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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