⚡Dynamic Fees

This is an ongoing case study on TWAMMs where fees can be adjusted based on future orders that are queued to be executed. Below is a problem and related parameters we're researching.

Problem Statement

What is the optimal swap fee discount for dedicated arbitrageurs (toxic, atomic swaps, short term) to maximize price updates for traders (non-toxic, non-atomic swaps, long term) and MEV kickback to LPs?

Optimization

• LPs: maximize swap fees & MEV remittance to compensate for IL and toxic flow from arbitrageurs

• Traders: maximize price updates of assets to keep parity with external venues and get a smoother order fill

• Arbitrageurs: maximize MEV opportunity and minimize swap fee for a profitable arbitrage opportunity

Assumptions

• Pool parameters:

  • ETH/USDC

  • Partner Fee: Dedicated Arbitrageur (0.025%)

  • Short Term Fee: Mempool Users (0.05%)

  • Long Term Fee: Traders (0.15%)

• Gas (transaction) fees can vary on number of virtual orders that need to be executed

  • For the purpose of this problem, assume a fixed amount

• Trades last multiple blocks and can be cancelled at any time

• Mempool arbitrageurs will always exploit opportunity if dedicated arbitrage don’t act in time

• Dedicated arbitrageurs get a fee discount to get a first right arbitrage opportunity

Background

• TWAMMs have two swap interfaces: non-atomic swap (traders), atomic swap (arbitrageurs)

• TWAMM pools are 2 asset, 50/50 Uni V2 style pools that follow X*Y=K invariant

• Dedicated arbitrageur fees can be changed in-flight and are customizable per pool

• Long term trades create back running opportunities as prices move on the bonding curve

  • Traders are primarily uninformed flow (non-toxic), benefit from arbitrageurs keeping prices fresh

• Dedicated arbitrageurs remit share of MEV extracted to LPs for the swap fee discount

  • Arbitrageurs are informed flow (toxic), profit from correcting prices and pay gas to write traders virtual orders on-chain

• LPs get swap fees from long term traders, and MEV + discounted short term swap fees from arbitrageurs

• MEV remitted to pools are automatically invested and distributed pro-rata to LPs similar to swap fees, but on a weekly basis

Existing Solutions

• Private relays: ineffective because first right advantage is negated after the first block

• Rook auctions: group of arbitrageurs bid on the arbitrage opportunity, 90% of bid is remitted back to LPs. Note bid != potential MEV opportunity

• SLAs: require off-chain agreements and trust with 3rd parties to behave ethically

Related Research

https://a16zcrypto.com/content/article/lvr-quantifying-the-cost-of-providing-liquidity-to-automated-market-makers/a16zcrypto.com

https://research.paradigm.xyz/uniswaps-alchemyresearch.paradigm.xyz