The Pillars of Chronos Pt. 3— Understanding the Chronos Flywheel

9 min readMar 24, 2023

The ve(3,3) primitive addresses the challenges of incentivizing liquidity providers (LPs) and ensuring revenue accrual for decentralized exchange (DEX) governance token holders.
While initial implementations have had varying degrees of success, striking the right balance in the economic design and implementation of the flywheel is crucial for the ve(3,3) model to outperform existing DEX models.
By conducting in-depth research on the successes and failures of previous ve(3,3) protocols, the Chronos team has optimized the model and built innovative solutions on top to maximize its potential.

Traditional DEX Challenges

Before we dive into the ve(3,3) primitive, we would like to provide some background on the principles — why this primitive exists and is needed to begin with.

Traditional DEXs, like Uniswap, face a few fundamental issues with revenue accrual for governance token holders and sufficient incentives for LPs.

Firstly, trade fees are often insufficient to attract LPs, especially for new pairs, which has led to liquidity mining programs with native token emissions. This was the basis of the DeFi summer 2020 “fruit farm” phenomenon. However, as observed, these emissions negatively impact token prices over time for projects looking to incentivize liquidity. As the markets have matured since this time, inflationary LP incentives are no longer sufficient to sustain liquidity for projects.

Secondly, the DEX governance token holders have difficulty redirecting revenue away from LPs to the DEX because any revenue taken away will cause more LPs to leave, reducing their liquidity. The consequences of this are reduced trade volumes and then fees. This is an existential problem for existing DEX protocols like Uniswap because the investors and team will need returns at some point to sustain their operation.

Although innovations like Uni v3 concentrated liquidity pools have been effective in increasing LP revenues on blue-chip liquid pairs, this same fundamental problem remains. As concentrated liquidity pools can be implemented in other exchange models, which could offer higher net rewards to liquidity providers.

Furthermore, concentrated liquidity pools are not effective on most long-tail assets, especially those still in price discovery. This is due to magnified impermanent loss on concentrated liquidity positions.

The ve(3,3) Model:

Chronos adopts the ve(3,3) primitive to solve these issues through a unique fee and incentive structure:

Directing all trade fees to $veCHR voters
Incentivizing LPs with $CHR emissions
Supporting $CHR emissions through transaction revenue and utility

This structure ensures high utility and rewards for holding and locking the $CHR token, which in turn helps maintain the required liquidity.

Projects seeking to incentivize liquidity for their tokens can also bribe $veCHR voters directly, receiving a portion of emissions. This approach provides a secondary income source for $veCHR voters and allows projects to source liquidity efficiently without relying on high native token emissions.

Economy Participants:

The ve(3,3) model harmonizes the incentives of all participants in the Chronos protocol. This includes $veCHR voters, liquidity providers, traders, and protocols.

Liquidity Providers — incentivized to add liquidity to the pools with the highest $CHR emissions.

With the maturity-adjusted return model, LPs are also incentivized to commit their liquidity for a longer duration to receive maximal rewards. This aligns our TVL with the long-term health and sustainability of the project. — More on this in the second Pillar of Chronos article.

$veCHR voters — incentivized to vote to direct incentives to high-volume and most bribed pools because these pools generate the most fees

Traders — benefit from low slippage and better rates thanks to the liquidity provided

Protocols — benefit from a public liquidity layer and can easily bribe voters to attract more incentives — and, therefore, more liquidity — to their pools

By aligning the incentives of these key participants, Chronos makes it possible for everyone in the ecosystem to benefit.

By voting for the pairs that generate the most fees, $veCHR voters provide a clear incentive for liquidity providers to add liquidity to those pools.
Liquidity providers get rewarded for their capital in the form of $CHR
Traders benefit from deeper liquidity, which reduces the amount of money lost to slippage while executing a trade.
Voters benefit from the increase in trading activity by earning more fees.

When these mutually beneficial incentives work together, they create what is known as the “flywheel effect” — the actions of each participant in the system naturally creates value for every other participant in the ecosystem, and this effect increases over time.

Rebasing Models

This Medium article by Chronos team member levy, provides a comprehensive analysis of the ve(3,3) design and economy, focusing on the implications of various rebasing implementations.

Several rebasing models have been observed:

Model 1: 100% Anti-dilution

This model aims to maintain the % ownership position of veTOKEN holders by distributing additional veTOKENs to them each epoch in proportion to the amount of emitted TOKENs. While it sounds appealing in theory, the 100% anti-dilution model has several negative consequences.

Concentration of voting power: Over time, this model leads to an unhealthy centralization of voting power among early users, as they continue to accrue tokens without dilution.
Disincentive for new participants: The concentration of voting power makes it increasingly difficult for new actors to enter the ecosystem, decreasing competitiveness and market accessibility.
Inflationary pressure: By reallocating inflation from liquidity providers to veTOKEN holders, the model introduces unnecessary inflation that reduces the value of buying and locking TOKENs.

To elaborate on this last dynamic, we can think of rebasing to veTOKEN holders simply as additional inflation. Although instead of going to liquidity providers who are the engine of the economy, it is going to veTOKEN holders who do not contribute to the flywheel in the same way. This has the effect of adding more inflation than necessary to support the flywheel.

Further, the more veTOKENs there are, the lower revenue each individual veTOKEN receives, so the value of buying new TOKEN emissions to lock and vote is reduced. This is a key part of the flywheel that is damaged by excessive rebasing.

Model 2: Capped Anti-Dilution

Capped anti-dilution aims to strike a balance between early adoption incentives and long-term project health. This model offers 100% anti-dilution until a 30% lock rate is achieved, after which the rate of anti-dilution decreases as the lock rate increases. While this approach allows new participants to join, it still has some shortcomings.

