Temperature check about making $UNI great again.
A short history of uniswap
Initially launched in 2018, from an idea inspired by Vitalik’s post in r/ethereum and a blog post:
https://www.reddit.com/r/ethereum/comments/55m04x/lets_run_onchain_decentralized_exchanges_the_way/
https://vitalik.ca/general/2017/06/22/marketmakers.html
While a proof of concept was first made just before Devcon 3, this lead to an ethereum grant application which got accepted in grants update wave 3. Uniswap v1, as it was called, was launched in 2018.
https://twitter.com/haydenzadams/status/1058376395108376577?s=20&t=Q6_qavrwVC85_CuoisvVcg
Uniswap v2’s overview was first published in march 2020 and was launched just a few months later, just before a period, and probably also a catalyst, called defi summer.
Uni was one of the most thriving decentralized exchange and by September 2020, just before the launch of its token, it had:
The token launch was almost entirely spurred by the fork of the protocol called sushi which launched the first vampire attack of its kind by incentivizing LPing with the use of $sushi tokens.
The UNI Token
First, let’s take a look at the tokenomics
The uniswap token launched with a supply of a billion tokens, where 40% was reserved for advisors, investors and the team, while 60% was reserved for the community.
There’s also token inflation which will start at 2% from the 4th year onwards, i.e. 2024 for us.
A quick overview of the 60% given to the community, 15% was airdropped to LPs, users and Socks holders, while 43% was given to the “community treasury”, and the 2% was used to run the only Incentivized liquidity program in Uniswaps existence.
Uniswap V3
Just a year after the launch of Uni v2, Uni v3’s introduction was made and similarly launched in May 2021. By the time v3 was launched around 150 billion dollars of volume had been clocked on Uni v2.
Uni v3 was launched with the idea of Concentrated Liquidity AMM, while the v2 was a xy=k AMM. The CLAMM was, in practice, meant to be more efficient but came at the sacrifice of a more straightforward interface with LP tokens. Liquidity providers had to control the range of their liquidity in a tick-based fashion, similar to what we see in CLOBs. This information capture meant that the LP token could no longer be a simple ERC 20 token and was shifted to an NFT. Also, passive LPing was no longer entirely possible (although the full range option was possible, fee capture would be a few magnitudes lower than those who controlled their LP positions somewhat actively.
Having suffered the issue of forks with Uni v2, Uni v3, for the first two years of its existence, would be under a business license and will convert to a GPL immediately after i.e. uni v3 will be under a GPL license by May 2023.
Was the CLAMM model successful? Since the launch of Univ V3, it has seen a cumulative volume of 640 billion dollars$. Achieving a variety of milestones along its way,
https://twitter.com/haydenzadams/status/1384534770214916097
https://twitter.com/haydenzadams/status/1529105703427878912?s=20&t=oLu-SGSiQNrkkrmNJ_JOIQ
Uniswap, on average daily, sees at least 1-1.25 billion dollars of volume daily and also enjoys an almost monopoly status capturing the majority value share in the dex market.
Uniswap a Business or a public good?
Since the launch of Uniswap v2, everyone was waiting for the launch of the token. Once the token launched, it debuted as a “valueless governance token” and has maintained that status quo since then.
Despite seeing a trillion dollars in volume, none of the value that could’ve been captured as fees by the protocol has been captured, and, as it stands, uniswap today makes no revenue.
One of the significant contentions for not starting the fee switch on Uniswap pools is that LPs would migrate to other exchanges. While true to a certain extent, what is also true is that Uniswap v3 enjoys its position as the only CLAMM in existence and LPs enjoy capital efficiency just as much. With UNI v3’s business license ending in a year and other concentrated liquidity DEXes launching soon, that status is under question.
Before I talk about the other potential issues and address a recent proposal for this fee switch, let’s do a hypothetical analysis of what it would have been like if uniswap successfully flicked the fee switch on.
The protocol in the past week has seen a volume of around 6.5B $ and has accrued ~7.6M $ in fees to LPs.
Assuming that the lowest possible fee is chosen around 1/10th, that is about 760k$, but given that the average weekly volume of uniswap has been around 9-10 billion dollars, that is about 900k - 1M $ per week, or about 46.8 - 52 million dollars of fee accrual, i.e. in simple words revenue accrued to the protocol.
