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HBS Professor Marco Di Maggio and independent researcher Wenyao Sha prepared this case. It was reviewed and approved before publication by a company designate. Funding for the development of this case was provided by Harvard Business School and not by the company. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2024 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

M A R C O D I M A G G I O

W E N Y A O S H A

Uniswap: Decentralized Crypto Trading

“One of the defining aspects of Uniswap from the very beginning was that anyone can list any asset permissionlessly and provide liquidity for it.”

— Hayden Adams, Inventor of Uniswap Protocol and Founder/CEO of Uniswap Labs

It was an early morning in August 2023 and Uniswap Labs chief operating officer Mary-Catherine “MC” Lader was on her way to company headquarters in Manhattan’s SoHo neighborhood. Uniswap Labs was a four-year-old, 90-person venture-capital backed company that helped create the Uniswap protocol, the most used decentralized exchange (DEX) protocol for crypto assets (see Exhibit 1 for Uniswap’s market share). The company was now plotting a future of building products on top of the open-source protocol to bring more people into the crypto space. She had taken the professional plunge into crypto one year earlier when Uniswap Labs CEO Hayden Adams recruited her away from a senior role at BlackRock, the world’s largest asset manager. Like many in the crypto community, Lader characterized her move from traditional centralized finance (TradFi) to decentralized finance (DeFi) as an exhilarating leap of faith–though in some ways less risky than staying in TradFi.

Despite her enthusiasm for cryptocurrencies, Lader initially viewed the notion of a decentralized exchange as oxymoronic. Modern stock exchanges were founded on the premise of eliminating counterparty risk and facilitating fairness and efficiency by operating as a central clearing counterparty. Centralized exchanges were unchallenged in the TradFi world, as evidenced by the dominance of longstanding institutions.a Centralized exchanges had even taken hold in the crypto realm,b accounting for more than 90% of total trading volume of the crypto markets in 2021.1

Instead, on Uniswap’s decentralized exchange (DEX), users provided liquidity to enable trades. Uniswap’s popularity among the growing DeFi community seemed to demonstrate that an algorithm– even one as simple as a*b=c–could perform many of the same functions as a centralized exchange— from bookkeeping to market making to price discovery—while realizing crypto’s promise of decentralization. The Uniswap Protocol had recently hit the milestone of $1.7 trillion in lifetime volume on its platform, representing nearly 100 million trades and for 8.3 million unique blockchain

a London Stock Exchange (1571), New York Stock Exchange (1792), and NASDAQ (1971).

b Coinbase (2012), Binance (2017), and FTX (2019).

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addresses.2 Uniswap Labs created the web app (also open source) through which a portion of users access the protocol. Despite these relative successes, the company had yet to earn revenue, as fees on the protocol went to liquidity providers rather than the company itself.c

Lader would soon be joined on her first call by the entire executive team as well as several investors. The question on their collective minds was how to generate revenue and profit as a business, while not jeopardizing the robust Uniswap community nor losing market share to competitors. Lader discovered Adams already in the meeting room, a cup of coffee in hand, deep in thought.

A Brief History of Uniswap Labs3

In 2018, Adams found himself laid off from his job as a mechanical engineer at Siemens. In his newfound spare time, he took an interest in cryptocurrencies and blockchain technology. It was a particularly challenging moment in the young history of cryptocurrencies. After a stellar 2017, major cryptos like Bitcoin and Ether were down more than 80% from their prior highs.4 The initial coin offering (ICO) boom, a form of raising money to fund new technologies named to evoke the initial public offering (IPO), had gone bust in the wake of a few ambitious technology projects but many more fraudulent scams, and the consequent regulatory pressure.5 Panic prevailed as people rushed to wind down their positions and unload bitcoin mining rigs. As Adams observed the market, he interpreted the crash as a liquidity problem: an abundance of tokens, yet insufficient liquidity. He believed this was because few centralized exchanges listed tokens aside from the two primary ones, Bitcoin and Ethereum. Moreover, there was scant liquidity for those few of the thousands of other tokens that did make it to the exchanges (see Exhibit 2 on market cap of top 20 cryptocurrencies in 2018).

