The Economics of Automated Market Makers

TL;DR

This paper models how automated market makers like Uniswap can sustainably set their fee take rates to maximize revenue, considering loyal trade volume and competitive dynamics.

Contribution

It introduces a model for optimal fee setting in AMMs, accounting for loyal trade volume and competitive fee rates, to ensure sustainable revenue.

Findings

AMMs can sustainably set non-zero take rates with loyal trade volume.

Optimal take rate depends on loyal trade volume and competitors' fee rates.

Model guides AMMs in fee strategy to maximize revenue without losing liquidity.

Abstract

This paper studies the question whether automated market maker protocols such as Uniswap can sustainably retain a portion of their trading fees for the protocol. We approach the problem by modelling how to optimally choose a pool's take rate, i.e\ the fraction of fee revenue that remains with the protocol, in order to maximize the protocol's revenue. The model suggest that if AMMs have a portion of loyal trade volume, they can sustainably set a non-zero take rate, even without losing liquidity to competitors with a zero take rate. Furthermore, we determine the optimal take rate depending on a number of model parameters including how much loyal trade volume pools have and how high the competitors' take rates are.