Protocol fees lead to attacks

Article: Stackelberg Attacks on Protocol Fee Governance

Alex @lajarre | 🧈 Butter

Edge City

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1. 🦄 AMM model
2. 🧛🏼 Attack

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🦄 AMM model

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AMM fork competition

Game:

• 2 competing AMMs
• Swappers allocation:
  cost ≃ price impact
• LPs allocation:
  revenue ≃ volume

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Fee switch

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Dynamic competition

block i-1

block i

block ii+1

Traders allocate

LPs allocate

Traders allocate

LPs allocate

Traders allocate

LPs allocate

...

Traders allocation

Price impact:

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See Angeris et al: "An analysis of Uniswap markets", 2019

Traders allocation

Utility:

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Allocate more towards AMM with larger reserves:

Traders allocation

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LPs marginal allocation

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If no protocol fee: proportional allocation

If protocol fee                  :

🧛🏼 Attack

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Game:

• Governance: set fee

• LPs: commit to any smart contract strategy

             => includes forking!

Governance vs LPs with arbitrary commitments

Grim Forker contract

New equilibrium

• "Mere LPs" should participate in Grim Forker (interim rational)

• Induces a threat => upper bound on protocol fee

🧈 forking & smart contracts influence governance

🧈 grim trigger on UNI tokenholders

Internalize externalities

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🧈 XV is the present value extracted by UNI tokenholders out of the protocol

🧈 XV is limited by the attack:

• either ρ > 0 is fixed: volume will be reduced ultimately to 0
• either ρ is modulated to limit liquidity flight

Upper limit on Governance Extractible Value

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👋 🧈

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twitter.com/lajarre

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