Governance Design for AMMs

LABS

Governance Design for AMMs

Core Governance Components

The foundational mechanisms that define how an AMM's protocol is managed, upgraded, and steered by its community.

Governance Token

The governance token is the primary instrument for voting rights and proposal submission. It represents a claim on protocol ownership and decision-making power.

Enables voting on parameter changes, treasury allocations, and upgrades.
Often includes mechanisms for delegation to reduce voter apathy.
Its distribution model (e.g., liquidity mining, airdrops) critically impacts decentralization and initial community alignment.

Proposal Lifecycle

The proposal lifecycle is the formal process from idea to execution, designed to ensure thorough discussion and security.

Typically includes stages: Temperature Check, Consensus Check, and On-chain Execution.
Incorporates timelocks for critical changes to allow for community reaction.
This structured process mitigates governance attacks and ensures changes reflect broad consensus.

Voting Mechanisms

Voting mechanisms define how token-holder preferences are aggregated into decisions, balancing efficiency with representation.

Common models include simple majority, quadratic voting, or conviction voting.
May feature vote delegation to knowledgeable delegates (liquid democracy).
The chosen mechanism directly impacts plutocratic risks and the cost of influencing outcomes.

Treasury Management

Treasury management governs the protocol-owned pool of assets (often from fees), funding grants, incentives, and development.

Proposals can allocate funds for liquidity mining programs, bug bounties, or core development.
Requires robust multi-sig controls or gradual vesting for large disbursements.
Effective management is crucial for long-term sustainability and growth initiatives.

Parameter Controls

Parameter controls are the specific, upgradeable variables within the AMM smart contracts that governance can adjust.

Includes swap fee percentages, protocol fee cuts, and liquidity provider incentives.
Allows the protocol to adapt to market conditions (e.g., adjusting fees during high volatility).
Granular control enables fine-tuning of economic efficiency and competitiveness.

Emergency & Security

Emergency and security components are safeguards like a pause mechanism or a multi-sig guardian for critical vulnerabilities.

A timelock delay allows users to exit before major, potentially risky upgrades.
A security council may hold limited powers to pause contracts in case of an exploit.
These features create a crucial safety net, balancing decentralization with operational security.

Tokenomics and Incentive Models

Understanding AMM Incentives

Tokenomics refers to the economic design of a protocol's native token. For an AMM, this model dictates how liquidity providers (LPs) and governance participants are rewarded, aligning their interests with the protocol's long-term health.

Key Components

Liquidity Mining: Protocols like SushiSwap distribute SUSHI tokens to users who deposit assets into liquidity pools. This incentivizes deep liquidity, which reduces slippage for traders.
Fee Distribution: A portion of trading fees (e.g., 0.25% on Curve) is often distributed to LPs and token stakers, creating a direct revenue share.
Vote-Escrowed Tokens: Models like veCRV lock CRV tokens to grant boosted rewards and governance power, encouraging long-term alignment over short-term speculation.

Example

When you provide ETH/USDC liquidity to a Balancer pool, you earn BAL tokens as an incentive on top of your share of the trading fees. This dual reward makes providing capital more attractive.

Implementing a Voting System

Process overview for deploying and configuring an on-chain voting mechanism for AMM governance.

Define the Governance Token and Snapshot Mechanism

Establish the token used for voting and the method for determining voting power.

Detailed Instructions

Define the governance token that will represent voting power, such as a standard ERC-20 or ERC-20Votes. The snapshot mechanism is critical for determining a voter's balance at a specific block to prevent manipulation. Use OpenZeppelin's ERC20Votes which automatically creates checkpoints of token balances.

Sub-step 1: Deploy or designate your ERC-20Votes token contract.
Sub-step 2: Configure the clock() and CLOCK_MODE() functions for timestamp or block number based snapshots.
Sub-step 3: Verify that the getPastVotes(address account, uint256 blockNumber) function returns correct historical balances.

solidity
import "@openzeppelin/contracts/token/ERC20/extensions/ERC20Votes.sol";

contract GovToken is ERC20Votes {
    constructor() ERC20("GovToken", "GOV") ERC20Permit("GovToken") {}
}

Tip: For gas efficiency, consider using a timestamp-based clock instead of block numbers, as it's more predictable for users.

