At GFX, we’ve been working towards getting the Fee Switch turned on for more than a year and, over the last several months, have been slowly gathering opinions from delegates and UNI holders. Our general observation has been that most UNI holders are interested in seeing the protocol monetized. The differences in opinion tend to come from when and how the protocol should be monetized. Some believe it should be put off until Uniswap gains greater market share, while others believe that monetizing the protocol today could rekindle interest in the protocol, governance, and UNI. Over the last six months, there has been a jump in interest in getting the switch activated, and now how has become the main question.
The how (implementation) generally consists of the flowing questions (ignoring v2 to simplify this):
- Which pools should protocol fees be turned on for?
- What should the protocol fee be set to?
- How will the protocol set the fees?
- How will the protocol claim the fees?
- How will the protocol manage the positions it will accrue?
- What will the protocol do with its revenue?
However, those questions only address the technical implementation of the Fee Switch. There are several legal questions we’ve come across that voters would like to see addressed, such as the following:
- Is Uniswap responsible for paying income taxes (and other potentially relevant taxes)?
- Do UNI voters need to come up with their own process to assess whether assets in the protocol are or aren’t securities similar to traditional exchanges?
- What might happen if Uniswap generates fees from a pool that contains an asset designated as a security?
We think there are certain ways to activate the Fee Switch, which could maximize the value of the protocol while minimizing legal risks.
The metric to measure success of the experiment is the following: If trading execution is not diminished for the pools with the “fee switch” turned on – the experiment is a success.
We’ll be voting against the proposal if it progresses to a formal governance vote because we believe the primary metric of success is unlikely to be met with the proposed implementation. Additionally, the proposal needs to address the above key questions. The below explains why we believe success is unlikely; we can make a follow-up post regarding why the proposal doesn’t sufficiently address the above question if it needs to be clarified.
While some may say that the proposal is merely an “experiment,” an unsuccessful implementation will likely hinder future efforts to monetize the protocol and reflect poorly on the state of Uniswap.
Question: Why do we think the proposal will not meet its stated success metric?
If passed, the proposal will set a protocol fee of 1/10 of the fee tier of the pool for the designated pools: ETH-USDT 5bp, DAI-ETH 30bp, & USDC-ETH 100bp. For example, the USDC-ETH 100bp pool applies a 100bp fee to trades and distributes the full fee to the LPs. With the fee applied, the fee on swaps remains the same, but the fee to LPs drops to 90bps.
The protocol has four fee tiers: 1bp, 5bp, 30bp, and 100bp. Each asset pair can only have these four fee tiers; no additional pool can exist. For example, there is one ETH-USDC 1bp pool, one ETH-USDC 5bp pool, one ETH-USDC 30bp pool, and one ETH-USDC 100bp pool. If someone were to try to make a second ETH-USDC 30bp, the factory contract would prohibit it. If someone tried to make the inverse pair like USDC-ETH 30bp, the factory contract would also prohibit it.
To help normalize this information, its best to view them in a familiar format:
Takers are people swapping with the pool, whereas the Makers are the LPs in the pool. Makers are currently receiving a 100% rebate for liquidity provided.
Answer: By introducing a 1/10 Protocol Fee on select pools, the protocol is reducing the rebate the LP will earn. Further, by only introducing the Protocol Fee to select pools, active LPs will likely move to one of the other three fee tiers where the rebate remains 100% or will move to a like-kind pair.
For example, if we were an active LP in the ETH-USDT 5bp pool and saw a rebate reduction of 10%, but the ETH-USDC 5bp still offered a 100% rebate, we’d simply move to that pool instead.
Below are our brief thoughts on implementing a Protocol Fee for the purposes of analyzing changes to LP behavior and swap execution. The list is from the most optimal implementation to the least optimal implementation to active Protocol Fees.
- Set a single fee for all Uniswap deployments: leaving LPs the fewest alternatives
- Set a single fee for a single deployment: LPs could move to another deployment
- Set a single fee for a pair, and it’s like kind pairs: the LPs could move to other assets
- Set a single fee for a select few pairs: the LPs could move to like-kind pools
Call to action
If you’re a UNI token holder and supportive of a thoughtful proposal to turn on the fee switch, please reach out.