Swap Finance Example: Trading ETH for DAI on Uniswap

Swap finance, often synonymous with decentralized exchanges (DEXs), revolutionizes asset trading by removing intermediaries and allowing peer-to-peer transactions directly on a blockchain. Let’s illustrate this with a practical example: trading Ethereum (ETH) for Dai (DAI) on Uniswap, a popular automated market maker (AMM) DEX.

Imagine Alice holds 1 ETH and wants to exchange it for DAI, a stablecoin pegged to the US dollar. Instead of relying on a centralized exchange like Coinbase or Binance, she chooses to use Uniswap. Here’s how the swap process unfolds:

Accessing the Uniswap Interface: Alice first connects her Web3 wallet (e.g., MetaMask, Trust Wallet) to the Uniswap interface. This wallet allows her to interact with the Ethereum blockchain and authorize transactions.
Selecting the Trade Pair: Within the Uniswap interface, Alice selects ETH as the input token and DAI as the output token. She specifies the amount of ETH she wants to sell – let’s say 1 ETH.
Viewing the Estimated Output: Uniswap then calculates an estimated amount of DAI Alice will receive based on the current ETH/DAI pool’s state. This estimation takes into account factors like the pool’s liquidity, trading volume, and swap fees. Crucially, the estimate considers “slippage,” the potential difference between the expected price and the actual price due to the transaction’s impact on the pool. A higher slippage tolerance allows the transaction to proceed even if the price shifts unfavorably, but might result in fewer DAI received.
Understanding the AMM Mechanism: Uniswap uses an AMM to determine the exchange rate. The ETH/DAI pool holds reserves of both ETH and DAI. The price is determined by the ratio of these reserves and maintained according to the formula: ETH Quantity * DAI Quantity = Constant (k). When Alice sells ETH, she adds ETH to the pool and removes DAI, slightly shifting the price to make ETH cheaper and DAI more expensive.
Approving the Transaction: Before the swap can occur, Alice typically needs to “approve” Uniswap to spend her ETH. This is a one-time action per token pair. The approval allows Uniswap smart contracts to deduct the specified amount of ETH from her wallet.
Confirming the Swap: After approving (if needed), Alice reviews the transaction details, including the estimated DAI received, slippage, and transaction fees (gas fees). If everything looks correct, she confirms the swap in her Web3 wallet.
Transaction Execution on the Blockchain: The transaction is then broadcast to the Ethereum network. Miners or validators include the transaction in a block, executing the swap according to the smart contract’s rules.
Receiving DAI: Once the transaction is confirmed (typically after a few blocks), Alice receives the DAI in her wallet, and her ETH balance is reduced. She can then use the DAI for other purposes within the DeFi ecosystem, such as lending, borrowing, or providing liquidity to other pools.

This example highlights the core functionalities of swap finance: permissionless access, automated price discovery, and direct peer-to-peer trading without intermediaries. The AMM mechanism allows anyone to participate as a liquidity provider, earning fees for contributing to the pool. While swap finance offers numerous benefits, it’s important to be aware of risks such as impermanent loss, smart contract vulnerabilities, and high gas fees during periods of network congestion.