Deploy the Governor Contract with Core Parameters

Initialize the governance framework with voting delay, period, and quorum.

Detailed Instructions

Deploy a Governor contract, such as OpenZeppelin's Governor, which handles proposal lifecycle. Set the core voting parameters: votingDelay (blocks between proposal and voting start), votingPeriod (duration of the vote), and quorum. For an AMM, a votingDelay of 1 block and a votingPeriod of 65,800 blocks (~1 week) is common. Quorum can be a fixed number or a function of total supply.

Sub-step 1: Choose a base contract like Governor or GovernorCountingSimple.
Sub-step 2: In the constructor, set parameters: _votingDelay = 1, _votingPeriod = 65800.
Sub-step 3: Implement a quorum strategy, e.g., quorumNumerator = 400 for a 4% quorum of total token supply.

solidity
import "@openzeppelin/contracts/governance/Governor.sol";
import "@openzeppelin/contracts/governance/extensions/GovernorSettings.sol";

contract AMMGovernor is Governor, GovernorSettings {
    constructor(IVotes _token)
        Governor("AMMGovernor")
        GovernorSettings(1 /* 1 block */, 65800 /* 1 week */, 0)
    {}
    function quorum(uint256 blockNumber) public pure override returns (uint256) {
        return (token.getPastTotalSupply(blockNumber) * 400) / 10000; // 4%
    }
}

Tip: Use GovernorSettings for upgradeable parameters, allowing the DAO to change delay and period later via governance.

Integrate the Timelock Controller for Execution

Add a delay between vote passage and execution to allow for review and exit.

Detailed Instructions

A Timelock is a multisignature-like contract that queues and executes proposals after a mandatory delay. This provides a safety window for users to react to passed proposals. Deploy OpenZeppelin's TimelockController with a minDelay (e.g., 2 days) and set the Governor contract as a "Proposer" role and an "Executor" role.

Sub-step 1: Deploy TimelockController with a minDelay of 172,800 seconds (2 days).
Sub-step 2: Grant the PROPOSER_ROLE to the Governor contract address.
Sub-step 3: Grant the EXECUTOR_ROLE to the Governor contract or a public address (0x0 for anyone).
Sub-step 4: Configure the Governor to use the Timelock as its executor via the _executor() function.

solidity
// Deploy Timelock
TimelockController timelock = new TimelockController(2 days, new address[](0), new address[](0));
// Grant Roles
timelock.grantRole(timelock.PROPOSER_ROLE(), address(governor));
timelock.grantRole(timelock.EXECUTOR_ROLE(), address(0));
// In Governor contract
function _executor() internal view override returns (address) {
    return address(timelock);
}

Tip: Set the Timelock as the owner of the core AMM contracts (e.g., PoolFactory) so only it can execute governance-upgraded parameters.

Create and Structure a Proposal

Define the proposal's calldata and submit it for voting.

Detailed Instructions

A proposal bundles one or more governance calls (target, value, calldata) into a single vote. Use the propose function on the Governor. For an AMM, a typical proposal might change a protocol fee parameter in the pool router. Ensure the proposal description hash includes a clear title and specification.

Sub-step 1: Encode the function call, e.g., router.setProtocolFee(500) to set a 5 bps fee.
Sub-step 2: Calculate the descriptionHash using keccak256(bytes(description)).
Sub-step 3: Call governor.propose(targets, values, calldatas, description) with the required proposal threshold of tokens.
Sub-step 4: Monitor the transaction to get the returned proposalId.

solidity
address[] memory targets = new address[](1);
uint256[] memory values = new uint256[](1);
bytes[] memory calldatas = new bytes[](1);
string memory description = "Proposal #1: Set protocol fee to 5 bps";

targets[0] = address(router);
values[0] = 0;
calldatas[0] = abi.encodeWithSignature("setProtocolFee(uint256)", 500);

uint256 proposalId = governor.propose(targets, values, calldatas, description);

Tip: Use a front-end interface like Tally or build a custom UI to simplify proposal creation and encoding for delegates.

Manage Voting and Execution

Facilitate the voting process and execute passed proposals via the Timelock.

Detailed Instructions

Once a proposal is active, token holders cast votes using castVote. Votes are weighted by the voter's past token balance (from the snapshot). After the voting period, if quorum is met and the vote succeeds, the proposal moves to the Timelock queue. After the delay, anyone can call execute to run the proposal's calls.

