Uniswap Fee Switch Proposal Explanation | Deducting a portion of LP fee profits to protocol revenue

The token UNI of the leading decentralized exchange protocol Uniswap, while pioneering as a governance token, has long been criticized for its perceived lack of utility. Earlier this month, The Block researcher mhonkasalo proposed four improvement mechanisms for the UNI token, with the most notable change being an experiment to transfer transaction fees. On the 19th, Leighton, co-founder of PoolTogether, initiated a discussion on the governance forum and launched a community vote to assess the community's opinion on this change.

Where Will the Transaction Fees Go?

According to mhonkasalo's proposal, it is suggested that Uniswap can activate a transaction fee switch in specific liquidity pools to generate protocol revenue by sharing 10-25% of the LP fee profits with liquidity providers.

As Uniswap currently does not impose any service fees, mhonkasalo believes that this approach could bring revenue to the protocol treasury.

However, in subsequent community discussions, there arose assumptions that protocol revenue would be transferred to UNI token holders, which Leighton clarified in the community proposal here.

Leighton pointed out that the term "fee switch" might not be the most appropriate phrasing, as it means Uniswap retains a portion of the fees that were originally meant for LPs to provide UNI holders with new resources to foster protocol development, such as:

• Increasing funding for public goods
• Establishing protocol-owned liquidity
• Providing funding for technical grants or donations

However, this does not imply that token holders will receive additional token income.

Additionally, Leighton mentioned that Uniswap, as the most utilized DeFi protocol, would face significant risks if this proposal were to be implemented.

Should This Approach Be Adopted?

Despite the need to bear some risks, Leighton believes that testing this approach in a limited environment could be beneficial. Apart from providing real data, it also allows the community more time to consider how to utilize the assets accumulated through this mechanism.

Leighton proposed conducting experiments with this mechanism on the two largest liquidity pools:

• USDC / ETH with a 0.05% fee level, charging a 10% fee
• USDC / USDT with a 0.01% fee level, charging a 10% fee

According to Dune Analytics data, the total LP fees over the past 7 days amount to approximately $9.93 million, which could generate nearly $1 million in revenue based on a 10% charge.

How to Determine Feasibility?

Leighton suggested using transaction volume to assess the impact of this mechanism on the ecosystem. Many users are concerned that this mechanism may lead to LP migration to other protocols, affecting the depth of liquidity pools. Therefore, Leighton believes that if the transaction volume does not decrease due to the implementation of this mechanism, to some extent, the experiment is successful.

However, some users propose testing this mechanism on pools with lower utilization to avoid significant impact on protocol operations. Additionally, there are dissenting voices regarding the 10% fee proportion being too high. Considering temporary losses, imposing an additional 10% fee could potentially turn LPs from profit to loss directly.

Leighton has initiated a community vote on this proposal to gauge the initial community sentiment, with the current approval rate nearing 100%.