But won’t the LPs migrate? Let’s assume in this instance that turning the fee switch on has an LP value erosion effect, and about half the volume drops, so about 4.5-5B $ volume every week and the fees would amount to 23-25 million dollars annualized.
Even if you assume that about 20% is given to the treasury for protocol growth, about 18-20 million dollars of revenue could be returned to holders of the token, which at current rates would result in about an earning per token of about 0.04$ EPT (only circulated supply considered).
This does not account for any protocol growth and assumes adverse LP effects (which is not necessarily true).
Do LPs in uniswap v3 make money? In a series of blog posts, 0xfbifemboy analyzed the nature of LPs in various scenarios.
- In “A Study on Apes: Profits vs Impermanent Losses”, a study of the first 24 hours of LP performance after the launch of apecoin, around 86% of LP positions were in profit, but the majority of them suffered IL loss, the profit of LPs could be attributed to the performance of apecoin. Another aspect is that the median fees earnings were 3.3% of the principal.
- In “Impermanent Loss and JIT Liquidity in the Uniswap ETH/USDC 0.3% Pool”, a study of a relatively mature pool ETH/USDC in the 0.3% fee pool. It was found that smaller LPs found it challenging to manage LP positions actively, and as a result, their LP positions drifted out of range (in this case, the LP position suffers from IL and doesn’t accrue any trading fees either). 41% of the LP positions in the pool (when the post was written were not earning any trading fees). About 4.1% of all minted positions were JIT liquidity and it was found that they are highly efficient in generating trading fees.
- In “Theory vs Practice: A Deeper Look at ETH/USDC Liquidity Dynamics”, A deeper look at the most liquid pool on ethereum, i.e. the ETH/USDC, across different fee tiers. The concentration of liquidity in the 0.05% fee pool was found to be higher than that in the 0.3%, showing a conscious rational choice by the LPs. While also pointing out that the liquidity in the 0.05% fee pool was dominated by a small number of large players. An analysis of the fee generation revealed that the 0.3% fee pool consistently outperformed fees generated in the 0.05% fee pool, often by double digits percentages.
- In “Unraveling a Puzzle: A Per-Wallet Analysis of ETH/USDC Liquidity on Uniswap V3”, An exploration of the ETH/USDC liquidity on a per wallet basis showed that the profits were essentially random. The users with the highest profits were deploying liquidity in narrow positions akin to a limit order, also adding that this was not due to skill but that positions tended to converge to this style of liquidity deployment.
- In “Stablecoins on Uniswap V3”, a preliminary study of stable positions in uniswap v3.
TL;DR, LP-ing in uniswap is hard.
Where does Uniswap spend money?
Uniswap has spent money on
- Uniswap grants program, which spends about 1.5M $ per quarter. Look here for details of what ideas and avenues have been funded. The retrospective for this program can be found here.
- Funding a few liquidity mining programs on arbitrum and optimism
- Funding a 1M uni for political defence of defi/ Defi Education Grant.
- An ongoing proposal to fund a Uniswap Foundation with 74 million dollars is likely to pass. The proposal can be found here. The proposal also requests about 2.5M Uni for voting purposes.
- The foundation will also subsume the UNI grants program and is asking for 60 million dollars for it.
While there have been various reasons to oppose this, the idea of a uniswap foundation somewhat seems antithetical also because protocol management seems to be one of the most significant responsibility of such foundations, and this already happens on uniswap forums through its governance process, which is non-trivial to involve yourself in given the proposal creation and quorum criteria. The raison d'être of this uniswap foundation majorly seems to expand the grants program.
A recent governance proposal
It would be sloppy to miss the recent governance proposal, which suggested a small pilot on this matter.
https://gov.uniswap.org/t/fee-switch-design-space-next-steps/17132
Something that seems to have been quietly spoken about and being passed.
Some points in the proposal and discussion in this and the follow-up proposals
- No information on LP reaction if the fee switch is turned on. Essential to note that an adverse reaction affects the usage of the protocol, i.e. if LPs migrate to other platforms.