Sub-step 1: Users call governor.castVote(proposalId, support) where support is 0 (Against), 1 (For), or 2 (Abstain).
Sub-step 2: After voting ends, call governor.queue to submit the proposal to the Timelock.
Sub-step 3: Wait for the Timelock's minDelay to pass.
Sub-step 4: Call governor.execute to trigger the final on-chain transactions.

solidity
// Voting
function vote(uint256 proposalId) external {
    governor.castVote(proposalId, 1); // Vote For
}
// Queueing (after vote succeeds)
governor.queue(proposalId);
// Executing (after delay)
governor.execute(proposalId);

Tip: Implement vote delegation via ERC20Votes.delegate() to allow users to delegate their voting power to other addresses, which is essential for representative governance.

Governance-Controlled Protocol Parameters

Comparison of common parameterization options for AMM protocol control.

Protocol Parameter	Conservative Setting	Balanced Setting	Aggressive Setting
Swap Fee Tier	0.05% (5 bps)	0.30% (30 bps)	1.00% (100 bps)
Protocol Fee (of swap fee)	0%	10%	25%
Maximum Tick Spacing	1	60	200
Governance Voting Delay	2 days	1 day	6 hours
Governance Voting Period	7 days	3 days	24 hours
Proposal Threshold (Token Supply)	1.0%	0.5%	0.1%
Minimum Quorum for Execution	4.0%	2.0%	0.5%
Emergency Proposal Timelock	72 hours	48 hours	24 hours

Security and Attack Vectors

Understanding the critical vulnerabilities and adversarial scenarios that must be mitigated in AMM governance design to protect protocol funds and ensure system integrity.

Governance Token Attacks

Vote manipulation through flash loans or token borrowing to pass malicious proposals. Attackers temporarily acquire voting power to drain treasuries or alter fee parameters. Mitigation involves vote-escrow models, time-locks on newly deposited tokens, and high proposal quorums to increase attack cost.

Parameter Exploitation

Governance lag between proposal and execution allows for front-running and information leakage. An attacker can observe a passed vote to change pool fees and immediately execute a large trade at the old, favorable rate before the update. This necessitates timelocks and shielded execution.

Treasury Management Risks

Proposal payloads can contain arbitrary code, risking fund theft if approved. A malicious proposal might grant unlimited token allowances or transfer ownership of protocol contracts. Defenses include multi-sig guardians for high-value actions, rigorous proposal auditing, and segregating treasury control from pool parameter updates.

Voter Apathy & Low Participation

Plutocratic stagnation occurs when low voter turnout allows a small, potentially misaligned group to control governance. This reduces the system's legitimacy and resilience. Solutions include delegation mechanisms, incentive programs for participation, and ensuring proposal stakes are meaningful to a broad tokenholder base.

Smart Contract Upgrades

Upgradeability risks are inherent in governance-controlled proxy contracts. A malicious upgrade could introduce backdoors or disable safety checks. Mitigation involves using transparent proxy patterns, multi-sig timelocks for upgrades, and optional escape hatches that allow users to exit before changes take effect.

Economic Attack Vectors

Governance tokenomics can create perverse incentives, like staking rewards that encourage holding over active voting. This can lead to centralization. Furthermore, proposal spam with high deposit costs can stifle legitimate governance. Designing token lock-ups and slashing for bad proposals are countermeasures.

SECTION-FAQ

Governance Design FAQ

Protocol References and Audits

Uniswap Governance Documentation

Specification of Uniswap governance architecture, including UNI token voting, proposal lifecycle, and onchain execution via Governor contracts.

Visit resource

Uniswap v3 Security Audit by ConsenSys Diligence

Independent audit covering Uniswap v3 core contracts, design assumptions, risk areas, and recommendations relevant to protocol governance and upgrade safety.

Visit resource

Uniswap v2 Audit by Trail of Bits

Formal security review of Uniswap v2 contracts, useful for understanding governance constraints imposed by immutable AMM design.

Visit resource

Curve DAO Contracts Repository

Source code for Curve's DAO and voting escrow mechanisms, illustrating governance design tightly coupled with AMM incentives.

Visit resource

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