"Fee Switch" Design Space & Next Steps

Meanwhile Kyberswap, fee switch fully enabled and no shenanigans on getting around of paying it to holders.
Concentrated Liquidity tick-based or as LP tokens both.
Deployed on 12 chains.
Faster in deployments (see OP 0.01% fee tier).
All Uniswap has at this point is the brand.

I am for using a fee on strategic pools as @guil-lambert has stated. It is true that if you charge a fee on only a part of the fee levels, the liquidity will spread out to where it is treated best. The idea is maximum extraction of value for minimum effects on liquidity. I would also restrict fees from full-range liquidity positions, since they protect from long tail events, but are inefficient during normal conditions. At the same time, I do not think the specific plan matters for the revenue, and starting small and gathering some empirical evidence minimizes the risk for the protocol

I’d like to offer an alternative perspective on some comments I’m seeing.

@ConcernedLP, @Brenner, @Buckerino and @eek637 have all voiced concerns along these lines:

  • Fee switch is not high priority at this stage, and other projects are higher priority
  • Uniswap Governance needs to figure out what it wants to even spend funds on first

Other Internet has studied Uniswap governance extensively and has talked to stakeholders of many different types, and while I hear these concerns, I do not believe they are entirely correct.

  1. Part of the reason for general governance inaction in Uniswap is, in fact, the lack of non-UNI funds in the treasury. Without stables or more liquid currencies like ETH to spend, the UNI token must be liquidated every time a significant opportunity arises. We currently are in a situation in which UNI selloffs to service providers, public goods projects, and grantees that exert downward price pressure on the token in the long run. (Recall the significant backlash about UNI price when DeFi Education Fund liquidated $12.5m in one day). Moreover, generating assets in the treasury that can be spent on protocol growth and expansion makes the governance token more valuable. Recently governance nerds have been obsessed with NounsDAO, a protocol with extraordinarily high levels of governance activity. The number one reason Nouns has generated such a high volume of proposals is that it has significant treasury holdings, spending of which do not dilute Noun holders’ token value. Everything we’ve seen so far suggests that if Uniswap were generating even $10k of ETH & USDC in fees per day, we would likewise see a much higher volume of governance activity and proposals on this forum.

  2. Firstly, we have to stop referring to “Uniswap Governance” as a monolith. What we are is a collection of actors with very different incentives. Uniswap is very poorly structured from an ownership perspective, having airdropped to all classes of users. This makes it incredibly unrealistic for people to come together to intentionally decide what to fund at the current moment. Outside of an off-site retreat for major UNI voters, I don’t see a good way to reach consensus on this. OI has taken some responsibility for advocating for specific outcomes we’d like to see here; one of these is the creation of concentrated centers of authority, such as an expanded version of Uniswap Grants Program with a bigger mandate, who we believe would be suitable to set specific goals and drive specific visions.
    In lieu of these authority centers existing right now, I believe that the higher volume of proposals stimulated by more liquid assets in the treasury would incentivize a greater degree of competition and higher quality proposals brought to this forum. Right now delegates have too little work to do. Perhaps this is idealistic, but more competition among a higher volume of proposals would force all of us to be more selective and evolve a set of criteria for treasury spend.

A final comment is that nonnative assets in the treasury would make it easier to conceive of spending money on things like paid delegation programs, which would overall improve the quality of governance.

In short, I can’t conceive of the fee switch initiative as low priority. The fee switch is one of the few clear on-chain levers we have available to us to drive more governance work and better outcomes at this time.

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There are two ways to get non-UNI funds into the treasury.

  1. Sell UNI from the treasury, which impact UNI holders (by decreasing the price)
  2. take a portion of LP fees, which impacts LPs (by taxing them)

Assuming LPs are providing liquidity out of pure economic interest, to impose #2 on LPs, the case has to be made “this tax will improve your economics in the long run”.

I have looked through everything I can find from/on Uniswap, and I cannot find a stated goal or mission.*

I agree that having some amount of ETH or USDC in the treasury might attract more proposals. But without having a more clear goal or mission for UNI holders and arguably more importantly, for LPs to get behind, the fee switch is a hard case to make.

A world in where I see turning on some fees working:

  1. State the goal of UNI is to create the deepest liquidity and thus the best to trade in the universe
  2. Pick a number: $5m, $10M, and turn fees on for less important pools until that number is reached, and then turn them off. It’s a seed round.
  3. Fund individuals / teams that are directly aligned with the stated goal of UNI.

