# Cost of Fee Switch _activating the protocol fee comes at a cost_ --- ## Agenda 1. Uniswap model 2. Attack 3. Funding mechanism 5. Teachings --- ## Uniswap model 🦄 --- ### Uniswap v2 fork competition game Model: - 2 competing AMMs - A ↔ B pools - Swappers allocation: cost ≃ price impact - LPs allocation: revenue ≃ volume  --- ### Swappers allocation Price impact:  --- ### Swappers allocation Utility:  See Angeris et al: "An analysis of Uniswap markets", 2019 <!--  --> --- ### Swappers allocation 🧈 allocate more towards AMM with larger reserves --- ### LP allocation  🧈 marginal allocation 100% towards AMM with larger volume --- ### Equilibrium under network effects   --- ## Attack Simple model: - fee switched on forever 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. --- ### Fee switch  --- ### Subsidy (vampire attack) 🧈 at equilibrium, subsidy makes LP allocation indifferent 🧈 equilibrium +ε counteracts network effects: **liquidity flight**  --- ### Total cost As a function of ratio of LP re-allocating: ⚠️ ratio will be lower because of switching costs (brand, smart contract risk, legal…).  V = 10^8 USD R = 10^7 USD R_1(0) = 100% --- ## Funding mechanism Intuition: - AMM 2 has **no fee switch in its capture surface** - raise debt rather than equity to fund the subsidy - funding via governance mechanism or crowdfunding --- ### Subsidy funding  --- ### Source of funds 🧈 avoid equity-like funding: capture via wealth condensation 🧈 if governance surface: `Debt(GovernanceFutureRevenue)` - parameter auctions - proposal auctions - auctions & futarchy: https://ethresear.ch/t/governance-mixing-auctions-and-futarchy/10772 🧈 crowdfunding: LPs and swappers will fund if more efficient (coasean argument)  --- ## Teachings _what does this prove about governance?_ --- ### Upper limit on eXtractible Value 🧈 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 moduldated to limit liquidity flight  --- ### Internalize externalities 🧈 forking & smart contracts pressure actual governance 🧈 grim trigger on UNI tokenholders --- # 👋 🧈 twitter.com/butterymoney twitter.com/lajarre https://bit.ly/3QvNsQj