Unboxing Uniswap’s ‘Fee Switch’ – Decipher

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Decrypt DeFi is Decrypt’s DeFi email newsletter. Drawing: Grant Kempster

There has been a long-running debate within the DeFi community over a small piece of code in Uniswap, the popular decentralized exchange.

This is called the “fee switch” and has massive implications for the protocol and the holders of its token, UNI.

Here’s how it works.

Currently, it costs 0.3% to trade tokens on Uniswap. Of this small percentage, the entire amount goes to the Liquidity Providers (LP) for that specific transaction. But if this fee change (also called “protocol feeby Uniswap) were activated, 0.25% would go to LPs and the remaining 0.05% would theoretically go to UNI token holders just for holding the token.

However, it is still unclear exactly how they would capture this value (i.e. as a return on their holdings for staking, more airdrops or something else). SushiSwap, a fork of Uniswap, also allows users to earn 0.05% on all trades by holding a staked version of SUSHI called xSUSHI, for example.

The idea goes, according to the team behind the project, that these redirected funds “would go to a decentralized funding mechanism used to support contributions to Uniswap and its ecosystem.”

It is important to note that this fee could be activated by a governance vote. If enough UNI holders want to flip the switch, they can.

Let’s take a look at what value this could bring to UNI holders. Over the past month or so, Uniswap has hosted between $36.9 million and $130 million in daily volume.

Let’s say, for the sake of simplicity, that averaged out to about $83 million a day.

Now, if we take 0.05% of that $83 million, we get about $41,500 that would be distributed to UNI cardholders every day. Remember, this is based on medium volume; the figure could be much higher or lower.

No one knows exactly, of course, but it would make sense that the more UNI someone owns, the more they could potentially earn from that distribution.

For UNI holders, this obviously looks extremely attractive – it’s essentially more free money.

So what’s the problem ?

Well, those LPs might not be very happy to see their revenue drop. It’s even possible that a drop in revenue will cause them to withdraw their holdings from Uniswap and drain its liquidity. And as we all know, a decentralized exchange is only valuable through its depth of liquidity.

With so much at stake, trying to make the right choice is tricky.

But many smart people are already working hard to try to find common ground. Leighton CusackCEO and co-founder of the PoolTogether no-loss lottery project, suggests testing the fee change on a few select pools to see how LPs respond.

He believes the switch must indeed be activated, but “within a limited test capacity”. Trialling the fee change in low-stakes pools would give the community real data to work with and provide “more time to think about how assets accrued through this mechanism should be used,” he said. he writes Monday in a Uniswap governance proposal.

Cusack also pointed out that this decision is not as binary as people think.

Instead, he wrote, the decision to “toggle the switch” should be discussed as an opportunity “to think creatively about how protocols, governance and value accumulation can work. in Web3”.

Basically, it’s more than just free money for holders. This sum could again be divided into grants for other projects or sponsoring developers to build cooler things.

It’s a big move, and with UNI currently enjoying a stellar run over the past month (up 75% since June 20), there might not be too much appetite to scare the bulls with new tokenomics.

John Pelliceran analyst at IntoTheBlock, confirmed much of the same, telling Decrypt that ‘UNI has performed better than others’blue boat‘ DEX such as CRV (#94), SUSHI (#134) or BAL (#176). This outperformance compared to its competitors shows that UNI does not necessarily need to generate income. Margins for liquidity providers are already low, and removing some of their revenue with the fee change could lead to a potential loss of liquidity for the protocol.

Only time will tell, but as Uniswap is one of the most influential DeFi projects, watching this decision closely is a must.

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