Fee switch: the long-awaited game changer for DeFi?

What is the Fee Switch?

The fee switch refers to a mechanism through which a decentralized finance (DeFi) protocol shares a portion of its revenue—typically derived from transaction fees or other activities—with holders of its native token. In practice, this allows users participating in staking or governance to earn financial returns proportional to the protocol’s economic performance.

Today, most DeFi tokens primarily serve governance purposes. While this is essential for ensuring true decentralization, it offers no tangible economic value to holders. The fee switch could address this gap by transforming these tokens into yield-generating assets.

Despite growing interest in the concept, it has yet to see widespread adoption. The primary reason lies in regulatory uncertainties, particularly in the United States. However, with Donald Trump’s election and promises of a more favorable regulatory environment for crypto innovation, the debate around the fee switch could take a new direction.

---

Why is the Fee Switch a Game Changer?

The fee switch represents a major lever for DeFi protocols as it could solve a fundamental problem: the lack of intrinsic value in utility tokens. These tokens, often limited to governance roles or providing access to protocol services, offer no direct financial benefit to investors.

With the fee switch, protocols could incentivize users to hold their tokens for the long term by directly linking them to the protocol’s success. It would also reduce dependence on inflationary models, where new tokens are continuously issued as participant rewards.

Moreover, it would strengthen the alignment between token valuation and economic performance, utility, and the real value of the protocols. Investors would finally have a concrete reason to hold these assets with a long-term vision.

---

Why Is the Fee Switch Being Discussed Again?

A Market Hindered by Regulation

The primary obstacle to adopting the fee switch for DeFi protocols remains the regulatory context. Over the past two years, the Securities and Exchange Commission (SEC)—one of the entities responsible for regulating financial markets in the United States—has intensified its scrutiny of the cryptocurrency industry, labeling many tokens as securities.

According to the SEC, a token offering regular returns to users, especially based on protocol-generated revenue, is classified as a security token. As a result, implementing the fee switch on a DeFi protocol would cause its token to be classified as a security, subjecting it to strict regulatory requirements, which is undesirable.

In the case of Uniswap, the proposal to activate the fee switch has been rejected three times by the community. In particular, the wallets of entities dominating governance (a16z, Hayden, etc.) have pushed for the proposal’s rejection, citing regulatory risks.

Donald Trump’s Election

The fee switch topic returned to the forefront of discussions following Donald Trump’s election. During his campaign, he expressed a favorable stance toward cryptocurrencies, promising clearer and less hostile regulations. A major change has already been initiated with the removal of Gary Gensler, chairman of the SEC, who was widely considered responsible for the regulator’s aggressive stance toward the industry.

Other initiatives proposed by Donald Trump, such as transferring some regulatory responsibilities to the Commodity Futures Trading Commission (CFTC), could also shift the landscape. Part of the cryptocurrency market could then be classified as commodities, avoiding the security classification and its associated restrictions.

---

Uniswap: The Most Anticipated Fee Switch

The Stakes of the Fee Switch for Uniswap

Uniswap is recognized as one of the pillars of DeFi, with over $7.5 billion in Total Value Locked (TVL) and an average weekly transaction volume of $3 billion (as of this analysis, dated November 27, 2024).

Currently, Uniswap’s UNI token ranks as the 25th largest cryptocurrency by market capitalization, with a valuation of approximately $8 billion. Despite this, it generates no yield for holders and has no utility other than participation in protocol governance.

However, token holder participation in governance is notoriously low. Among the 30 largest delegates by voting power, 14 have not participated in any of the last 10 proposals, and only seven have created a proposal.

Over the past two years, Uniswap has repeatedly attempted to implement a fee switch mechanism through governance proposals. The idea was to encourage user participation in governance by distributing a portion of protocol fees to stakers who delegate their tokens. However, these various proposals were systematically rejected by the community for the reasons mentioned earlier.

The Impact of the Fee Switch on UNI Holders

As noted, evolving regulatory conditions in the United States could lead Uniswap to reconsider its stance on the fee switch. In this scenario, let’s explore how this might impact UNI token holders.

Currently, Uniswap charges a 0.3% fee on each transaction executed on the protocol. These fees are fully distributed to the liquidity providers of the corresponding pools. In October 2023, Uniswap Labs introduced a 0.15% commission on certain trades via its interface, but this measure remains limited to their web application and does not directly impact the calculation of protocol-generated revenues.

If the fee switch were activated, a portion of the fees redistributed to liquidity providers would be allocated to UNI holders participating in staking. Let’s hypothesize an allocation of 20% of collected fees, the option that received the most support during community discussions.

Since the beginning of 2024, Uniswap has generated approximately $881 million in fees. With a 20% fee switch, this would represent $176.2 million redistributed to stakers. If this trend continues through the end of the year, the annual amount would reach $195 million.

Currently, about 30% of circulating UNI tokens are staked, equivalent to 203 million tokens. At an average price of $13.3 per UNI, this represents a total staking base of approximately $2.69 billion. Under this scenario, UNI stakers would have earned an annualized yield of approximately 6.5% in 2024.

---

Other Protocols Exploring the Fee Switch

Uniswap is not the only DeFi protocol considering the activation of a fee switch. Several other major or emerging players in the ecosystem see this mechanism as a way to turn their tokens into revenue-generating assets, creating long-term incentives for holders.

Aave (AAVE)

Aave is one of the largest decentralized lending and borrowing protocols. In July 2024, Marc Zeller published a governance proposal that raised questions within the community about activating a fee switch on Aave.

Specifically, this mechanism would include a "buy & distribute" program, where part of the revenues generated by protocol fees would be used to buy AAVE tokens on the secondary market for redistribution to stakers.