Long term, I think fees on top of LP fees instead of taking a portion of the LPs’ fees is more sustainable. It affects LPs less, and doesn’t directly drive liquidity to other AMMs.

  • Which can or may be separate from Uniswap Lab’s goal or mission. Since it’s a C-corp, by default it is “make a return on investment for shareholders”. And I’m sure they have their own way(s) they plan on doing that, separate from the fee switch.
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I like some of this thinking, specifically #2.

I’ve been thinking of it being more time bounded though rather than focused on acquiring a specific amount of capital.

i.e. run this experiment for 90 days after which fees revert to 0%.

Functionally somewhat similar to what you are suggesting but IMO simpler because you avoid needing to determine any specific usage of capital. As stated in my original post, I think that is crucial to keep the discussion simple and empirically driven.

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This is a good point. My gut tells me that instead of removing liquidity, LPs will go and buy UNI token… Most LPs love the protocol and will be willing to contribute more capital to the ecosystem by buying UNI token. I also would like feedback on my Temperature check here, for UNI-based Fee Tiers. Upon turning on the fee switch, this would provide additional incentive for LPs to buy UNI instead of withdrawing liquidity.

https://gov.uniswap.org/t/temperature-check-uni-based-fee-tiers/17217

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For example, Imagine you are an LP and the fee switch is turned ON. What do you say to yourself? You say, “Ok, now I am making less return because we are paying UNI holders. What should I do?” Let’s explore that – What can you do? Option 1) Move liquidity to another AMM that is far less reputable and has far less growth momentum, or Option 2) Buy UNI tokens so that i) you partake in the fees switch being turned ON, ii) partake in any other future utility ascribed to the UNI token, iii) continue accruing significant fees as an LP on Uniswap, iv) gain voting power in Uniswap governance.

I’d choose option 2 all day, everyday.

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This is the crux of where you and I disagree. As an LP, why would I want to be taxed without any explanation as to where my taxes are going?

LPs are here to trade IL risk for fees.

Theoretically, UNI holders hold UNI because they are aligned with UNI’s goals (which aren’t even explicitly “make the value of UNI go up”).
If UNI leadership wants more eth/usdc in the treasury to prove out UNI’s ability to allocate capital efficiently towards UNI’s goals in a way that is net-positive to LPs, I think they should sell enough UNI to reach that number.

Only then, with some track record for LPs to look at, should the ask for capital be directed to LPs

Taking your assumption as true. The “why” actually doesn’t matter at all to LPs. If they are purely acting in economic interest they will leave if it no longer benefits them and return if / when it does benefit them. There would be no reason to stay in anticipation that it might benefit them more in the future. They would simply return at that future time. The “why” does not matter to an LP acting purely in economic interest.

Perhaps there is some subset of LPs that don’t act purely in economic interest and therefore might stick around solely based on a “why” but I doubt that is a large amount.

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Hey, LP speaking, I think this proposal is great, whichever form it takes. However, the ratio should be carefully considered. Taking away 10% of revenues from LPs risking impermanent loss etc… Might be considered too high. On the other hand, LPs are indeed interested in seeing Uniswap have more assets to incetivize development and innovation. Instead of doing a unilateral proposal for fee switch with predetermined parameters, I think an invite to LPs should be done and ask what would be an ideal fee switch for them to decide to provide more liquidity, in different pairs, for example. I think this kind of proposal should be really discussed with LPs, a roadmap should be designed, and the future should not be uncertain, the opposite as Uniswap only exists because of the LP-protocol relationship. Having said that, until april 2023, Uniswap has a form of protection, what will happen after that, what about VCs, using the Uniswap code, forking it and developing for stocks for example… So many questions out there, but honestly, I feel like the fee switch is something that could benefit everyone if enacted properly.

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After having read a lot of interesting comments, there is one crucial thing that comes to my mind, as a large LP on UNI V3. Decentralized governance is achieved through holding UNI tokens. If LPs want to have a say here, they should hold UNI tokens and vote on proposals. The power of UNI V3 is its safety and liquidity. Safety will not be impacted by the fee switch. Liquidity can be controlled by the fee switch, for example, do a proposal to award UNI tokens at a discount to LPs that commit to provide liquidity for a certain amount of time. That would be “money well spent” or some sort of incentive so that research can strive along the giants that provide for “gasoline”…

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Disclaimer: this comment was co-authored by Alana Levin and Derek Walkush, investment partners at Variant. Variant is an investor in the UNI token and Uniswap Labs, Inc.

