We at a16z would like to thank LlamaDAO for their hard work on this proposal.
After analyzing the proposal, we don’t think that the benefits of the proposal outweigh the cost of ~$50M in payments to LPs for the following reasons:
- Uniswap v3 already has dominant DEX market share on Ethereum layer 1 without incentives.
- A better use for liquidity mining would be incentivizing liquidity provision on layer 2 chains.
- There are issues with the pairs chosen for incentivization.
Given these reasons, a16z does not support the proposal in its current form.
We explore each of the aforementioned points in greater detail below:
Uniswap v3 already has dominant DEX market share on Ethereum layer 1 without incentives.
Uniswap v3 alone already has >50% DEX market share on Ethereum layer 1. Furthermore, it already has deep liquidity with over $2.9B in value locked.
While there is more capital currently locked in v2, it’s not clear that the benefits of adding more liquidity to v3 will exceed the cost of the program, especially since v3 allows for much greater capital efficiency than v2 by design.
A better use for liquidity mining would be incentivizing liquidity provision on layer 2 chains.
The most pressing problem for Uniswap v3 on Ethereum layer 1 is not the depth of its pools but rather the cost of interacting with it. The median gas cost of trading through the v3 swapRouter contract over the last 7 days is 160K, which is ~$60 per swap at prevailing gas prices of ~100 gwei.
The most effective thing the Uniswap community could do in the short term is migrate to more scalable layer 2 blockchains like Arbitrum and Optimism.**
Liquidity mining is most effective when it’s used to “jump-start” network effects in a nascent ecosystem. In Uniswap’s case, a jump-start for liquidity could encourage trading and integrations from applications that require external liquidity. Taker demand and integrations could encourage more folks to provide liquidity to earn trading fees, which in turn could encourage more integrations, and so on. This “flywheel” effect has played out to some extent on Ethereum layer 1 already, but has yet to be sparked for layer 2 deployments.
Liquidity mining incentives on these chains could be a helpful jump-start.
There are issues with the pairs chosen for incentivization.
“Deposit Receipt Tokens” are not a promising DEX market. Redemption of these tokens from the protocols themselves (e.g. Compound) would potentially be more straightforward and less costly (avoiding slippage and a 5 bp fee). Furthermore, COMP rewards accruing to the cDAI in the DAI-cDAI market would be forfeited.
It’s worth noting, however, that a relatively small portion of incentives (~2%) will be going toward these pairs.
Incentivizing 5 bps stablecoin pairs won’t necessarily make Uniswap v3 more competitive. Offering low slippage on stablecoin<>stablecoin pairs is easier due to their low price volatility. As such, the determining factor is trading fees. Pouring more capital into a 5 bps fee pool won’t necessarily make Uniswap v3’s pricing more attractive, as lower cost pools exist such as Curve’s 3pool (3 bps fees) and DODO’s USDC-USDT pool (1 bps fees). Indeed, most USDC-USDT volume from 1inch is routed to DODO.
There isn’t a clear quantitative methodology behind identifying the mid tail pairs. The reasoning isn’t clear behind the 5 DeFi governance tokens chosen for incentivization as “mid tail pairs.” One of these tokens, AAVE, is not a great candidate given that liquidity is dominated by a balancer pool that provides users with LP tokens that can be used in AAVE staking. 1inch AAVE-ETH routing is dominated by this pool.
These shortcomings, in conjunction with the high price tag, should encourage the community to look for other ways to address the core purposes fueling the proposal. In light of this analysis we offer a few potential solutions below and welcome the community’s feedback in continuing this dialogue.
Looking forward:
There could be some lower cost ways for the treasury to incentivize LP migration to v3:
- If the problem is high gas cost, the treasury could subsidize a % of gas costs for new LPs.
- If the problem is lack of awareness and tools, there could be a grant for building better tools and documentation around v3 LPing.
- There could be a grant to build easy tools for other teams to incentivize liquidity on v3. For example, Fei incentivizes a large pool on Uniswap v2. Understanding these uses and working with teams to incentivize v3 liquidity instead of v2 could be high leverage for UNI holders.
Furthermore, we think using liquidity mining to bootstrap layer 2 deployments could also be a high leverage use of funds.
**a16z is an investor in Optimism.