The Uniswap protocol does things differently to centralised exchanges. It is an open-source software has been built on the Ethereum blockchain, and allows users to trade cryptocurrencies without the need for a middleman. As well as helping to reduce fees.
Liquidity providers play a big part in making everything happen without the need for a market maker. Anyone can get involved in these liquidity pools as long as they contribute the equivalent value of two tokens, such as ETH and stablecoins such as USDC or BUSD. In exchange, they'll get liquidity pool tokens that can then be used on other decentralized apps. This also ensures that they can get their contribution back at any time.
Users pay transaction fees whenever they complete a swap, and a portion of this goes to the liquidity provider based on how many pool tokens they own. Uniswap pools rely on an equation that's known as X x Y = k.
Here, x may represent ETH, y may represent USDC and k reflects what happens when you multiply x and y to discover the pool's total liquidity. Constant product market makers, the smart contracts that hold liquidity pools, work on the basis that k must remain constant at all times.
Let's imagine that someone uses a liquidity pool to buy ETH in exchange for USDC. This transaction would ultimately mean there is now less ETH in the liquidity pool, and more USDC.
Someone who purchases ETH in exchange for USDC from a liquidity pool would ultimately affect the balance between the two assets in this trading pair, increasing the price of ETH, and decreasing the price of USDC. This slippage is generally less pronounced in larger liquidity pools.
The main advantages of Uniswap include that it is far less complicated to use than other decentralised exchanges, and it means buyers and sellers are no longer responsible for creating liquidity.
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