TLDR:

  1. In favor of experimentation
  2. The experiment should test non-core pools for data points that map to the rest of Uni pairs; strong candidates include WBTC/USDC, DAI/ETH, and USDC/ETH
  3. The first fee switch worth testing may be one that generates non-UNI assets for the treasury; these funds should be used to incentivize ecosystem growth among other Uni stakeholders

Derek and I are in favor of experimentation with fee splits, and think the proposal outlined is incredibly thoughtful and a strong step in the right direction.

Pool Analysis
We agree that the biggest risk, as pointed out by several commentators, is a liquidity drain among core pools. As such, there’s likely a good middle ground of pools to test – ones that are not core pools (e.g., USDT/USDC and USDC/ETH, as pointed out by Monet Supply) but are still sufficiently large to gather data points that map to the rest of Uni pairs. Having relevant data points will help better understand the potential impact of broader / more widespread fee switch implementations.

The optimal pool should satisfy the following conditions:

  • Relatively high Volume / TVL (APY) so LPing still remains profitable
  • Relatively deep liquidity to not potentially drain important liquidity
  • Ideally relatively similar valued assets to avoid potential IL increases

Below is an analysis of Uni V3 pools 11th-20th in TVL:

From the analysis, WBTC/USDC, DAI/ETH, and USDC/ETH (1% tier) seem to be suitable pools for experimentation.

Fee Switch Design
We’re supportive of directing a portion of the fees toward building non-UNI reserves in the treasury (with funds potentially stored in stables), in line with Toby’s comment. We agree that those funds should be invested in continued growth, e.g., funding grants, incentivizing integrations, and whatever else the community determines may help Uniswap grow.

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I agree it would be nice to test this on pools that are a bit less important (measured by volume) but curious what you both think of @guil-lambert’s comment? It seems important to pick one stable / volatile pair and then compare across non-overlapping fee tiers with a consistent fee switch setting.

It’s a good point, and our suggested pools are mostly in line with @guil-lambert’s argument. DAI/ETH (0.3%) and USDC/ETH (1%) are both stable/volatile pairs with non-overlapping fee switches, while still being in the top 11-20 pools by TVL. A solid candidate for a third pool to test might be ETH/USDT (0.05%) instead of our original WBTC/USDC suggestion.

The key difference between these suggested pools and the ones @guil-lambert suggests is that our proposed pools rank much higher in TVL, which we think is important for simulating the outcome should new fee switch designs be implemented on more core pools. We do agree that having stable/volatile pairs and non-overlapping fee tiers is useful.

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It is difficult to gauge the likely impact on LPs from a fee switch without understanding the state of profitability for LPs in various pools.

The “Impermanent Loss in Uniswap v3” paper released in Nov’21 sampled pools representing ~50% of TVL and found that those LPs, in aggregate, are operating at a -30% margin.

If this is still the case today, I don’t think it would suggest a lot of room for the protocol to extract revenue.

To that end, has anyone seen a more updated version of this study or seen / has conducted similar analysis on LP profitability?

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I see a lot of good comments, good ideas, and good direction toward the question “how should the fee switch be enabled” - rather than -should we enable the fee switch" - as this discussion matures, LPs will slowly but surely realize that the UNI token price is currently extremely low compared to what it will be when decentralized governance starts to really work out. This experimentation is amazing, thrilling, and it will probably be seen by others as one of the biggest revolutions in Web 3.0 if properly enacted. Probably a sort of “think-tank” should be put in place and the HOW should be discussed extensively. More than happy to participated.

One problem with only enabling certain pools to “test” is you are now changing the properties of very similar pools. You’re very likely to see liquidity leave ETH/USDT 0.30% pool if you enable the fee switch because they can just join ETH/USDC 0.30% pool without the fee switch on.

If you’re going to turn it on for a pool, it needs to be on all comparable pools (same/similar risk profile) if you actually want a proper test.

Disclaimer: I work at Pantera Capital but views expressed are my own

TLDR:

  • You can’t create protocol fees for free
  • Either traders or LPs have to pay, and in practice both will
  • A protocol switch will result in worse net pricing for traders

@guil-lambert’s post is excellent but could be slightly misleading - there isn’t, of course, any way to create protocol fees ‘out of thin air’ without the ‘tax’ being paid by someone.

