โšกDynamic 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 donโ€™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

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