If the fee switch were activated, it could provide tangible yield to AAVE holders and better align their interests with the protocol’s growth. Since the beginning of 2024, Aave has generated $350 million.

Then, considering the current amount of AAVE tokens staked ($607 million) and a 20% redistribution ($77 million), the annualized yield for stakers would be approximately 12%.

Lido Finance (LDO)

Lido Finance, the leading liquid staking protocol in the ecosystem, has also considered introducing a revenue-sharing mechanism through a governance proposal published in May 2024. With over $15 billion staked in ETH, Lido has one of the most stable revenue streams in the ecosystem.

The proposal aimed to allow users to stake their tokens to earn between 20% and 50% of the protocol’s future revenues, distributed weekly through a buyback mechanism. A key feature is that tokens acquired via this mechanism would be subject to a six-month vesting period.

Since the beginning of 2024, Lido Finance has generated $921 million in fees. If the fee switch were activated, this would represent between $200 million and $500 million annually distributed to stakers.

With a current market capitalization of $1.6 billion and assuming 30% of circulating tokens are staked (480 million), LDO stakers would earn an annualized return of between 41% and 104% on their position thanks to the introduction of the fee switch.

Ethena Labs (ENA)

Ethena Labs is a protocol known for its algorithmic stablecoin USDe, backed by delta-neutral strategies on perpetual contracts and liquid staking tokens in Ether (ETH). In a governance proposal dated November 6, 2024, Wintermute proposed the idea of a fee switch, allocating a portion of protocol-generated revenues to stakers of the governance token sENA.

Ethena Labs generates approximately $250 million in annual revenue through its USDe stablecoin, which now has a market capitalization exceeding $4 billion. In the current model, 80% of revenues are distributed to USDe holders (yielding 12%), and 20% are allocated to the protocol’s treasury.

Although Wintermute’s proposal did not specify figures, let’s assume the fee switch allocates 20% of revenues to sENA holders (leaving 60% for USDe holders and 20% for the treasury).

This would slightly reduce the annualized yield for USDe stablecoin holders to approximately 9%, while offering an APY of 7% to sENA holders. This model would better align the ENA token with the protocol’s growth while maintaining the attractiveness of USDe.

Raydium (RAY)

Raydium is one of the leading decentralized exchanges (DEXs) on Solana. Currently, Raydium employs a fee mechanism similar to Uniswap, where liquidity providers receive 84% of pool swap commissions, 4% goes to the treasury, and, uniquely, 12% is allocated to RAY buybacks.

While this may resemble a fee switch system, it is not truly one since revenues are not directly shared with stakers. No proposals have been made within Raydium’s governance to introduce a fee switch, but Uniswap’s initiatives could legitimately prompt them to follow suit.

As of this writing, Raydium has generated $558 million in fees in 2024. This is largely due to its status as the preferred DEX for memecoin trading, a particularly trending activity on Solana.

If 20% of fees were allocated to stakers through a fee switch and 30% of circulating RAY tokens were staked, considering Raydium’s current market capitalization of $1.57 billion, the annualized yields would be around 26%.

---

An Opportunity for Protocols Without Tokens

Many major protocols in the ecosystem currently do not (yet) have tokens. Whether or not they have mentioned the idea of launching one, the reasons are often the same: the regulatory framework is too unclear, and a token would have no real utility for the protocol. Among these protocols are OpenSea, Pumpfun, and Polymarket.

• OpenSea is a pioneering marketplace in the NFT space. However, since investor interest in this sector has waned, OpenSea has experienced a significant drop in activity. Additionally, the launch of Blur’s tokens and the success of Magic Eden have severely diluted its market share.

It’s also worth noting that OpenSea has received multiple notices from U.S. regulators, which has hindered its operational growth. With the potential easing of regulatory constraints in the United States, OpenSea could consider launching a token and activating the fee switch, thus offering tangible value to investors through a redistribution of fees.

• Pumpfun is a decentralized protocol built on the Solana (SOL) blockchain, designed to easily create, launch, and trade memecoins. Since its launch in March 2024, Pumpfun has generated over $4 billion in volume and $264 million in fees.

In October 2024, Pumpfun announced plans to launch its own cryptocurrency during a live session on X, aiming “ to reward early users. ” However, concerns quickly emerged: what purpose would this token serve? Activating the fee switch could be a way to align investors with the protocol’s performance.

• Polymarket is a predictive market platform that allows traders to bet on everyday events. The protocol saw a massive surge in activity during the U.S. presidential elections, reaching over $2.5 billion in volume and 250,000 unique users in October.

The end of the U.S. elections was naturally followed by a sharp decline in activity on Polymarket, raising questions about mechanisms to sustain user interest. The idea of launching a token has been discussed, and as with Pumpfun, the community has asked: what’s the point? Since Polymarket collects 2% of winnings as revenue, implementing a fee-sharing mechanism with token holders could be a viable solution.

---

Conclusion

Since 2021 and the frenzy surrounding DeFi, the tokens of these protocols have not particularly regained their appeal. However, financial and on-chain metrics have continued to rise steadily over the past few months, whether in terms of TVL, user numbers, or revenue generated.

Currently, the cryptocurrency market is driven by narratives or trends that capture the majority of liquidity and investor attention. For the most part, these narratives are entirely disconnected from the actual performance of protocols — as evidenced by the success of memecoins.

In this context, the fee switch could become the next major narrative in the crypto ecosystem. It has the potential to reignite the spirit of DeFi Summer by drawing investors back to this asset category for the long term. More importantly, it would finally align the economic value of DeFi protocols with the market value of their tokens.