Disclosure: I own CVX and this is not financial advice, but merely a Saturday hobby.
Introduction
Since launching in May 2021 Convex has gained significant traction and attention in the DeFi community. Within a 4–5 month period, the protocol has attracted ~$10b worth of assets staked in the system; as of writing the project has the 7th highest TVL, trailing just behind Compound.
Convex is designed to create a collaborative relationship between Curve liquidity providers and yield-focused CRV investors. In this relationship Curve liquidity providers earn boosted rewards from their positions by indirectly staking their LP tokens in the Curve gauge system through Convex. Locked-in CRV investors provide the veCRV necessary to deliver the boost, and in return they share in the excess return generated by liquidity providers.
Demand for CRV has been at the centre of competition that has developed between several yield optimising protocols, protocols that have Curve at the centre of their proposition. Yearn Finance is the most notable competitor to Convex in terms of CRV acquisition and deployment. This is because the direct return offered to liquidity providers is often dependent on the amount of vote escrowed CRV that the protocol (Convex, Yearn etc.) is able to deploy to boost earnings. Beyond the boosting of pools, control of CRV also translates to the governance of the Curve protocol and demand has increased to levels of significance. Higher-layer applications are actively seeking to gain influence over the Curve protocol, the very infrastructure that their proposition relies on.
The purpose of this report is to explore the current environment and to better understand the opportunity that is presented in this composability-heavy sub-sector. An attempt is made with limited data to develop a model that would serve as a foundation to value CVX, the governance token behind Convex. Through assessing current and potential revenue it is possible to determine project roadmaps that could disrupt and create significant value. This research opportunity was also used to capture the complex game theory behind DeFi protocols and their potential dependence on one another. Which often results in symbiotic or parasitic type relationships beyond their base functional composability.
This report is for research purposes only and not financial advice
What is a DeFi Primitive?
Compared with Web2.0 FinTech applications the most innovative aspect of DeFi is the directly composable nature of the industry, for the first time in history the approach has evolved from building proprietary technology to utilizing publicly accessible infrastructure.
Core components of an application could be developed and tested long before the application itself has even been conceptualized. To create a robust decentralized financial system it is necessary that some services form core layers of the wider industry; these protocols that fundamentally function as core building blocks are called DeFi primitives. To date, the market has adopted various types of primitives that facilitate lending, exchange and issuance to name a few.
Curve Finance
Curve Finance is the largest DeFi protocol by total value locked and has proven itself as one of the most critical primitives by offering low-slippage stable asset trading through an Automated Market Maker (AMM) market setup. This was achieved when Curve Finance introduced the stableswap invariant which allowed the protocol to concentrate liquidity around a specific price and greatly minimize slippage. By doing so, Curve became the most important decentralized exchange (DEX) for stable assets such as stablecoins or pools of volatile assets in different holding vehicles ie. trading renBTC for wBTC (different versions of tokenized bitcoin). Essentially, the protocol allows for efficient trading of assets with the same price, an anti-slippage exchange.
While the Curve team has recently announced that V2 would allow for the creation of pools for trading between volatile assets, competing with the likes of Uniswap and Balancer, the core function of the protocol will remain low-slippage stable asset trading. This essential role combined with the low levels of automation we see in the protocol is why Curve is viewed as a DeFi primitive. Low levels of automation created an opportunity for products that focus on maximizing yield and rewards for liquidity providers and CRV investors in the Curve ecosystem.
CRV — Curve’s DAO token
Curve Finance is a community owned and governed protocol, with the Curve DAO token (CRV) at its centre. The high-level purposes of CRV are to incentivise liquidity providers in the Curve Finance ecosystem as well as getting as many members involved as possible in the governance of the protocol. Liquidity pools are disproportionately incentivized with CRV inflation, as determined by the protocol’s governance mechanisms which are controlled by current CRV holders.
Currently, the three active uses of CRV are voting, staking and boosting. Simply put, CRV provides a share of the fees collected in the Curve protocol as well as voting rights in protocol governance.
veCRV — Vote locked CRV
Users have to time-lock CRV to access the full benefits of the token. Time-locking is the process of staking CRV tokens within Curve for a set period of time, between one week and four years, in return for which one receives vote-escrowed CRV (veCRV).
veCRV is non-transferrable and the time-lock cannot be reversed, meaning that once you convert CRV to veCRV you are stuck for the time being.