Suboptimal returns: In the long run, TOKEN lockers and voters can experience up to ~30% lower returns than under a strict zero anti-dilution model.
Remaining centralization: Although this model reduces centralization compared to the 100% anti-dilution model, it still retains some degree of centralization that may hinder the project’s overall health.

Although this model was a good evolution and stepped away from the 100% rebase model, strictly speaking, it is suboptimal for the same reasons. Albet to a smaller degree.

Model 3: Zero Anti-Dilution

The zero anti-dilution model provides no anti-dilution protection but has been effective in practice. It promotes a range of positive economic forces:

Progressive decentralization: By not favoring early adopters, this model allows for a more equitable distribution of voting power and encourages new participants to join the ecosystem.
Aggregated demand: Projects have an ongoing incentive to accumulate tokens from the market to increase their voting power, generating a consistent demand for TOKENs.
Incentivizes productive pools: As veTOKEN holders need to maintain their voting positions, they are less likely to support unproductive or low-volume pools in the long run.
Sustainability: The constant influx of new participants and the upward price pressure on the token from existing participants help maintain the token’s value as a liquidity incentive.

We have observed that despite not rebasing, this has not discouraged users from locking TOKENs in other successful implementations. This is because the revenue streams the veTOKEN voters are high enough to incentivize this action without any added and unnecessary mechanics. And without rebasing, this revenue and APR incentive will be maximized the future, creating sustainability.

The Chronos Solution

Rebasing Strategy:

Following meticulous research, the Chronos team has determined that the zero-rebase model serves as the optimal approach for the enduring stability and sustainability of the project. This model not only ensures the most advantageous economic incentives for all participants but also attracts new protocols and mitigates supply centralization among early adopters.

We firmly believe that the zero-rebase model represents the most equitable means of incorporating the ve(3,3) mechanism, and will solidify Chronos as the liquidity layer for every participant in the Arbitrum ecosystem.

Still, we recognize that early $veCHR lockers are taking a risk, so to reward early adopters without jeopardizing the project’s long-term sustainability, Chronos has set aside 5% of $CHR initial supply (2.5M tokens) as an airdrop bonus for users who lock over 1,500 $CHR for two years. These users will receive 20% of their locked position as a bonus$veCHR NFT.

Qualifying users will receive 20% of their locked position as a bonus$veCHR NFT.

By offering qualifying users a 20% bonus in the form of a $veCHRNFT, we support our early adopters while maintaining the project’s long-term equilibrium.

Furthermore, our conviction is that the most effective method to encourage the locking of $veCHR is not through uncertain promises of “anti-dilution,” but rather, we will be placing a focus on education around the model. We are confident the economics of $veCHR will speak for themselves, and users locking will be rewarded in the form of high and sustainable APR from real revenue streams.

Chronos Flywheel: A Virtuous Cycle

To visualize the Chronos flywheel, please refer to the infographic below:

The Chronos flywheel is a powerful, self-sustaining cycle that drives the platform’s growth and enhances its liquidity. As the flywheel gains momentum, it becomes an unparalleled source of liquidity. Arbitrum has yet to witness the true power of the ve(3,3) flywheel — until Chronos.

The counter-cyclical effect that supports this flywheel occurs when the CHR price decreases, causing the veCHR APR to increase. A lower price with the same revenue results in a higher APR, making CHR a more attractive investment. Eventually, buyers will seize this pricing opportunity, stabilizing the price of CHR and allowing the flywheel to continue spinning.

Previous ve(3,3) projects have faced difficulties in sustaining the flywheel during market volatility. When the DEX token price falls, liquidity tends to be withdrawn as the APR decreases. This issue is particularly prevalent on Arbitrum, where many professional money managers actively seek the best yields. With the DEX token down and TVL fleeing, it is very difficult to stabilize the price of the DEX token and re-start the flywheel.

To overcome the challenges presented by market volatility, Chronos has introduced the concept of Maturity Adjusted LPs, as detailed in the “Pillars of Chronos Pt.2 — Introducing Maturity Adjusted LPs” article, which enables us to create “sticky” liquidity.

By introducing an emissions boost based on maturity, we ensure that liquidity providers are adequately rewarded and they are incentivized to maintain their liquidity position during times of price volatility. Failing to do so would result in the loss of up to six weeks of maturity boost.

The maturity-adjusted LPs mechanism revolutionizes the Chronos flywheel by ensuring that liquidity remains on the platform, allowing the counter-cyclical effect (price down = APR up) to take place and stabilize the CHR token price.

This benefits LPs as well, as it makes CHR more price-resilient and their farming more sustainable. Typically, most high APR farms converge on zero. By making Chronos a sustainable place to farm with our powerful flywheel and sticky liquidity, we believe LPs will value their mature positions over chasing unsustainable farms every 1–2 days.

This is why the Chronos flywheel, bolstered by the introduction of maturity-adjusted LPs, will be the strongest Arbitrum has ever seen. Once set in motion, it will stand the test of time, benefiting investors, liquidity providers, and the entire Chronos ecosystem.

Conclusion:

The ve(3,3) flywheel is a robust system, and with strategic optimizations, we believe this model will be unrivaled in attracting high-quality liquidity, partners, community, and traders.

Through the integration of the zero-rebase model and maturity-adjusted liquidity positions, Chronos cements its status as the liquidity layer and “public good” within the Arbitrum ecosystem, fostering a balanced and sustainable landscape for all participants.

Together, we can unlock the full potential of the ve(3,3) flywheel and shape the future of decentralized finance.