens in your wallet. Sometimes the transaction will fail because of low liquidity, low slippage, network congestion, or insufficient funds to cover fees. Identify the problem and try again to complete it.

Remember to add each token contract to your wallet or you won’t see any balances.

While you wait a few seconds to complete the transaction:

• Smart contracts register your transaction on the Ethereum blockchain
• The exchange swaps your tokens for a fee
• Liquidity providers receive proportional revenue from your fee
• The AMM updates prices based on the new token ratio
• Arbitrage traders take advantage of these changes and rebalance the pool
• ETH nodes validate the transaction block in 12s-14s and complete your operation

Most forks follow similar steps. But what Uniswap version should you use?

UniSwap vs Pancakeswap vs Sushiswap

When it comes to volume and TVL, these three exchanges rank among the top 10 highest. Both Pancakeswap and Sushiswap are Uniswap forks, and so are most ERC-20 DEXs. That’s why we’ll start comparing it first.

Uniswap: Best ETH DEX Overall                                                                                                                                             

Uniswap has a $5.2B TVL, a $4B market cap, and a 0.76 Mcap/TVL ratio. The highest stats recorded were $22.5B in market cap and $44.97 per UNI token in 2021. This 2022 they’re 4-8x lower because of bear market cycles, but Uniswap continues leading DeFi exchanges.

Here’s an overview of UniSwap’s evolution:                                                                                                          

• The initial concept, UniSwap v1, introduced ETH-ERC-20 swaps and LP tokens in 2018. That means traders can only swap ERC-20 tokens (Ethereum-built projects) by swapping to ETH first. Not the best way to save on fees, but it was groundbreaking at the time. LP tokens are extra rewards along with fee revenue given to liquidity providers.

For example, providing USDC-ETH liquidity would give you UniSwap USDC-ETH LP tokens. These are proof that you own a share of the pool assets. LP tokens allow you to withdraw without anyone’s intervention, and they use up when you do. Alternatively, you can use these for yield farming.                                                                                      

• UniSwap v2 launched in 2020, allowing users to swap ERC-20 tokens directly. As long as you had enough ETH for fees, you could use ERC-20-ERC-20 swaps and pools. The following year, TVL rocketed from $65M to $9.1B.
• In 2021, UniSwap v3 made v2 (literally) thousands of times more capital-efficient. The improvements introduced include liquidity concentration, active liquidity, flexible fees, advanced oracles, and multi-range pool positions. Essentially, liquidity providers can now earn the same fee revenue with eight times less money (and 8x risk reduction).

When reinvesting all capital saved, the new UniSwap pools would have eight times more liquidity for high-volume prices. For example, a $1 token might have most funds allocated between $0.95 and $1. There’s minimal liquidity outside this range, but this concentration prevents prices from deviating in the first place.

That’s how UniSwap became the most efficient DEX and cheaper than SushiSwap.

Sushiswap: Best Multi-chain DEX                      

SushiSwap launched as a fork of UniSwap in 2020 (before UNI tokens were launched). The goal: a more decentralized UniSwap that rewards the community, not just the largest LPs. Before UniSwap v3, it might have been the best DEX to date.

In SushiSwap, liquidity providers get revenue of 0.25% fees instead of 0.3%. But the other 0.05% goes to SUSHI holders instead. As token prices rose above $10, yield-farmers rushed from UniSwap to SushiSwap (essentially stealing +$1B of liquidity).

When v3 launched, UniSwap flipped the tables. Today, SushiSwap remains relevant because it’s feature-rich. It offers several DeFi services besides the DEX, supports 14+ networks, and is cheaper in some cases:

• UniSwap v3 charges 0.05% to 1% depending on the project. On SushiSwap, you can get the same new token for a fixed 0.3%.
• You can trade many non-Ethereum tokens without having to go to other DEXs like PancakeSwap
• It’s sometimes more responsive than UniSwap due to its trading volume

However, SushiSwap doesn’t inherit v3’s capital efficiencies. Which makes it the most expensive of the three.

PancakeSwap: Best BNB Chain DEX

New traders are likely to choose PancakeSwap because the BNB chain is more cost-efficient. Even though we see ETH fees falling rapidly below $10, $0.20 on BNB is too much difference. If the same project has contracts on both chains, most trading volume will go to PancakeSwap (native CAKE token).

This DEX launched in 2020 in the Binance Smart Chain (now BNB Chain). Ironically, it’s a UniSwap fork that doesn’t trade ERC-20 tokens. You’ll need an ETH-BNB bridge to convert them to BEP-20, and many new tokens aren’t BNB compatible.

On the flip side, you can trade any token with BNB contracts 4x faster and 10x lower fees. PancakeSwap charges a 0.25% fee, 0.17% of which goes for liquidity-providing smart contracts.

All three DEXs have similar interfaces and rates. The biggest difference is token availability:

• UniSwap has the most liquidity for all ERC-20 tokens
• SushiSwap trades tokens among a dozen networks (including ERC-20s) with lower liquidity
• PancakeSwap has the best rates for BEP-20 tokens or ERC-20 projects with BNB-chain contracts

What is PulseX (PLSX)?

Since most projects are ERC-20, the ideal DEX should be Ethereum-based with the efficiency of the BNB Chain. PulseChain (PLS) is the Ethereum fork that increases speed four times and reduces fees while increasing network rewards. PulseX aims to become the Uniswap of PulseChain, as it also trades ERC-20 tokens in PRC-20 format.

The PulseChain hard fork will happen soon. If you hold any tokens on Ethereum before the launch, you could get free copies to swap on PulseX (ETH -> PLS, LINK -> PLINK, and so on). Learn more about PulseX here.