Uniswap, the main decentralized exchange, is introducing so-called hooks. A hook also allows the identity of traders to be verified. There are fears in the scene that the days of a permissionless DeFi ecosystem are coming to an end and that “decentralized finance” will only be an empty phrase in the future…
Uniswap, the largest decentralized exchange, which manages a daily volume of around half a billion dollars even in the worst bear market, has long been a fixed star in the sky of decentralized finance.
Info: Decentralized finance apps (DeFi) like the Uniswap exchange are not companies, but rather a structure of smart contracts on Ethereum and other blockchains. These smart contracts replicate a stock exchange by structuring the interaction of decentralized connected parties. The website is not a center, just an interface; It doesn’t control anything, it just helps users interact with the smart contracts. Every operation takes place decentrally via the users’ wallets.
With the fourth version of the protocol, Uniswap introduced so-called hooks in the summer of 2023. These are plugins that allow you to enrich liquidity pools with your own features. Liquidity pools are, so to speak, the many pillars of Uniswap: They contain holdings of two cryptocurrencies – for example WBTC and ETH – with the help of which users can exchange their coins. The hooks allow you to customize the pools. “They lead,” explain the Uniswap developers on Twitter, “Input code at key points in a pool’s chronology, such as before or after a swap.”
Uniswap Labs is setting a good example and introducing the self-developed hook “Time-Weighted Average Market Maker” (TWAMM). This is intended to allow a pool to reduce the impact of large trades on price by breaking them down and executing them over time. Other hooks introduce new oracles, allow limit orders instead of the usual purchases at market price, bring dynamic fees into play or enable a hedge against “impermanent losses”, i.e. losses that liquidity providers incur when the assets they contribute lose their balance .
In short, hooks decentralize the development of the mechanics of switching on Uniswap. They allow you to try out a lot of things without jeopardizing the core functionality of the exchange.
KYC for Uniswap
Hooks are wonderful in themselves. But only in itself. Because they also carry the potential to change Uniswap in an unpleasant way. You can see this in the directory of hooks “From the Community”.
There are also hooks that limit participation in the pools. “Whitelists” only allows certain addresses, “NFT Owners Only” only allows owners of certain NFTs, and, most clearly: “KYC” requires that some kind of identity verification be carried out before a user is allowed to trade. Hooks make it possible to create pools in which only verified, professional, adult, European, Russian investors, party members, men, women, princes, Brahmins, Catholics and so on are allowed to trade.
Of course, this screams that the hooks will become a gateway to regulate DeFi. “It starts as an ‘option’ but we all know how it ends… Uniswap is a fake DeFi” complains a crypto influencer on Twitter. More options, one might say, also includes the option to allow less, and more freedom also includes the freedom to impose new constraints.
Bitcoinik, a Bitcoin-focused online magazine, even expects “all Defi protocols to introduce KYC barriers in the near future” because of the hooks. You could also say that the definition of Defi protocols will be different in the next few years.” DeFi will align with TradFi, the traditional finance, will adopt its restrictions and cumbersomeness and will ultimately be at most a technical upgrade to which the revolutionary teeth were completely pulled out.
KYC als Chance
You can see it that way, and it is also important to warn early and stay vigilant. This always requires freedom and decentralization. However, you shouldn’t exaggerate either. There is still no reason for hysteria. In fact, you can even see an opportunity in optional KYC. Without user verification, decentralized exchanges will probably never be able to trade stocks or government bonds – traditional securities that pay interest or dividends.
The model that tends towards KYC verification through NFTs is also more promising than dystopian. Identity service providers can issue (Soulbound) NFTs that confirm that a wallet owner is verified, without requiring those recognizing the token to actually know the identity. It is enough to know that the identity can be revealed in the event of a problem. Such a model would be technically possible and a huge step forward from the primitive KYC we have today. Today you have to submit your private data, including your ID photo, to every bank and stock exchange and even show it when you activate a SIM card. This inevitably leads to private data sitting on dozens of servers waiting to end up on the dark web through the next hack. An NFT would be both more discreet and secure.
If a Uniswap hook establishes identity NFTs, for example for trading treasury bonds or stocks, this would be a win that goes far beyond Uniswap itself. On the one hand, it would bring blockchain and the real world closer together, but on the other hand, it could also lay the tracks to finally put the traditional digital identity system on a solid basis.
No reason for hysteria
In addition to these advantages, there is no need for dramatization. First of all, a hook is just one option that pools can choose. Some hooks can make the pools more convenient for users – such as the TWAMM mentioned above or insurance against permanent loss – but KYC is not one of them. Identity verification is, first of all, a burden that should be avoided if possible.
More restrictions means fewer traders, so less turnover and therefore less income for liquidity providers, which results in lower liquidity and worse prices, which is why there will be fewer traders and so on. For common pools, such as the strong currency pairs with Ether, Bitcoin and Dollar, there is no chance of a KYC pool taking the lead. Not even with the mass of pools that integrate new altcoins and tokens faster than any exchange is capable of. To survive, KYC pools must offer something that other pools do not. For example, government bonds, real stocks or a special backup. So they will probably remain a niche phenomenon.
Even if all Uniswap pools introduce the KYC hook, there are plenty of other decentralized exchanges whose developers operate beyond the reach of regulators and law enforcement. At most, as a harbinger of a global ban on KYC-free DeFi apps – which is probably impossible to enforce – hooks can be part of DeFi regulation. Therefore, one can relax at this point and see the option of integrating KYC into the pools for what it is: an option that does not limit the scope of the possible, but expands it.