What happens when Uniswap turns on the fee switch?

Uniswap is by far one of the most striking examples of a protocol’s massive success and a disjointed token performance. Uniswap is the largest decentralized exchange by trading volume on Ethereum L1, with a 67.9% share, and it is like a cash cow, generating $1.2 billion in revenue for its LPs over the past year. It even surpassed Ethereum in daily fee income at some point.

What happens when Uniswap turns on the fee switch?

Uniswap Market Share – Source: Dune Analytics 

In the Ethereum ecosystem, Uniswap is the largest protocol by market value, but UNI has performed quite poorly. For example, in the past year, UNI has lost about 51% of its value relative to Ethereum.

Despite the considerable volatility in the market right now, the common argument for underperformance stems from the fact that Uniswap cannot turn on the protocol fee switch.

The opening of the protocol fee switch can only be done through governance voting by UNI holders. When the fee switch is turned on, the Uniswap DAO is able to take 10%-25% of the revenue of the decentralized pool. This is why the Uniswap protocol itself has value.

The fee switch has not been turned on since Uniswap V3 went live in May 2021. That may soon change, however, as PoolTogether founder Leighton Cusack’s proposal to turn on the fee switch for three mining pools has passed the first two stages of Uniswap governance voting. If the proposal officially passes execution, it will show the market that Uniswap governance can turn the fee switch on. This also raises some key questions:

  • Can Uniswap successfully flip the fee switch without losing market share?
  • How much can the protocol gain from this proposal?
  • How much does it cost to activate fee switches for all liquidity pools?
  • What does this mean for UNI tokens?

Proposal Status

Before we expand, let’s first understand what a fee switch proposal is.

The proposal proposes to charge 10% of LP fees from the three stablecoin pools deployed by Uniswap on Ethereum, which is the lowest possible charging standard, and the protocol allows for 10%-25% of LP fees to be drawn on a per-pool basis. The selected pools and their fee tiers are as follows:

  • ETH-DAI (0.05%)
  • ETH-USDT (0.30%)
  • ETH-USDC (1%)

The fee switch will open in about four months, and all earned fees will be credited to the Uniswap DAO treasury. In the meantime, another proposal will come up where token holders will have the option to vote to turn off the fee switch for all three pools.

So far, the proposal has passed the first two stages of Uniswap governance in Snapshot: temperature and consensus check voting. 3.5 million UNIs voted in favor, while only 54 UNIs voted against, overwhelmingly passing the temperature check.

The second proposal with the fee switch turned on will go to a consensus check vote after the community gets feedback and studies the revision again. Unlike activating the two most active pool fee switches on the DEX, in order to test preset time periods for multiple fee tiers, this secondary implementation requires more verification methods to activate the fee switches of the three pools mentioned above. The second proposal passed again overwhelmingly, with 19 million votes in favor and only 481 against.

While the proposal still needs to go through a final, binding on-chain vote to be formalized, based on turnout and governance forum comments, the proposal appears to have gained broad support within the community and Uniswap seems likely to open all three Pool fee switch.

Will Uniswap lose market share?

Why can Uniswap flip the fee switch without losing a lot of market share?

If there is an objection to turning on the fee switch, the rationale is simple: if Uniswap turns on the fee switch, they will lose a large market share and liquidity will move out due to their profit compression. This risk is largely due to the fact that providing liquidity on Uniswap V3 is very difficult, as it uses centralized liquidity and requires more active management than constant products or LPs that trade AMMs stably.

In a sluggish market context, cutting LP’s margins could create a negative feedback loop. Uniswap loses liquidity, resulting in poor transaction execution experience, resulting in lower transaction volumes and returns for LPs, which in turn causes DEXs to further lose market share, while competitors gain more market share.

This risk is magnified in the highly competitive DEX field. There is almost no difference between products of the same type. If the price increases by itself, the market will choose the cheaper one. At the same time, DEX is also easy to fork. Since the Uniswap V3 code is protected by a commercial license, there are few unauthorized forks.

While this argument may seem convincing, Uniswap should be able to flip the fee switch for several reasons. Of these, sticky volume and sticky liquidity are probably the most attractive. Due to its strong branding, many traders will use Uniswap exclusively, rather than routing all their trades in aggregators in search of best execution, giving rise to the concept of sticky protocol participants, and the same is true for liquidity participants. Uniswap has a track record and design where contracts are immutable except for fee switches. Despite protocol fees, LPs may prefer to keep doing things on the DEX rather than migrating to a competitor.

Additionally, almost all other major spot or derivatives DEXs such as Curve, Balancer, SushiSwap, GMX, dYdX, and Perpetual Protocol charge LP fees. Uniswap also appears to be able to collect fees without losing a sizable percentage of its market share.

What happens if the fee switch for all three flow cells is turned on?

Let’s start analyzing how much Uniswap would gain if three pools charged a 10% protocol fee. In order to understand the benefits under different market conditions, we will look at the fees earned over the past 30 days, 120 days (the activation time in the proposal) and 365 days, in addition, we will also look at the total Uniswap trading volume and LP fees from the three which of the pools.

30 days

What happens when Uniswap turns on the fee switch?

