Unpacking Uniswap’s ‘Fee Switch’ – Decrypt

There’s been a long-standing debate within the DeFi community about a small piece of code in Uniswap, the popular decentralized exchange. 

It’s called the “fee switch” and has massive implications for the protocol and the holders of its token, UNI. 

Here’s how it works.

Right now, it costs 0.3% to trade tokens on Uniswap. Of that small percentage, the entire amount goes to liquidity providers (LPs) for that specific trade. But if this fee switch (also called “protocol charge” by Uniswap) were flipped on, 0.25% would go to LPs and the remaining .05% would theoretically go to UNI token holders just for holding the token.

It’s still unclear, however, exactly how they would capture this value (i.e. as a yield on their holdings for staking, more airdrops, or something else). SushiSwap, a fork of Uniswap, also lets users earn .05% on all trades for holding a staked version of SUSHI called xSUSHI, for example.

The thinking 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.”

Importantly, this fee could be activated by a governance vote. If enough UNI holders want to flip the switch, they can.

Let’s examine how much value this could accrue to UNI holders. Over the past month or so, Uniswap has played host to between $36.9 million and $130 million in daily volume.

Let’s say, for simplicity’s sake, this averaged out to about $83 million per day.

Now, if we take .05% of that $83 million, we get roughly $41,500 that would be distributed to UNI holders each day. Remember, this is based on average 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 held, the more they could potentially earn from this distribution.

For UNI holders, this obviously seems hugely enticing—it’s basically more free money.

So, what’s the catch?

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

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

But many clever folks are already hard at work attempting to find a middle ground. Leighton Cusack, CEO and cofounder of the no-loss lottery project PoolTogether, suggests testing out the fee switch on a few select pools to see how LPs react.

He believes the switch should indeed be turned on, but “in a limited testing capacity.” Trialing the fee switch in low-stakes pools would give the community real data to work with and offer “more time to consider how assets accrued via this mechanism should be used,” he wrote in a Uniswap governance proposal on Monday.

Cusack also made the important point that this decision isn’t as binary as people think.

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

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

It’s a big decision, 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 spook the bulls with new tokenomics.

Juan Pellicer, an analyst at IntoTheBlock, confirmed much of the same, telling Decrypt that “UNI has been performing better than other ‘blue-chip’ DEXs such as CRV (#94), SUSHI (#134), or BAL (#176). This overperformance compared to its competitors shows that UNI does not necessarily need to accrue revenue. Liquidity providers margins are already low, and removing some of their income with the fee switch could cause a potential liquidity loss to the protocol.”

Only time will tell, but as Uniswap is one of the more influential DeFi projects, keeping close tabs on this decision is a must.

Want to be a crypto expert? Get the best of Decrypt straight to your inbox.

Get the biggest crypto news stories + weekly roundups and more!

Leave a Reply

Your email address will not be published.