In his pursuit of crypto knowledge and know-how, Adams was drawn to the writings of Vitalik Buterin, Ethereum blockchain co-founder. Buterin was a prolific blogger and proponent of the tenets of DeFi.d In 2017 he posted on a Reddit thread about a self-custody, self-market-making, self-clearing smart contract.6 Adams was intrigued by the idea’s potential to address the liquidity issues many cryptos were facing at the time. He connected with the broader blockchain and Ethereum ecosystems while developing a prototype of Buterin’s vision, despite having almost no budget. In April 2018 he finally met Buterin, who, impressed with his work, suggested the name “Uniswap” and encouraged him to apply for an Ethereum Foundation grant. A $100,000 grant awarded by the Ethereum Foundation was spent outsourcing code auditing and front-end development to validate the logical soundness of his work and improve its user experience, at which point, in Adams’ words, “Things became kind of real.”

The Uniswap v1’s debut at Devcon 4 on November 2, 2018, was the first time many learned of the project. The message sent was a powerful one of a decentralized, permissionless liquidity pool for any asset. Uniswap empowered anyone who wanted to list an ERC-20 token[3] to provide liquidity for it. Approval from a central authority to list a new name, as was standard practice at any of the existing exchanges, was no longer a requirement. Nor was help needed to provide liquidity and create a

c Uniswap Labs is a software development company that primarily contributes to the development of the Uniswap protocol. The company works on the smart contracts and other technical aspects that make the protocol secure and apps such as a user interface to make access to the protocol user friendly. While Uniswap Labs plays a significant role in the development of the protocol, it doesn’t control the Uniswap Protocol itself, just as the inventor of Bitcoin, known as Satoshi Nakomoto, does not control the bitcoin protocol. The protocol is automated and nobody blocks or authorizes transactions. The protocol governance is handled by UNI token holders.

d The early AMM design was originally developed in this paper: https://mason.gmu.edu/~rhanson/mktscore.pdf.

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marketplace, functions typically carried out by professional market makers like Citadel, Jump Trading, and Two Sigma. Uniswap was a protocol for truly decentralized trading.

Uniswap’s early success stemmed from the growth in the number of DeFi protocols and their associated tokens, most of which had not made their way onto the centralized exchanges or had not done so quite yet.e On its first day, $30,000 was deposited into the Uniswap Protocol and by the end of the first week, a few hundred thousand dollars were deposited. Three months later, deposits were numbering several million dollars. Uniswap, as such, was seen to be the exchange of cryptos that was aligned with Ethereum’s decentralized ethos.

The Evolution of the Uniswap Protocol In traditional markets with a centralized exchange, two parties, buyers (representing demand) and

sellers (representing supply), enter in a limit order book specifying the price and quantity at which they are willing to buy (sell). The exchange–or a preferred partner–facilitates the trade when there is a match, fulfilling the price discovery mechanism, and finalizes the deal through clearing and settlement. Greater efficiency, transparency, and fairness accrue to electronic exchanges compared to over-the- counter (OTC) transactions as a result of tasking a central authority to handle this process end-to-end. Modern exchanges’ centralized nature might also, however, be their greatest weakness, entailing reliance on trust in the underlying entity, introducing systematic risk associated with constituting a single point of failure, and dictating which assets can be traded, by whom, and at what price.

Traditional exchanges, for example, were unable to cope with the Gamestop meme craze because stocks take two days to settle, rather than less than 15 seconds for assets on the Ethereum blockchain. In addition, centralized exchanges struggle to have considerable liquidity for long tail assets, as market making in an asset is expensive (requiring business school and mathematics graduates implementing hedging, algorithmic, and high-frequency strategies), so few assets justify the expense. Often, exchanges encourage trading in specific time windows, such as the last hour of an eight-hour trading window, to allow for more available liquidity at the time of trading. Traders sometimes turn to “dark pools” to fill liquidity, and public information about pricing in these pools is opaque. Meanwhile, Uniswap aimed to provide liquidity for even long tail assets, in an automated way, 24 hours a day, seven days a week, with fully lit on-chain transparency. Despite their success in both the fiat and crypto space, exchanges seemed, until the birth of Uniswap, fundamentally incompatible with the decentralized narrative of blockchain technology.