Guillaume suggests that liquidity reshuffling between fee tiers would create an equilibrium of LP fees per unit of liquidity provided, which is in theory completely correct. However, this equilibrium would either be:

  • a) Lower than the previous equilibrium - i.e., the protocol fee is ‘spread’ across all fee tiers (and ‘sister pools’ in theory) and still paid by LPs, albeit by each pool in a smaller amount;

  • b) The same/similar, but transaction routing moves trades to tiers with worse net pricing as a result of liquidity reshuffling, and so traders pay the fee;

  • c) Some combination of a) and b), which is what would happen in reality.

A key insight from a) is that a lower equilibrium fee switch, i.e., below the 1/10 minimum, could be applied to all LPs by only turning on the fee switch in select pools (as is being suggested for testing).

To think about this differently, the current liquidity distribution is, of course, optimizing for LP revenue, which in turn is optimizing for maximum daily volume per unit of liquidity in each pool, which in turn is optimizing to give traders the best net pricing experience across the pools. Turning on a switch in any fee tier will alter the liquidity distribution and result in sub-optimal/worse net pricing across all tiers for a given pair/collection of ‘sister’ pairs.

The traders who would have been trading in that pool on the margin will then either continue with their trade anyway (i.e., scenario b) or halt their trade entirely (scenario a).

The extent to which scenario a or b occurs will be determined by the price sensitivity of the traders, which in turn will be determined by the availability of strong alternative protocols.

Thank you for this proposal. I agree that we must explore this design space.

However, I think that you are not giving enough credit and consideration to the unique potential of UNI holders passively accruing fees simply by staking UNI. This possibility should neither be written off nor disregarded. Please consider this more carefully. The Uniswap protocol touches just about every compelling asset in cryptocurrency landscape by enabling permissionless liquidity provision. Now imagine staking UNI and passively accruing an entire portfolio of assets (volume-weighted by trading volume on uniswap).

UNI, in this sense, could become the ultimate Web3 “fixed-income” asset. Holders of UNI can passively accrue every asset that trades on the protocol. This is incredibly powerful and unprecedented. Wealth managers across the world would pile into UNI simply to have this exposure, and accrue exposure for their clients to all Web3 assets trading on the Uniswap protocol. Nothing like this has ever been done before. It’s magical, in a way. Eventually, we can assume that tokenized equities, fixed income assets, tokenized real estate, tokenized fiat currencies, tokenized derivatives/options/swaps/etc and much more may trade on Uniswap v3. And simply by holding the UNI token, one can slowly accumulate exposure to all these different assets… Imagine that. WoW! Incredible…

You say at the beginning of your proposal: “I see an assumption that using the fee switch = money going to UNI token holders. I think this is limiting.”

I disagree strongly. I don’t think this line of thinking is limiting at all. In fact, it is fascinating! I believe this is what UNI was in part destined to be… the primary asset that allows holders to accumulate and accrue a vast and diversified portfolio of positions across every Web3 asset that trades on the Uniswap protocol.

To me, a veteran of traditional finance, this is simply an incredible opportunity for the UNI asset - and it should not be ignored.

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So the last community call got me thinking about the fee switch and ways to overcome all the obsticles there are in creating this outside of a contract

The idea of testing this out with V3 having full control over which pools have this fee switch and how much

my proposal is that we create a Staking contract in conjunction of the fee switch contract receiver, and also adding on a ERC20 Wrapped UNI where this wrapped Uni is used in a ETH/WUNI pool, allowing this to be unwrapped as well via contract.

This would allow UNI holders to stake the uni and provide that wrapped UNI to the pool to limit loss from the fees lost in the LP, Also having a UNI/WUNI pool would allow routing through this pool with regular UNI token routes

Now the main reason we can bring in UNI LP providers is that in this contract we would want to retain UNI Holder Voting rights, the Vote would need to be done via this contract and have a ipfs site to vote on, but by tracking and setting the users ability to send vote via the contracts holding of their UNI, this would allow them to still Vote, although a different delegate system would also have to be set up

But by reducing the loss in LP fees and allowing UNI holders to keep their voting power, I do believe this would be enough incentive for LP providers of UNI token at least

Obviously this would be a very complicated contract, but I do believe that this would offer a good incentive to open a Fee Switch Testing pool

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