In 2018, the decentralized exchange Uniswap was launched. Within 3 years, it has become one of the best platforms for direct token exchange. One of the main advantages of this exchange is that it allows you to earn passive income by providing liquidity to pools of various assets.
What is Uniswap?
Uniswap is a decentralized exchange (DEX) based on the Ethereum blockchain. The main objective of Uniswap is to provide a seamless exchange of ERC-20 tokens. It stands out from other decentralized exchanges by offering a simple functionality and a high level of reliability, as there is no centralized management.
Thanks to all its advantages, Uniswap became a leader among Ethereum platforms in terms of trading volume and number of users. The exchange is based on Uniswap's automated liquidity protocol. To perform transactions on the platform, you do not need to use order book analogs.
The third version of the protocol is operational. Thanks to the introduction of Uniswap v3, it is now possible to place ERC-20 tokens in pools with other assets that share the same standard.
Unlike centralized crypto exchanges, Uniswap offers users the ability to create trading pairs in the liquidity pool for any token they need. You can use the platform without getting verified. All you need is to create an Ethereum wallet.
Liquidity pools in Uniswap v3
When users buy or sell crypto assets on Uniswap, they do not interact with individual counterparties. The trading is done through a common liquidity pool. These pools are formed by liquidity providers.
The liquidity pool is an automated market maker (AMM) technology implemented on Uniswap. Thanks to this feature, the standard order book is replaced by a list of trading pairs that match the assets of buyers and sellers. Depending on the availability of a particular cryptocurrency, the price of the asset will fluctuate.
For example, a user can pay with UNI tokens on the Uniswap v3 platform to buy ETH. Thanks to the addition of new tokens to the liquidity pool, the supply of UNI has increased. At the same time, the supply in the ETH pool decreased because a certain amount of Ether was withdrawn by the buyer; as a result, the value of an asset increases with a lower supply. In this case, the price of ETH will increase relative to UNI.
Uniswap constantly maintains a directly proportional decrease or increase in the value of assets. As a result, the level of liquidity in trading pairs always remains the same.
The platform provides an opportunity to generate passive income. This refers to the concept of providing liquidity to pools. The most important thing here is the possession of ERC-20 tokens. Providers fund smart contracts with liquidity reserves (AMM). This measure is the key to maintaining the supply of assets in various pools.
It is easy to become a liquidity provider. All that is needed is to add funds to the pool equal to the cost of two tokens of the traded pair. For example ETH and UNI.
When you add your assets to the liquidity pool on the Uniswap v3 exchange, you can benefit from the commissions that the traders pay. Commissions are divided among all liquidity providers according to the size of their investments.
How to provide liquidity to the Uniswap v3 pool
First, you need to create an Ethereum wallet for cryptocurrencies. One popular option is MetaMask.
Next, you need to connect the wallet to the Uniswap exchange. To do this, you need to go to the platform website and click the "Connect wallet" button. It is located in the upper right corner of the main page and in the center at the bottom.
After clicking, a window with a small menu will open. In it, you can select other wallets if MetaMask is not suitable for some reason.
After connecting the wallet, the user will be able to see the balance and perform the necessary actions on the exchange. To work with liquidity pools, you need to click on the Pools tab on the Uniswap v3 website. The page that opens will display various trading pairs.
You can choose any option here. One of the popular pools for providing liquidity is ETH/USDT. This trading pair is located on line 4.
To choose a pool, click on it. The page with detailed information about the ETH/USDT pair will open.
To add liquidity, you need to click on the Add Liquidity button. After that, a form will open that is designed to transfer funds to the exchange.
The page will display the pool itself - WETH9/USDT and the level of commission that traders pay to liquidity providers. In this case, it is 0.3%.
That is, the WETH9/USDT pool provider will receive 0.3% of the traders' trade volume on the Uniswap v3 exchange. You can ignore the unusual designation in the pair - 1 WETH9 equals 1 ETH.
The next step is to select a price range within which liquidity will be provided. One suitable value is 4% of the current market value of the asset. But there are other options to choose from.
After completing these actions you will need to indicate the amount of liquidity that will be provided. It is important to remember that you will have to deposit the amount of the two assets that form the trading pair. Moreover, their ratio should be approximately 50/50.
If you miss the moment to calculate the value of two assets, you may get to the point where you have invested too much. It is not necessary to calculate the token ratio. It is enough to enter the value of one asset, and the system will automatically choose the appropriate volume for the other.
To complete the process of providing liquidity to the selected Uniswap v3 pool, you need to go to the MetaMask wallet and confirm the transaction there. After that, the funds will be transferred from the wallet to the exchange.
From that moment on, the user becomes the liquidity provider and starts receiving a commission for all transactions within the selected pool/s.