The Evolution of Uniswap: from v1 to v3 The first iteration of Uniswap, known as “v1,” popularized the concept of an automated market

maker (AMM), adopting a constant product market maker model whereby price discovery was by means of a mathematical formula rather than by matching orders in a limit order book. The constant product formula, codified in the Uniswap smart contract, enforced a simple rule: in a given liquidity pool, the quantity of token X times that of token Y must be a constant during a swap. Uniswap v1 only allowed ERC-20s to be paired against ETH, requiring that ERC-20 to ERC-20 swaps required two simultaneous trades on different pools.

e An early competitor that was functionally similar to Uniswap v1 was substantially less gas efficient and had all ERC20 tokens paired against ICO tokens rather than ETH as in Uniswap.

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To create a Uniswap market, liquidity providers (who play a similar role to market makers in a traditional exchange) deposit a pair of tokens of equal dollar value (most likely, of differing token amounts) into a liquidity pool. Upon traders revealing their intent to sell a certain number of token X in exchange for token Y, the protocol calculates the appropriate number of token Y that can be withdrawn from the pool in a way that satisfies the constant product formula. A small fee paid by traders for completed trades is returned to the pool to be shared among liquidity providers on a pro rata basis, thereby incentivizing further liquidity provision, which results in a deeper, more liquid market.

Figure 1 An example of how a liquidity pool works.

Source: Di Maggio, Marco, Wenyao Sha, and Nicolas Andreoulis. “Awakening the Blockchain: An Overview of DeFi.”

Harvard Business School Background Note 222-001, August 2021.

Figure 1 shows how market makers (liquidity suppliers) initialize the ETH-USDC liquidity pool by depositing an equal value of ETH and USDC (green tokens). Takers (liquidity consumers) wishing to buy ETH with USDC deposit USDC in one pan (blue tokens) and withdraw ETH from the other (shaded green tokens). The liquidity pools are set up in such a way that 1) the values of the two pans are equal, and 2) the product of the numbers of tokens from both pans is a constant.7

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Figure 2 Price Dynamics

Source: Di Maggio, Marco, Wenyao Sha, and Nicolas Andreoulis. “Awakening the Blockchain: An Overview of DeFi.”

Harvard Business School Background Note 222-001, August 2021.

Figure 2 shows an example of how an order to buy token Y with token X affects price according to the constant product formula. The red curves represent two cases with different liquidity pool sizes. The price of Y in terms of X is a constant along any black line; the larger the slope, the more expensive Y is relative to X. Price moves more in the solid red than in the dotted red case for the same amount of X sold due to the former’s limited liquidity.8

The most significant innovation of Uniswap V2, launched in May 2020, was that any ERC-20 token could be directly paired with any other ERC-20 token in a liquidity pool.9 Previously, a swap between two arbitrary ERC-20 tokens had to be routed via Ether (the token of the Ethereum network) as the common medium of exchange. Although it did not add undue complexity, doing so was nonetheless suboptimal, requiring settlement of twice as many swaps as were necessary. Ethereum charges fees for a transaction by the amount of work done on the transaction, meaning that extra swaps added extra costs for end users.

In May 2021, Uniswap Labs launched Uniswap v3 (see Exhibit 3 for its user interface).10 The defining feature was concentrated liquidity, a new idea introduced in V3. Concentration was especially useful for stablecoin-to-stablecoin pairs, most of the trading volume of which was expected to occur within a narrow price interval. The rest of the liquidity, despite being available from zero to infinity along the constant product curve, had not been well-utilized in v1/v2. v3 enabled liquidity providers to choose the desired minimum and maximum price and commit fully and exclusively to that price range. The net effect was much better capital efficiency compared to v1/v2. This permitted a new type of order referred to as “range orders,” where traders could use the liquidity feature to specify a highest (lowest) acceptable price when buying (selling) under previous versions, which is somewhat similar to limit orders on traditional exchanges.

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Shortly after launch, Uniswap v3 supplanted v2 as the most popular AMM protocol. With popularity came liquidity, as shown by Figure 3, popular trading pairs such as ETH/USD and ETH/BTC pairs, are shown to be at least twice as liquid on Uniswap V3 as other competing exchanges, measured by the daily average +/- 2% spot market depth.