It is important to note that for an external protocol to use veCRV the Curve community has to approve the protocol through a vote to be included in the whitelist contract.
Curve Protocol Participants
There are essentially three types of participants in the Curve ecosystem: traders (the users that swap between assets), liquidity providers (market facilitators) and CRV Stakers (the owners). This report does not deal with the traders.
Liquidity Providers (LPs)
LPs stake assets into trading pools that create an efficient exchange mechanism with an AMM structure so that the users are able to trade between assets. In return, LPs receive yield from trading fees (in the form of CRV) which is dependent on the gauge weight of a specific pool. A gauge weight determines how much of the daily CRV inflation a specific pool receives.
Worth noting that several projects, such as Alchemix and Lido, have also airdropped their native tokens to liquidity providers. This is often done to increase the attractiveness of certain pools, but also for other reasons.
CRV Stakers
Once staked, veCRV holders are entitled to:
- Voting rights for the Curve DAO
- 50% share of the trading fees on the Curve platform
- Up to 2.5x boosted CRV rewards for own liquidity provision.
Curve participant Dilema
Liquidity is the lifeblood of DeFi protocols and developers attempt to create a degree of capital stickiness. This is attempted by the Curve developers by encouraging LPs to make a long-term protocol commitment by essentially merging two populations, LPs and CRV holders through token mechanics. This is observable by the fact that veCRV holders / CRV investors are presented with the opportunity to boost their provided liquidity and LPs are rewarded in CRV, a speculative asset.
Convex Finance
Convex is a middle layer for Curve users, offering flexibility for both types of participants and creating a more symbiotic relationship when Liquidity providers stake LP tokens into Curve via Convex and CRV holders essentially lock-in via Convex.
Through this middle layer, it is possible to separate and maximize the ultimate yield and governance, which is not possible through direct interaction with Curve due to it being designed around the attraction of sticky liquidity.
This approach cements the symbiotic relationship where CRV stakers rely on LPs in order to generate additional revenue and LPs rely on CRV stakers in order to maintain liquidity pools with the maximum boost factor. This is not the case for LPs that wish to stake LP tokens directly in the Curve gauge or CRV holders that vote-escrow their CRV directly.
Liquidity Providers in Convex
By staking the LP tokens through Convex, LPs are able to earn boosted CRV rewards, trading fees, and liquidity mining rewards without having to lock CRV to boost their provision.
This is important as it allows the creation of a yield-focused user that has no long term interest in CRV.
CRV Stakers in Convex
The value addition of Convex to CRV holders (investors in the success of Curve) is the separation of the governance and yield components of veCRV.
CRV stakers that use Convex receive a share of boosted CRV rewards earned by Convex’s LPs for essentially facilitating the boost, as well as Convex governance token rewards. In return, governance rights offered by veCRV are passed on to the Convex protocol and its own governance.
cvxCRV
When a user (or protocol) deposits CRV into Convex, the protocol converts those holdings to veCRV and credits cvxCRV to the depositor at a near 1:1 ratio with veCRV.
Important: Converting CRV to cvxCRV is irreversible (permanently, not time-locked). cvxCRV is transferable (unlike veCRV) and liquidity is available on 3rd party DEXs. Due to this design, there is a one-way flow of CRV into Convex.
CVX
CVX is the governance token behind Convex. The token is issued to LPs that stake through Convex and all cvxCRV holders. Additionally, CVX is rewarded to LPs on DEXs that offer cvxCRV/CRV trading as a reward. These incentives are crucial to ensure that CRV stakers are able to access liquid markets and able to sell cvxCRV.
Total supply cap: 100 million CVX
Emission schedule: The ratio of CVX to CRV emitted is reduced after every 100,000 CVX minted.
vlCVX
In order to receive the full benefit of the token, it is necessary to vote lock. CVX is locked for roughly 16 weeks + 3 days and so provides access to a share in protocol profits and governance.
While vote-locked, stakers are entitled to a share of the protocol’s CRV revenue earned by liquidity providers, which is distributed in cvxCRV. The fact that cvxCRV cannot be unbundled back to CRV results in all CRV farmed by Convex being captured and perpetually time-locked within the protocol. This mechanically increases the pool of veCRV even if no additional CRV deposits are made.
