Economic Analysis of Decentralized Exchange Market with Transaction Fee Mining

Blockchain-based Web 3.0, denoting the next-generation Internet, has attracted attention from academia and industry. However, the open-source application and the decentralized storage of users' interaction data break down the algorithm and data barriers, resulting in more fierce competition among service providers. To cope with the competition, decentralized exchanges (DEXs), the financial infrastructures of Web 3.0, adopt the transaction fee mining mechanism, which refunds the transaction fees to users in the form of governance tokens. However, the ratio of governance tokens a DEX decides to give to users would affect the enthusiasm of users to participate, which has not been discussed yet. In this paper, we establish the DEX market with transaction fee mining and formulate our model based on the Hotelling model. Besides, we propose a two-stage game to formulate the interaction between DEXs and users and derive the equilibriums under different conditions of two parameters: the transaction cost difference and users' stickiness. We show that though the service provider with a lower transaction cost can win the market, users' stickiness can offset the market advantage. Thus, incentivizing users with transaction fee mining has become a crucial strategy in the duopoly competition.