Figure 3 A comparison of liquidity on various crypto exchanges.

Source: Company documents available at https://uniswap.org/blog/uniswap-v3-dominance.

The Curse of Open Source Well before the 2021 release of v3, Uniswap hit its first major obstacle. In August 2020, an

anonymous developer “Chef Nomi” forked and rebranded the Uniswap codebase as the SushiSwap protocol.11 This was possible because all of Uniswap’s code was open source and thus visible to all– with Labs disclaiming any copyright restrictions so that anyone could copy the code outright. Functionality-wise, SushiSwap was a carbon copy of Uniswap except for its one unique selling point– the SUSHI token, a governance token distributed to SushiSwap users who transferred their liquidity from Uniswap to SushiSwap. Thanks to the additional perceived value that SUSHI token brought, liquidity providers could thus earn more on SushiSwap than on Uniswap, on top of the fees they were able to receive.

In the days following, crowds of users flooded into SushiSwap with freshly deposited capital transferred from Uniswap. The incident was later characterized as a “vampire attack.”12 According to DefiPulse, total value locked into SushiSwap went from essentially zero at the beginning of September to $1.4 billion by September 11, while Uniswap dropped from $1.7 billion to $617 million. As SushiSwap’s popularity exploded, so did the price of the SUSHI token, attracting further inflow. One of SushiSwap’s biggest liquidity providers–who eventually took control of the project–was none other

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than Sam Bankman-Fried, who at the time was hailed as a herof and was later convicted of orchestrating unrelated fraud.g It appeared that Uniswap was suddenly losing the game it had started and excelled at.

SushiSwap was not Uniswap’s first or only competitor. Yet, the tone of competition from the SushiSwap camp was different. Adams recalled a toxic atmosphere developing around the matter on Twitter and other messaging platforms. Whereas prior competitors had tended to compete in the technical arena, winning users over by building technologically-superior products, he felt that SushiSwap had done so through economic incentives. A narrative in the crypto community had developed alleging that Uniswap’s venture capital backing rendered it less pro-community than SushiSwap.

Uniswap not only survived the SushiSwap incident, but, according to Adams, it came back stronger as a result of lessons learned. The vampire attack shaped how he handled the launch of v3, which was released under a Business Source License (BUSL) that prohibited commercial use of the source code for the first two years, a protective mechanism to prevent the next Chef Nomi from immediately copying its code while staying true to the open source root. Adams’ appreciation for the demand for a decentralized governance system, moreover, led to Uniswap creating 1 billion of its own governance token on the Ethereum blockchain, UNI (see Exhibit 4 for UNI’s price history).13 It managed to distribute roughly 60% of UNI to its users (through an airdrop of 400 UNI to each address that had used the platform previously and an amount to liquidity providers proportionate to the value provided over time) and the remainder was set to be distributed to investors, advisors, and team members over four years. UNI holders could participate in an on-chain governance process where they voted on proposals independent from Adams and the Uniswap Labs company they created. Furthermore, Adams and the Labs employees had internal policies against voting on UNI governance decisions even if they hold the token.h Perhaps most important of all, the incident propelled Uniswap Labs to search for a sustainable business model that would set it apart from copycats and further cement its leadership status.

The Path to Monetization As the meeting began, Lader pulled up her notes. The challenge of monetization in the business of

open-source software development was hardly new. A viable solution that had been pursued by individual developers was donation, and for bigger teams, it was selling technical support as a service. Ads and paid promotion were another popular source of revenue. The plan Lader had in mind, however, was designed to cater to its three largest customer groups: retail users, the broader Uniswap community, and institutions (see Exhibit 5 for a summary of Uniswap’s strategy). She and Hayden also heavily prioritized generating value from users only if/where the product was clearly delivering value to users.

Transactions Fees The typical way most crypto exchanges generated revenue was by charging a transaction fee on each trade. Centralized exchanges such as Coinbase and Binance generally had a

f Adrianna Hamacher. “The Man Who Saved SushiSwap.” https://decrypt.co/41606/the-man-who-saved-sushiswap, accessed February 2024.

g Ephrat Livni and Bernhard Warned. “Sam Bankman-Fried Could Get 100 Years in Prison. What is Fair?” https://www.nytimes.com/2023/11/11/business/dealbook/sam-bankman-fried-sentencing.html, accessed February 2024.

h For a brief period the policy permitted an employee to vote up to 10% of his or her tokens, but the policy was updated to prohibit voting for simplicity.

