Cost of Fee Switch

activating the protocol fee comes at a cost

Alex @lajarre | 🧈 Butter

EBS 2023-11-07

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Agenda

  1. πŸ¦„ Uniswap model
  2. πŸ§›πŸΌ Attack
  3. πŸ’° Funding mechanism
  4. 🀯 Teachings

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πŸ¦„ Uniswap model

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Uniswap v2 fork competition game

Model:

  • 2 competing AMMs
  • A ↔ B pools
  • Swappers allocation:
    cost ≃ price impact
  • LPs allocation:
    revenue ≃ volume

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Swappers allocation

Price impact:

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

Swappers allocation

Utility:

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🧈 allocate more towards AMM with larger reserves

Swappers allocation

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🧈 marginal allocation
towards AMM
with larger volume

LPs allocation

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Equilibrium under network effects

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πŸ§›πŸΌ Attack

fork + subsidy = liquidity flight

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Simple model:

  • fee switched on forever

Fee switch

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Intuition:

  • If fee switched on, then no-fee competitor captures more than its fair share.
  • Use this extra volume to fund a subsidy.
  • With enough subsidy, network effects move equilibrium towards competitor.

Allocation game

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🧈 at equilibrium, subsidy makes LP allocation indifferent

🧈 equilibrium +Ρ counteracts network effects: liquidity flight

Subsidy

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⚠️ reallocation will be lower because of switching costs
(brand, smart contract risk, legal…)

V = 10^8 USD
R = 10^7 USD
R_1(0) = 100%

Total cost

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πŸ’° Funding mechanism

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Intuition:

  • AMM 2 has no fee switch in its governance surface
  • raise debt rather than equity to fund the subsidy
  • funding via governance mechanism or crowdfunding

Funding mechanism

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Subsidy funding

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🧈 avoid equity-like funding: capture via wealth condensation

🧈 if governance surface:

Debt(GovernanceFutureRevenue)

➑️ parameter auctions
➑️ proposal auctions
➑️ auctions & futarchy

🧈 crowdfunding: LPs and swappers will fund if more efficient (coasean argument)

Source of funds

see https://ethresear.ch/t/governance-mixing-auctions-and-futarchy/10772

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what does this prove about governance?

🀯 Teachings

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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 eXtractible Value

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🧈 forking & smart contracts influence governance

🧈 grim trigger on UNI tokenholders

Internalize externalities

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πŸ‘‹ 🧈

twitter.com/butterymoney

twitter.com/lajarre

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Cost of Fee Switch

By lajarre

Cost of Fee Switch

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