Over the past 30 days, the three pools have traded a combined volume of $1.31 billion and earned around $2.9 million in fees. If the fee switch is turned on, Uniswap will receive $290,000 in protocol revenue in the past month, or $3.48 million annually.

What happens when Uniswap turns on the fee switch?

By far, the largest fee contributor is the WETH-USDT pool, which contributed 74.4% of the protocol’s revenue during this period, while the three pools also accounted for 3.08% and 5.71% of Uniswap’s total transaction volume and fees, respectively.

120 days

What happens when Uniswap turns on the fee switch?

Over the past 120 days, the three pools had a combined transaction volume of $6.41 billion, generating approximately $16.04 million in fees for LPs. If the fee switch is turned on, Uniswap will receive $1.6 million in protocol revenue, or $4.87 million annually.

What happens when Uniswap turns on the fee switch?

By far, the largest fee contributor is the WETH-USDT pool, which contributed 81.7% of the protocol’s revenue during this period, while these three pools also accounted for 3.32% and 6.68% of Uniswap’s total transaction volume and fees, respectively.

365 days

What happens when Uniswap turns on the fee switch?

Over the past year, taking into account the cyclicality of on-chain transaction activity, the three pools had a combined transaction volume of $40.4 billion, generating approximately $78.19 million in fees for LPs. If the fee switch is turned on, Uniswap will receive $7.82 million in protocol revenue.

What happens when Uniswap turns on the fee switch?

By far, the largest fee contributor is the WETH-USDT pool, which contributed 80.8% of the protocol’s revenue during this period, while the three pools also accounted for 5.69% and 6.47% of Uniswap’s total transaction volume and fees, respectively.

Further explanation

As analyzed above, if the fee switch is turned on for the three pools, Uniswap will generate annualized returns of $3.48 million to $7.82 million, depending on the time period. In addition, in the three time periods, the largest contribution to the profit will be the WETH-USDT pool, which accounts for 74.5%-81.7% of the protocol revenue. The bottom line is that these three pools only account for a small percentage of Uniswap’s total trading volume, ranging from 3.08% to 5.69%, and 5.71% to 6.68% of total fees.

All in all, this suggests that the proposal is only a small step in Uniswap’s monetization attempt, and if the fee switch attempt proves to be successful, it suggests that there is still plenty of upside in terms of earnings.

What would happen if the fee switch for every pool was turned on?

It may seem impractical to turn on the fee switch for all mining pools, but if the experiment is successful, Uniswap will likely choose to turn on more fee switches, and it is customary for DEXs to earn fees from each transaction on their platform. Through calculations, we can better understand the potential profitability cap of Uniswap.

For simplicity, we will assume a fixed rake of 10% for all pools, and we will test again in the same time frame.

What happens when Uniswap turns on the fee switch?

If the 10% protocol fee is used as a standard, Uniswap has earned $5.07 million (about $61.68 million annualized), $23.99 million (about $72.96 million annualized) and $120.8 million in the past 30 days, 120 days, and 365 days, respectively Dollar. It is worth noting that this will be pure protocol profit, Uniswap does not issue any token rewards to liquidity providers.

What happens when Uniswap turns on the fee switch?

Dapp’s Protocol Revenue – Source: Token Terminal

Looking at 365 days of data, Uniswap will generate the seventh-highest revenue among all DApps, behind NFT marketplaces such as Axie Infinity, OpenSea and LooksRare, DEX’s PancakeSwap and dYdX, and MetaMask Swap.

But considering protocol revenue minus token releases, Uniswap would have the third-highest protocol revenue after OpenSea and MetaMask.

High Yield UNI Token

Although the fee switch proposal does not require distribution of income to token holders, it is highly likely that in the future UNI holders will choose to reward themselves by repurchasing or distributing assets such as ETH and stablecoins. UNI will also transform from a purely worthless governance token into a productive asset.

Let’s assume that the Uniswap DAO chooses to distribute 50% of the profit from the fee switch through some mechanism, and UNI holders can earn income through token staking. Let’s also assume that 75% of the circulating UNI is staked and some supply remains on the exchange. From the graph we can see that UNI holders will receive 1.25% to 2.44%.

What happens when Uniswap turns on the fee switch?

UNI benefits if fee switches are active for all liquidity pools

Although this return is lower than other DEX tokens like veCRV and GMX, which typically pay between 4% and 8% in 3CRV and Ethereum. But considering Uniswap’s brand position in the industry, the return is still very attractive.

summary

As analyzed above, the impact of turning on the Uniswap fee switch is huge. The activation of the three pools is also just a small attempt to monetize its monetization capabilities, and the wider fee switch will immediately turn Uniswap into one of the most profitable applications in the Web3 industry. In addition, if the DAO rewards some of the proceeds to token holders, UNI will become an attractive productive asset, and the yield is not as good as some of its peers, but it is also very attractive.

Of course, these numbers are based on certain assumptions and are extrapolated using historical data and do not include any potential future growth. Given Uniswap’s special status as a DeFi protocol, its successful opening of the fee switch will signal to the market that valueless governance tokens can actually capture value.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/what-happens-when-uniswap-turns-on-the-fee-switch/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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