It Feels Good

This past Friday, a governance proposal was posted to the Uniswap portal, igniting the token prices of decentralized financial applications. The UNI token popped 70% and the significance rippled across the space. DeFi’s total market capitalization jumped 5% to $90B and its market share of total capitalization popped 30 bps to 4.8%. These are levels not seen in years.

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Developed by a team of demonstrated innovators and backed by some of the best venture capitalists in the business, Uni is one of the most important protocols in crypto. The technology processes about 55% of overall Decentralized Exchange (DEX) volume or roughly 12% of the total crypto spot market and is often the lone venue for trading smaller cap tokens.

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Decentralized Exchange Trading Volume (in billions, USD)

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The Uniswap Foundation’s (UF) proposal aims to revitalize Uniswap's governance by sharing fee revenue with those who have staked their tokens and delegated the voting rights, addressing issues of apathy and free riding within the protocol's community. Holders of UNI tokens with a long-term investment horizon are likely to be interested in generating yield on their holdings to enhance their overall returns. The proposed framework necessitates that these investors either delegate their voting rights to a more actively involved party or step forward to participate in the governance process themselves. This arrangement has positive supply/demand implications for the token’s price and importantly doesn’t revolve around new issuance/dilution of the asset. Further, concentrating the decision-making among more engaged parties should make for streamlined governance.

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The proposal also outlines technical adjustments necessary for implementing this change, including the introduction of two new smart contracts to facilitate the collection and distribution of protocol fees. Both programs, which are said to be relatively “lightweight”, have been written and audited.

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Scheduled for a Snapshot vote on March 1, 2024, followed by an on-chain vote on March 8, 2024, this initiative represents a strategic effort to enhance the long-term sustainability and growth of the Uniswap Protocol by fostering a more dynamic and participatory governance environment. However, discussions have revealed that this vote is merely for the implementation of the staking and governance, with a second vote being required to enable the revenue sharing.

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Because it was initiated by the UF, many have heralded the “fee switch” proposal as a unanimous (no pun intended) commitment of Uniswap’s core team. However, the fact that neither Hayden Adams (founder) nor Uniswap Labs (UL) acknowledged the move on social media is notable. The Foundation is a non-profit focused on governance and community, whereas UL, a commercial entity, handles protocol development and innovation. Both groups are U.S.-based where the regulatory emphasis towards tokens has been centered on whether the digital assets represent securities. Recent headlines have featured a handful of important industry wins over the SEC and while we’re still in the early days of discovery, it’s clear that the Bitcoin spot ETFs will have a meaningful impact on the crypto ecosystem and financial markets more broadly. Bringing it all together, given their critical role in overseeing the Uniswap protocol and reputation, it is likely that the UF’s proposal was carried out with consultation across the various stakeholders, prompting Blockworks research analyst Matt Fiebach to comment that “although past attempts at turning on the fee switch have failed, I am confident this time is different, and the proposal is poised to succeed.”

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Since most holders can be expected to desire the additional return, a significant number of UNI tokens is likely to be staked and delegated. However, it’s also probable that many owners will elect to offload the responsibility of governance on more engaged participants. I’m guessing the outcome will be that a smaller group of engaged, active, and educated participants will be left to drive the go-forward decisions of the DAO. While this is more centralized than some of the purist visions of governance would strive for, it will likely allow for faster and better action. However, this also carries some risks.

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The “fee switch” effectively acts as a transfer of income from Liquidity Providers (LPs) to token holders and the former group is a foundational element of the protocol's utility. Voters will be required to balance the desire for income against the need for market depth. Considering the cryptocurrency sector's tendency to favor short-term profits over enduring strategies, concerns about the implications of such priorities are well-founded. Yet, as the industry gradually attracts more institutional interest, it appears likely that Uniswap’s governance will increasingly be influenced by stakeholders with a focus on long-term value creation and stability. Regardless, there’s a bit of a failsafe in play if things get out of hand. The current proposal is focused on Uni V3, but the next iteration increases the composability of the technology by enabling the writing of “hooks”, which could be customized in such a way to avoid the transaction levies altogether.

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It will be interesting to see how this plays out. Readers are reminded that a large installed userbase and early-mover advantages do not create sustainable moats in and of themselves. Uniswap is an open-source protocol which can be forked. As one prominent LP put it, “Onchain trading is currently going through a metamorphosis and Uniswap Protocol could remain at the center of it, but this isn’t preordained, retaining network effects around Uniswap liquidity depth will be incredibly important.”

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Amidst a backdrop of significant market movements and regulatory developments, the “fee switch” proposal seeks to align the interests of UNI token holders with the long-term sustainability and growth of the Uniswap Protocol. By incentivizing active governance participation through a potential revenue sharing mechanism, Uniswap aims to address the dual challenges of voter apathy and the need for more engaged community stewardship (a critical component of our last discussion of a similar proposal). However, the proposal also surfaces critical considerations regarding the balance between rewarding token holders and maintaining the essential liquidity required for trading. As the crypto landscape continues to mature, with institutional players becoming increasingly prevalent, the outcome of this proposal could set a precedent for how decentralized protocols navigate the complex interplay between governance, utility, and regulatory compliance.

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