In this piece, we will show how Velodrome consistently outperforms Arrakis PALM in building liqudity for protocols.
TL;DR
- Protocols face challenges in establishing liquidity for their tokens, which often requires allocating funds for liquidity incentives or building Protocol Owned Liquidity (POL)
- Velodrome is the most capital-efficient way for protocols to build liquidity by depositing incentives or locking tokens to receive VELO emissions for their pools, enabling over 50 protocols on Optimism to collectively attract $200M+ in TVL
- Arrakis provides active liquidity management vaults (PALM) that allow protocols to sell their native tokens to build POL and capture fees. More precisely, it is a custodial and centralized solution that, in essence, charges protocols 1% of the TVL under management and 50% of the fees generated to help protocols dump their native tokens on their holders for assets like ETH or USDC, under the pretense of building protocol owned liquidity. They recently wrote a thread comparing their PALM product against Velodrome’s long-term liquidity programs
- The aforementioned comparison between Arrakis PALM and Velodrome Bribes was not in good faith, analysing cherry-picked data and making an “apples to pears” comparison in order to paint a false picture. A fairer comparison would be with a POL strategy on Velodrome for Kwenta, which would then clearly show Velodrome’s superiority, exhibiting significantly lower net costs of liquidity and the DAO capturing a greater net profit in VELO emissions captured by this POL.
- In addition, value return to tokenholders is ignored: PALM vaults can suppress positive price action, whereas Velodrome does the opposite, allowing holders to earn 2x-3x the incentives offered as VELO emissions and helping protocols transition to Protocol Owned Votepower.
- Velodrome remains a leader in trading and liquidity solutions, continuously developing features to enhance its services
A quick note: Kwenta is a great protocol, a strong partner to Velodrome, and has an extremely capable team. This is in no way a criticism of them, as we do not believe Arrakis accurately communicates the mechanism behind their results (dumping treasury Kwenta on holders/vault not providing sufficient liquidity on its own). While we believe that Kwenta would be better served deploying their POL to Velodrome, we have previously contained our analysis to private conversation and governance forums.
This public article is a response to misleading, aggressive marketing from Arrakis.
Why are we writing this?
Protocols face a costly challenge when it comes to establishing liquidity for their tokens. If a trading pair doesn’t generate enough volume to organically bootstrap a Uniswap pool, protocols must allocate funds towards liquidity incentives and/or build Protocol Owned Liquidity (POL).
Velodrome is the most capital-efficient way for protocols to build liquidity. Protocols can deposit incentives for veVELO voters or lock VELO directly to direct VELO emissions to their pools. Over 50 protocols on Optimism are leveraging Velodrome’s mechanics to multiply the value of their incentives by 2–3X in VELO emissions for their pools. Complemented with POL, protocols can even build liquidity profitably by capturing more value in VELO emissions than they deposit in incentives. Several of our current partners are using this strategy to great effect.
A significant hurdle in building POL is that protocol treasuries often possess a large amount of their native token, but lack the necessary ETH or stablecoin to pair it with in order to ensure sufficient liquidity. Protocol communities are understandably reluctant to sell native tokens from the treasury to solve this issue.
Arrakis offers active liquidity management vaults (PALM) that allow protocols to use their native tokens to build POL. The vaults progressively sell the protocol’s token to reach a balanced LP, which is then used to enable trading and capture the trading fees. To promote their solution, Arrakis published a comparison between active management on UniV3 and Velodrome bribes.
This comparison provided by Arrakis has glaring omissions. In analyzing their own program, they only cover a narrow 8-week window and gloss over the need for favorable price action to bootstrap the vault. In addition, the Vault does not provide sufficient liquidity on its own and relies on the ability to attract other Uni V3 LPs. The track record of their other vaults is even less encouraging.
While their analysis shows that Velodrome’s pool is still higher performing and provides superior trade execution, they total up the bribes for the entire history of Velodrome’s pool for the cost comparison. Given the Arrakis pool performance, its unlikely it could serve as the only source of liquidity on Optimism even today. The relevant comparison is how a similar amount of POL on Velodrome could have performed and what what the costs would have been during a similar time frame. Properly optimized, Kwenta would realise a higher profit on Velodrome with the same amount of POL.
Analyzing Arrakis PALM’s Mechanisms
Velodrome’s value proposition is simple: protocols can currently (in a 100% decentralized and trustless manner) deposit $1 in incentives and receive $2-$3 in emissions for their liquidity pools. These emissions reward the protocol’s LPs and act as a tailwind for the protocol’s token. If the protocol uses POL to farm VELO, they can significantly reduce the net cost of their liquidity.
By constrast, PALM’s mechanisms can work, but come at a cost to tokenholders. During the initial phase (bootstrapping), the PALM vault sold KWENTA to shift the asset balance from $25K ETH to $400K ETH.