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complex regressive fee tier structure with fees up to 150-200 bps depending on the trade but no gas fees. Many of the DEXs on the other hand had not yet started charging fees, but for those that did, fees could still be high although lower than at centralized exchanges. For instance, MetaMask, one of the largest self-custody wallets, charged 87.5bps for trades originating from its wallet.14

In 2023 Uniswap Labs launched an iOS app, also known as a crypto wallet, for the retail market. Uniswap Labs was estimated to have, as of Q1 2022, 3.5 million wallets, or roughly 1.3 million users after deduplication. By comparison, Coinbase claimed 98 million verified users,15 representing a massive opportunity for Uniswap Labs to tap. A mobile app might be the perfect on-ramp to introduce the next 100 million to on-chain trading. Uniswap Labs could charge transaction fees on their web app and in their newly launched mobile app, and potentially consider different fees in each.

Given the app had been free to use for 4 years, that there were currently existing free competitors, and that the interface could be forked at any time, Uniswap Labs would need to approach this decision with extreme caution. Also, they would need to be highly confident in the value their interface was providing: trust, security, and user experience / ease of use. The current customer loyalty and market share would suggest those value props were strong, but there was really no way to validate it beforehand.

Community-Based Models of Revenue Lader saw further potential in the web and mobile apps beyond trading. She liked to call this concept, “Robinhood meets Wechat.” Arguably, Uniswap’s most valuable asset was its community, a group of pseudonymous individuals who initially came to Uniswap with a need to swap one token for another, but stayed in the broader community (such as in the Uniswap discord group) as it was a place to exchange opinions and bond with other crypto- proponents. The app could potentially serve as a portal to all things crypto, as the app could help make customers more loyal to the ecosystem. This could eventually lead to a subscription fee model.

APIs and v4 Lader also intended to double down on monetizing Uniswap’s business-to- business partnerships. By 2023, Uniswap Labs had created an enterprise-grade Trading API to allow institutions including market markers, traders, and prime brokers to tap into Uniswap liquidity to trade crypto at scale. The product was in pilot but soon could tap this multi billion dollar opportunity. It is worth noting that two other DEX competitors, 1inch and 0x, both already had API products on the market, neither of which saw much institutional adoption.

In addition, as of 2023, Uniswap Labs had announced the development of Uniswap v4 which was being built in public and would be released in 2024. v4 allowed for the creation of “hooks” on top of the protocol through which the protocol could be customized to fit different needs both for retail and institutions.

Uniswap’s professional customers were the source of some of the most interesting feature requests for the Uniswap protocol. Through v4 hooks, some institutions could employ KYC/AML[6] services. They could also utilize hooks to trade asset classes typically underserved by TradFi, such as foreign exchange and carbon credit. And in utilizing hooks via v4, they would have a more advanced need for analytics support, data feeds to real-time market analysis and in-depth research. All of which could eventually lead to a robust institutional product for Uniswap.

Lader was of the opinion that a pro version targeted at the bigger players would not run against Uniswap’s populist, grassroots image, precedent practice being widely accepted in the industry. Although the SMTP/POP3/IMAP protocols, for example, were readily available, email clients like Gmail and Outlook had proved able to add value through superior user experience and enterprise support. The same was true of Linux/Red Hat, Apache Spark/Databricks, or Apache

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Kafka/Confluent. Uniswap was no stranger to being the industry leader, a necessary foundation for charging a premium for the commercial adoption of its open-source products.

“It’s unusual,” Lader opined, “to have a business with this level of adoption and public scrutiny, yet no revenue and so many open questions, but I think that’s part of what makes it fun.” Her smile was returned by the executive team and investors.

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Exhibit 1 Uniswap’s market share over time

Source: Company documents.

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Exhibit 2 Top 20 cryptocurrencies by market cap as of Nov 2, 2018, the day Uniswap V1 launched.

Rank Name Symbol