- Uniswap v3 enjoys its position as the only CLAMM in the space, and I’m not entirely sure if LPs would prefer the less efficient and more IL-prone AMM model to this anymore.
- The fee switch discussion might be premature, and there is no concrete framework on utilization of the fees collected, i.e. how much should be handed out to users, if at all or to who does this accrue?
- Potential incentivization of LPs locking liquidity in the protocol.
- LP incentivization has always put the protocol at a loss if fees accrual is considered, and existing examples are yet to be analyzed heavily to support this argument. Sushiswap, one of the popular exchanges, was spending about 48 million dollars annualized at the height of its existence on LP incentivization.
- Gamma strategies mention the razor-thin margins in Uni v3 LP-ing and suggest finding other revenue accrual ways instead of putting negative pressure on LPs.
- Research on the Economics of AMMs shows (something spoken about in the proposal)
- In a perfectly efficient market, the protocol with the lowest take rate (fraction of fees that goes to the protocol) attracts all liquidity. This is an argument against flipping the fee switch.
- The result is different in a market where a protocol like Uniswap has a “moat”. According to our model, this competitive advantage makes it possible for Uniswap to sustainably introduce a non-zero take rate even when competing with zero take rate competitors.
- Legal implications of turning on the fee switch [Unknown]
The current proposal, in its final form under vote in snapshot, includes turning on the switch for the following pools:
- DAI-ETH-0.05%
- USDT-ETH-0.3%
- USDC-ETH-1%
Where do you use protocol revenue?
One contentious issue in the proposal seems to be the issue of “using” this, and in what form will it be used?
- Uniswap grants - Currently, Uniswap grants are spent out of the protocol treasury, and revenue could be used to funnel that.
- Dividend to UNI holders - Uniswap, if it does, would be one of the first protocols to give back to users without incentivizing the usage of this product, almost every other defi protocol which claims to give back when adjusted for LP incentivization is in a net negative.
- While the Uni foundation claims to be an entity for this, every penny spent in Uniswap through governance comes through its treasury (and while the treasury is vast and bigger than even ethereum foundation), this is bottom line fueled growth/spending and surely erodes the balance sheet were you to view uniswap as a business.
- Protocol growth
Final Thoughts
While the vote for the above proposal is still ongoing, There seems to be enough pushback inclining the position of a protocol-wide fee switch not possible soon.
Uniswap v3 enjoys a monopoly in the DEX design space today, which is not necessarily true in the future. While the protocol community treasury enjoys about 350 million UNI (about 2.5B dollars at current prices) in its hold, revenue accrual is probably a cornerstone of any successful decentralized finance protocol and uniswap could, if it chose to, become an exemplary defi business.
On the other hand, the community treasury could also be used to guarantee the existence of the protocol in perpetuity, funding various shenanigans along the way and still being a net positive to the ecosystem and enjoying a place as a public good. But would this keep the price of the UNI token afloat? Some proponents of this could argue that the speculation flywheel of crypto would always value UNI at a non-trivial valuation.
While protocol revenue remains a good argument for turning on the fee switch, one of the better arguments for turning on the fee switch is to collect fees from JIT Liquidity.
JIT Liquidity, or just-in-time liquidity, is common in UNI v3. In this instance, a (malicious) actor provides liquidity for a large trade when the trade is registered in the tick/s that the trade is happening and captures the majority of the fees possible. Turning on the fee switch would allow not only to capture part of the fees of this trade (since it’s done chiefly during large trades) it could also be considered to return some of the fees to the LPs to protect them. JIT liquidity also harms the users that have provided liquidity passively and makes IL worse for them. While I’m not aware if the uniswap protocol allows this addition to its code (since it’s not upgradeable), it could also be possible for protocols to add dynamic fee capture (at least on pools where its a common occurrence), which targets JIT liquidity capturing up to 25-50% of the fees for liquidity that’s added during trade execution.
Is Uniswap a business or a public good?
Some Resources
- Dune Dashboard - Uniswap v3 volume and fees collected
- Dune Dashboard - Dex Metrics
- Dune Dashboard - Uniswap v2 vs v3
- Uniswap Governance Forum
- The economics of market makers - Arxiv paper