[Temperature Check] - Activate Uniswap Protocol Governance

This is definitely an interesting proposal and I think it is already visible here that there’s a lot of support and excitement. My view is that this grassroots support will only increase and it’s understandable why, UNI holders believe that the UNI token should concretely capture some value from the tremendous success of the Uniswap Protocol that it stewards. From this vantage point, I wholeheartedly agree and think the proposal is a great thing, I personally support the first step in this direction. But…

TLDR: In my opinion, for this to work well, there will need to be incentives introduced for Uniswap LPs in tandem, likely in the form of revitalized liquidity mining programs with the UNI token (open to other ideas as well).

Below is an in-depth explanation of why:

As a champion of Uniswap LPs (founder of Arrakis :wave:) this proposal needs to be balanced with the reality that the excitement apparent here is mostly around the UNI token having some value capture mechanism, and that this value is directly captured from Uniswap LPs pockets. Uniswap LPs support the protocol immensely and take a lot of risk / leak a lot of value to other parties, due to the nature of how Uniswap and all other current DEXs are designed (there is a huge amount of research and discussion going into next generation DEX designs that mitigate some of these problems, but today all the popular DEXs in production remain plagued with value leakage from LPs to arbitrageurs). Further, the Uniswap Labs user interface has already signaled it is increasingly open to reducing the amount that it’s precious non-toxic order flow is routed exclusively to the Uniswap Protocol. Basically, what needs to be addressed is how Uniswap LPs are going to also benefit from such an action, because if not, there remains legitimate risk that LPs will take their inventory elsewhere. If LPs don’t even lose access to Uniswap Labs order flow, then they really have nothing to lose and everything to gain by LPing on other venues. They avoid this new protocol “tax” and often gain further auxiliary token incentives used by competing DEXs to incentivize Uniswap LPs to move their inventory to new venues (famously the UNI token was actually released at least partially in response to just such a scheme by a Uni V2 copycat).

UNI holders and delegates will have financial incentive to maximize their earnings, by voting to maximize protocol fees. We’ve seen with other DAOs that once you introduce these direct financial incentives into what is voted on, it’s hard to reason with voters on any other metric (financial incentives are a hell of a drug). It seems clear to me that there’s basically no way for this to be a sustainable dynamic without also introducing new concrete incentives for LPs. After all, LPs are the bedrock of the protocol’s utility (you can’t swap on the protocol without having liquidity deposited by LPs to swap against).

Lastly there are some important technical questions in a world where Uni V4 is around the corner. AFAIU Uni V4’s flexibility makes it almost impossible to even enforce these protocol fees (you can write hooks in such a way that you try to avoid actual “swap fees” while still properly pricing liquidity and compensating LPs, basically hooks can try and get around the protocol fee which is something that definitely needs to be carefully considered by protocol engineers). In general we don’t want to create friction between LPs and UNI voters, and I see potential cat-and-mouse games once LPs can also customize DEX logic to their liking.

I really want to see the Uniswap Protocol succeed. From the beginning I have been captivated by the potential and by the groundbreaking research and engineering that is the Uniswap Protocol, a shining jewel of the ethereum application layer. I think this is a step in the right direction because the proper alignment between Uni Protocol, Uni LPs, UNI holders, and Uni Labs really needs to be investigated more. Onchain trading is currently going through a metamorphosis and Uniswap Protocol could remain at the center of it, but this isn’t preordained, retaining network effects around Uniswap liquidity depth will be incredibly important.