Selling KWENTA helped the vault’s performance when KWENTA lost value against ETH, but it’s likely that the process also dampened KWENTA’s positive movement to the upside. Active “boostrapping” in UniV3 ticks near the current price creates a buy wall for holders to, effectively, buy Kwenta direct from the protocol treasury. Without Velodrome’s liquidity pool, the price impact would’ve been significantly higher.
In return, the PALM vault captured $33K in fees for Kwenta, plus $33k in management fees for PALM, and now hovers around $400K in value with their vault providing only $63k of the liquidity. This shows that PALM also relies on other LP’s to participating on their UniV3 pool to create a competitive environment for swaps.
But what would have been the result if Kwenta had deployed the same POL on Velodrome instead?
Analyzing Velodrome POL Mechanisms
By deploying POL on Velodrome, Kwenta would capture a share of the VELO emissions directed to their pools by their bribes. If optimized correctly, the emissions value can exceed the cost of the bribes. Here is an example using the $400k Kwenta and $400K wrapped ETH at the start of Arrakis’ analysis if used on Velodrome.
Kwenta’s pool has averaged around $2.1million dollars in volume. At our v2 fees of 0.3%, they would earn around ~$6300 in fees a week as voting incentives. If they top up these incentives with an additional $6200 in bribes, their pool would historically produce $25k in emissions. We also cannot ignore Kwenta’s 2 million locked veVelo; Kwenta already has free liquidity incentives on Velodrome forever. Voting for their pool would return around $1700 in bribes and fees back to Kwenta, further increasing profits.
Recent trends show Kwenta’s average farming APR as 75% and at this rate these emissions would support ~$1.7 million in TVL. This is a small reduction in TVL from where they are now to optimize their protocol owned liquidity to 46% of the pool, so they can earn 46% of the emissions value. As we can see, a properly optimized protocol owned liquidity strategy is not only profitable, but higher than the revenue earned from a 1% fee concentrated liquidity pool.
In addition, only having 1 pool would add around another $800k in volume from the UniV3 pool, which would earn Kwenta an additional $2400 in voting incentives each week, further increasing profits. The protocol then has an option of what to do with their farmed VELO; they can buy more of the paired asset for additional POL, compound their voting position, rebuy their native token or increase their bribes to get more TVL. Velodrome opens up a wide variety of ways to build Protocol Owned Votepower that frees up treasury assets for other purposes.
This demonstrates the power of the Velodrome flywheel. When properly optimized, protocols can profitably incentivize liquidity, attract outsized TVL, and offer low-slippage trading without selling their own tokens. Velodrome’s emissions also incentivize LP’s to buy the native asset to farm, making it a net positive for holders. Over 50 protocols leverage Velodrome to collectively build over $180M in liquidity across nearly 100 liquidity pools.
Other Arrakis Examples
For over one year now, Velodrome’s ability to drive deep liquidity in capital efficient ways is reflected in the positive performance of 50+ incentivizes pairs.
However, it is clear why Arrakis chose to highlight KWENTA: their track record of their other pairs on Optimism are, at best, underwhelming, as shown below:
This information is taken directly from their publicly available dashboard, and clearly demonstrates that not only does the KWENTA example underperform a similar strategy on Velodrome, but their ‘success’ hasn’t been replicated for any other pairs in roughly the same market conditions.
A final note on Impermanent Loss:
Arrakis made much of their performance against impermanent loss in their report. Active liquidity management should certainly beat impermanent loss compared to an X*Y=K pool and this did happen for Kwenta during the 8 weeks highlighted in the Arrakis report.
But let’s think about this for a second. PALM won the market by actively managing their liquidity to minimize losses during a Kwenta downturn, but at whose expense? Kwenta holders. As a primary liquidity strategy, we do not believe that treasury POL should be used to actively market-make against holders. Active management means selling treasury tokens against community LPs during the “bootstrapping” phase and effectively trading against them during a market downturn. As a treasury management strategy in a pool getting toxic flow (e.g., from arb bots arbing the Velodrome pool) it could be understandable, but this is an additional reason PALM should not serve as the only source of liquidity on Optimism.
In Conclusion:
Arrakis offers a novel service for protocols looking to outsource their POL management. Through active LP management, PALM vaults can capture trading fees for protocols providing liquidity. However, this service can create significant sell pressure for the protocol’s token and actively trade against the token holder community.
Velodrome has a long track record and numerous partners optimizing their Protocol Owned Liquidity strategies for maximum long term profitability. Velodrome emissions incentivize LPs to buy the protocol’s native token and, with dynamic V2 fees, Velodrome pools become even more attractive. We acknowledge that innovations in the market can offer valuable alternatives to Velodrome’s services, and we’ll continue to develop features, such as concentrated liquidity pools, to ensure Velodrome remains the leader in trading and liquidity solutions on Optimism.