Boost-as-a-service
Convex’s revenue comes from a share of the boosted yield that LPs receive from using the Convex protocol. LPs are charged a 16% platform fee which is deducted from CRV rewards. The current distribution of this fee is as follows.
- 10% to cvxCRV in the form of CRV
- 5% to vlCVX in the form of cvxCRV
- 1% to Harvesters
Harvest function callers (Harvesters) are the system’s operational worker bees.
Convex and Curve game-theoretic relationship
Convex is designed to function entirely on top of Curve Finance and in synergy with it, one could view Convex as a sort of meta protocol. If we are to understand the value of Convex we have to understand the participant game theory
Convex is experiencing a positive feedback loop where participants (LPs and CRV stakers) are accruing additional value for themselves, but also for the other and the Convex ecosystem as a whole. This is achieved through symbiotic relationships created through token economics, while Convex aims to increase total liquidity and total veCRV locked in the system.
When LPs enter the system the amount of fees distributed to cvxCRV & vlCVX increases, this attracts more CRV to be locked into the system which in turn allows the system to further boost yield on liquidity provided to Curve through Convex. Cycle repeats.
vlCVX holders benefit from the loop, through the value flow of increased liquidity that also results in fees flowing to the token.
Governance as a commodity
As all Curve governance rights that flow through cvxCRV are absorbed by Convex and ultimately controlled by vlCVX holders, we are able to calculate and compare the cost-to-vote ratio of directly holding veCRV versus vlCVX.
Assuming all CVX is staked for vlCVX each token would control x8.40 the equivalent voting power of a recently 4 year locked unit of veCRV.
Due to the variable time in locking CRV for veCRV voting power in the Curve ecosystem, voting power would diminish as the lock comes to an end. This is not the case in Convex’s perpetual lock system which is another value add for CRV stakers.
This confirms the separation of governance from yield approach taken by Convex.
As mentioned above, for a protocol to utilize veCRV it has to be whitelisted by Curve governance, which is achieved through a vote with veCRV. This creates a chicken and egg problem for protocols hoping to enter the space.
Until recently governance rights have been difficult to value, but the onset of buy-a-vote protocols have allowed us to discover a market price. These protocols include Bribe and Votium. This consideration forms part of the potential valuation model.
Competitive environment
Several projects other than Convex make extensive use ofCurve. They offer alternative approaches to utilizing the shared infrastructure, even to the extent where protocols have become the biggest contributors of liquidity on Curve, and not users directly. Most of these competitor protocols are yield aggregators and in direct competition with Convex due to the necessity of holding CRV to effectively integrate Curve into their protocols.
Competitors include StakeDAO and Harvest, but the most relevant competitor to Convex Finance is Yearn Finance. Yearn is one of the largest and oldest automated fund managers. For the last couple of months, Convex and Yearn have been competitively involved in acquiring much-needed veCRV, as well as future CRV distribution to maximize the boosted rewards, their most important service offering.
The fundamental difference between Yearn and Convex is that Yearn as a yield aggregator is an ecosystem agnostic protocol that has tokenomics and strategies set in place to benefit users from opportunities as presented, whereas Convex is focused on maximizing the Curve ecosystem opportunity. This is best explained by the manner in which CRV rewards are managed. Yearn generally auto-compounds rewards (sells CRV for interest earning LP tokens), minimizing exposure to governance tokens or similar types of assets. In considering all of this it is important to note that Yearn is highly exposed to the Curve ecosystem.
In terms of governance, the Curve community, which includes the direct users and protocols that control CRV, are incentivized to prevent extended CRV sell pressure. Governance would view a Yearn type project as parasitic.
Another point to note is the high fees associated with using Yearn as a middle layer, with the most relevant being the 2% management fee. Whereas the fees collected by Convex are fully dedicated to participants, the Yearn management fee is aimed at reimbursing Yearn’s vault strategists which is less relevant in simple yield strategies that deploy assets to Curve.
These are factors that have contributed to the rise of Convex and its considerable control of CRV.
The competition in place for veCRV has been dubbed the Curve Wars by the crypto community. On the one hand, we have Convex’s cvxCRV boost mechanism and Yearn’s yvBoost. The fundamental difference is that Yearn is playing catchup by forcing all vaults to deposit 10% of CRV earned to the boost mechanism.
