The first generation of Automated Market Makers (AMMs) arbitrarily set a swap fee for LPs. For example, Uniswap v2 on Ethereum sets a 0.30% fee, while PancakeSwap on Binance Smart Chain (BSC) sets a 0.25% fee. They are reasonable choices but by no means optimal.
At Pact, we provide the flexibility for Liquidity Providers (LPs) to set their fee tiers for a particular pool. This allows LPs to experiment on which option generates the most capital-efficient return on capital.
The fees can also be considered compensation for taking on the risks associated with Impermanent Loss (IL), which is tied to the stability or volatility of the relative price movement of the token pairs in the pool.
By providing the flexibility of multiple fee tiers, Pact aspires to be the Home of Liquidity, creating the deepest pools of liquidity through the appropriate coordination of incentives amongst market participants while facilitating lightning-fast, low-cost, green swaps powered by the Algorand blockchain.
The following fee options are currently available for selection when creating a liquidity pool on Pact:
0.01% - Very stable pairs
0.05% - Stable pairs
0.30% - Most pairs
1.00% - Exotic pairs
Factors to consider when selecting fee options
Pact provides a market-standard 0.30% fee option suitable for most pairs.
We recommend selecting lower fee options for stable pairs, such as pools involving variations of stablecoins (e.g. USDT/USDC). The prices of the constituent tokens are close to 1:1, so lower fees will incentivize higher trading volumes, which, in turn, should translate to higher aggregate fees for Liquidity Providers (LPs) as the overall pie grows.
For more ‘exotic’ token pairs with low correlation, we recommend selecting the higher fee options to compensate for the risks associated with Impermanent Loss (IL). However, there is a trade-off as traders may be more reluctant to trade due to the higher fee.
In summary, the following factors should be considered to maximize fees and capital efficiency:
The expected relative price relationship between token pair (stable vs exotic).
Trading volume (i.e. lower fee may encourage greater trading volume).
Compensation for risks associated with impermanent loss.
Real-time accrual of fees
By providing liquidity, you'll earn a percentage of all trades on the token pair proportional to your share of the pool. Fees are added to the pool, accrued in real-time, and can be claimed by withdrawing your liquidity.
Handling multiple pools with varying fees of the same token pair
As outlined previously, Pact allows the creation of numerous pools of the same token pair with varying fee tiers. Suppose multiple pools are available for the same token pair with varying fee tiers. In that case, the Pact User Interface (UI) will route the user’s trades to the deepest liquidity pool with the highest TVL, thereby providing the most seamless and lowest-cost transaction for the user.
Pact aims to constantly improve its liquidity pool routing mechanics to ensure that users have the most seamless and cost-effective trading experience.