Understanding veNomics
Why the “veTKN” economic model for tokens is gaining traction amongst DeFi protocols
After the continued success of certain key protocols such as Curve ($23.01bn TVL) and Frax ($1.55bn TVL) many protocols are transitioning to use tokenomics models that involve vote escrowed tokens. Curve pioneered these mechanics by allowing token holders to access three key features by locking CRV into veCRV:
- Voting where token emissions are directed.
- Earning staking rewards.
- Boosting such rewards with token timelocking. These locked tokens are not liquid, so they cannot be tradable and/or tokenized.
This model can be generalized in the next diagram:
Acquiring voting power to participate in how the emission of new CRV tokens is directed is a mechanism that has been a critical gear of Curve’s economics. Curve’s technology minimizes stablecoin swap slippage, which allows cheaper transactions. As such, DeFi protocols issuing stablecoins are interested in having Curve pools. Being able to redirect CRV token emissions towards a pool means that liquidity providers of such pools will receive greater rewards and thus attract more liquidity. Greater liquidity will minimize swap slippage even more and help reinforce the peg of a stablecoin towards its pair. These stablecoin protocols usually earn seigniorage fees for emission of their stablecoins, so maintaining a tight peg to the dollar is critical to attract investors interested in using and holding their stablecoins.
Arguably, the biggest innovation they introduced is that vote weights and share of rewards are proportional to timelock. This means that those that lock the protocol token for more time will accrue greater rewards, with up to 2.5x rewards boost for those locking for a maximum of 4 years. Nowadays many people hold the opinion that this method might work better in certain scenarios than the old 1 token = 1 vote.
Why is it so? Time locking a token shows long term commitment from the holders. Furthermore it reduces circulating supply and thus potential selling pressure over the main token. The voting power that comes from vested tokens allows voting periodically where the tokens emissions will be directed. The current gauges allocations from Curve (Curve pools) and Frax (external liquidity pools) can be seen in the chart below, where each pool has a certain percentage over the total amount of rewards. Each share of rewards is voted periodically by holders of the locked token:
It is important to understand that in the case of these protocols, staking rewards do not come from token issuance, but from the trading fees generated. In the case of Curve, token issuance is directed towards liquidity providers. Curve charges a swap fee of 0.04%, of which 50% is directed towards liquidity providers and the other 50% towards veCRV holders by buying the liquidity provider token of 3pool (3CRV). This means that half of the $45.25m fees generated so far by the protocol have been distributed towards veCRV holders, which is an attractive incentive for users to lock their tokens.
Understanding these power plays help explain the so-called “Curve wars”, where a protocol such as Convex finance ($18.44bn TVL) allows users to deposit liquidity provider tokens from Curve that will be maximum locked by Convex. This way Curve’s liquidity providers earn extra CVX rewards without having to lock their tokens in Curve. Currently Convex holds roughly half the circulating supply of veCRV. Locking CVX allows greater voting power when deciding how the platform’s veCRV should be allocated, and thus to which Curve pools the CRV issuance will be redirected.
With their recent aggregation of Frax into Convex it is expected that a similar mechanism will play out. Using CVX will be incentivized as long as it is cheaper than directly providing liquidity on pools. Protocols will make use of the bribes on Votium (which allows for anyone to create a bribe for CVX-locked holders for a specific pool) to redirect rewards towards their pools (currently providing ~$0.60 in rewards for each $1 spent).
Besides Curve and Frax who initially popularised this tokenomics model, there are a large number of protocols that have either implemented similar mechanisms or plan to add them in the future. An adaptation of Curve’s model was proposed last year by Andre Cronje in the Sushiswap forums in some sort of oSUSHI token, but has not been approved yet. One of the older protocols using this model is Pickle Finance (yield aggregator). Also Yearn Finance is considering adding veYFI to its tokenomics revamp for the next months, while others like Hundred Finance (multichain loan market) and Astroport Finance (AMM of Terra) already have similar systems deployed for their governance tokens. Another protocol planning a transition towards similar mechanics is Angle protocol (forex on DeFi). Lastly, a surprising collaboration between Andre Cronje and Daniele Sesta will materialize in a new AMM launching on Fantom blockchain initially known as ve(3,3), where fees of the protocol will be directed by a timelocking governance token. Additionally it is planned that the ve tokens will be liquid through NFTs.
Certainly this model is one of the better choices of tokenomics for protocols based on token emissions that desire having a token with meaningful governing power and utility as value accrual. The veTKN model allows periodical and democratic control of token issuance and introduces positive feedback loops that mitigate selling pressure on the main token thanks to timelocks. Moreover the model encourages long term staking and actively participating in DAO proposals, which is something long sought due to the low quorum percentages that many DAO votes achieve. Beside these positive points, some criticism can be found arguing that this model resembles a plutocratic layered system reliant on bribes and heavily dependent on governance, which might not be much in line with the initial ethos of the crypto ecosystem. Only time will tell how these systems evolve, and only those really adding value to the users will perdue.