Convex has built a strong lead in ensuring CRV capture. Ground that is highly defensible based on the accumulation strategy set in place to acquire the maximum amount of future CRV emission.
- Higher yields from Curve
- Defensible mote inside Curve by being able to influence protocol whitelist process.
- Symbiotic relationship with Curve
- Attractive fee structure
- Incentive focused tokenomics that favour longevity in the Curve ecosystem and not opportunism.
To battle this approach Yearn has taken to utilizing Convex infrastructure as part of their multi-strategy approach, and subsequently earn part of the CVX emission. This strategy peaked in mid-June when Yearn controlled 21 % of all CVX, currently Yearn holds ~13%.
Yearn’s approach focuses on proportionate governance rights in Convex, but not the ability to boost their own pools with the veCRV that the CVX holders ultimately control.
In a relationship where Yearn pivots to utilizing Curve infrastructure through Convex a complementary relationship would develop between Yearn and Convex, rather than a pure competitive one. This is based on the fact that Yearn could earn higher yields through Convex, subject to the 16% fee. Also, the competitive nature of Yearn requiring to lock CRV in their yveBoost protocol reduces the selling pressure of CRV.
Simple Valuation Considerations
Any attempt at valuing CVX, requires extensive input from the Curve protocol. Most importantly one has to consider the price of CRV as Convex’s revenue is earned in CRV.
For this model the following should be considered.
- Convex dominance will grow and supply would reduce as yield aggregators (Yearn) earn relatively less CRV that has to be sold.
- Only CRV revenue is considered, excluding voting incentives and all others.
- Constant CRV lock of 76%
Observations
- Considering the current protocols revenue and earnings it is possible to conclude that at the current staked CVX ratio and prices of CVX and. CVX is trading at a PE ratio of x20
- Based on a target PE ratio of x30 we can conclude that CVX should be trading at $25.52
Curve Ecosystem Role Thesis
To reiterate, Convex offers CRV holders and liquidity providers the ability to enhance returns for both parties in a mutually beneficial way. A relationship that fundamentally forms a ‘workers’ union of Curve contributors.
This union is able to determine which Pools are added to Curve and also the relative portion of CRV emission that is allocated to said pools. This puts Convex in a position where access to the efficient markets of Curve are gate-kept by the Convex community and require projects (ie. Stablecoin projects) to pay for their right of access.
The governance rights of veCRV holders to control the CRV inflation across the different Curve pools is extremely relevant when significant voting power could be exercised. Convex, as the current largest CRV holder, has considerable influence in determining this inflation and essentially is able to allocateCRV rewards to the pools that are most beneficial to Convex, to the detriment of their competitors.
Possible Valuation Model
Lastly, a more detailed valuation that considers these thematics and revenue generation outside of Convex’s core model is presented.
The valuation specifically includes voting incentives. The latest Votium incentive round has a combined reward of ~$2m. In the future voting incentives are likely to continue to be relevant and of monetary value as a wider set of Curve pools become available. It is important to note the difference between Bribe and Votium are that the former distributes rewards to all vlCVX holders while the latter distributes to those that have delegated their holdings on the platform.
- We assume that all vote delegation rewards flow to clCVX holders, even though this is not the case.
- Average vote delegation fees are based on two historical and one upcoming round.
Observations
- By considering Voting incentives as net income, Convex’s total earnings are increased by a massive x3.8
- CVX is undervalued when considering vote incentives
Conclusion
Where competitors have built models that extensively utilized the Curve system and compete on the efficiency in doing so, Convex has built a moat with Curve by commoditising Curve Boost and acquiring considerable control over the protocol versus auto-compounding by selling CRV.
Convex currently sees a rate of $68m worth of CRV locked on a monthly basis into the protocol. As of writing, roughly $352m worth of CRV is already locked in Convex. This has resulted in the protocol controlling the largest single source of voting power in the Curve ecosystem.
Convex is well-positioned to become one of the most important DeFi projects as the user-owner union behind Curve Finance. Effectively able to influence and sell governance to one of the pillars of DeFi.
Thanks to the Convex community for being extremely helpful and the work done by Ape Froman.
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