Understanding value of CVP token and meta-governance value creation pattern

This article is devoted to CVP token value capturing mechanisms and new meta-governance value creation pattern

DISCLAIMER: it is the first version of the article, therefore it may contain errors and inaccuracies. It is currently sent to the community members, PowerPool testers, and other independent researchers. Once we will receive their feedbacks article will be updated.

Abstract

PowerPool first introduced, developed, and implemented the new meta-governance value capturing mechanism based on an aggregation of voting power in several protocols in the single asset. The value creation mechanisms and patterns in PowerPool products are reviewed. The interrelation “The product — Value creation patterns — CVP token value” is established and described for every product. Each ecosystem product is described from a value creation point of view, decomposing its operational logic into a set of value creation patterns. Each value creation pattern is described from a fundamental point of view with examples provided. PowerIndex provides three types of value flows for CVP token holders: internal product governance value, meta-governance value, and future cashflows value. PowerOracle provides value as a result of the implemented “work token” function and internal product governance value as well. All types of value produced in PowerPool products are compostable (can be received by any user regardless of users’ scenario of product usage). Based on its advantages, it is assumed that the meta-governance approach and meta-governance value creation pattern could receive significant adoption in Defi products as the on-chain governance industry matures.

Introduction

Every decentralized protocol is a complex system. The native digital asset, implemented into this system acts as an integral part of it. The proper implementation allows the system to achieve its goals capturing certain value for the community of token holders. A deep understanding of the token value is the key to understanding the project itself.

But, no one token is not valuable by design. Being implemented into a complex system, it participates in different system-related processes. If a certain process generates value to the system and a token is a part of it, it is possible to highlight this value-generating process as a value capturing mechanism or value creation pattern. The value-creation processes in web3.0 can be quite complex from the traditional point of view (and sometimes even don’t have clear analogies in a “fiat” world). Due to this reason, there are no established and approved standards for the token valuation. The community still lacks a way to value tokens.

The main purpose of this article is to dig as deep as possible into CVP token design, decompose it into value creation patterns, and highlight their interrelation with PowerPool products and system design. Describing value creation patterns on examples of other projects, token models of PowerIndex possible participants are used as a primary option.

Definitions

CVP holders: CVP holders + holders of PIPT, UniV2 LP, or BPT tokens, containing CVP in their underlying composition, including these tokens transferred to L2 networks such as xDAI and Matic;

TVL: Total Value Locked
APY: Annual Percentage Yield
CVP: Concentrated Voting Power
ETF: Exchange Traded Fund
AMM: Algorithmic Market Maker

Value creation patterns in PowerPool

A value creation pattern is a pattern of actions, being involved in which a token acquires value. In simple words, it is an answer to the question:

What can the end-user do only by owning this token and why this action results in value for him?

The second question following the first one is not less important: How can this value be assessed?

Commonly, teams build a project based on the end product, not on a token value creation pattern. The product goes first and the token goes second. It is the reason why a lot of successful projects implement the native token into their protocol only after solid product traction (Compound, Uniswap). Other ones significantly changed their token model, comparing the Whitepaper stage and a live product. Of course, the token design process never ends with the mainnet release, it just began — in such an early-stage scientific area nothing can be predicted and hardcoded.

When the PowerPool project was originated back in July 2020, we started from the new value capturing mechanism which resulted in the creation of a brand new value creation pattern.

PowerPool was originated as the idea of a new token value creation pattern

It was the main reason when development was started with a simple lending market for governance tokens but significantly expanded just in a few months. At the moment our community has a whole PowerUniverse, which system design is united around one goal: implement this value creation pattern in the most efficient way.

We named it the “meta-governance value creation pattern”

According to this idea, the native digital asset of PowerPool was initially named CVP = Concentrated Voting Power, as the main purpose of this asset is accumulating voting power in multiple protocols into a single asset. To simplify the understanding of PowerPool products and value creation patterns for CVP token in each of them the following table was created:

Value creation patterns powered by PowerIndex

PowerIndex is a Defi ETF-like product, consisting of 8 governance tokens. It is designed with an ability to use pooled tokens for meta-governance and fund management purposes (Vault-like strategies). It is entirely community-curated: CVP holders can add, remove GTs, change their shares, fees, and values of other index variables via governance proposals. Also, this index has several “community” fees. It means that the fee is charged for the community needs and is transferred to a special treasure contract named “Permanent Voting Power”.

Understanding the value of governance power

The possibility to govern a decentralized protocol or a product using a token as a share of voting power is defined as an “Internal product governance” value creation pattern.

Internal Product governance value creation pattern means that if you have a token (governance token in this regard), you can possibly change something in the protocol using this voting power. Ordinary, bigger token stake (share of token supply) corresponds to bigger influence in terms of this protocol. The influence is measured by The Banzhaf power index or simply by the token holder’s chances to swing the vote. Read more about this concept in two articles authored by Jake Brukhman [1],[2].

Note, that the “Internal Product governance” value creation pattern is described herein the “pure” form. It means that token holders cannot receive cash flows from the system, associated with holding or using protocol token. Token has only one function in this pattern — to vote on proposals.

Value for the token in this pattern is captured in the following way: the more influence protocol has on the Defi ecosystem (owns a bigger market share), the more valuable is the possibility to govern it. Even tiny changes can significantly affect big capitals using the protocol — imagine adding or removing collateral types in Compound, changing interest rate model, or value of fees. Compound COMP token is a good example of a token, which value is captured via the Internal Product Governance value creation pattern.

But, how to measure this “governance power” from the monetary point of view? Unfortunately, there are no established valuation frameworks for pure governance tokens. The main indicator of any Defi protocol is TVL (Total Value Locked), but there is no clear correlation with the market cap of the project. For example, comparing two AMM-based DEXes — Curve and Uniswap it is easy to find out that the market cap of UNI is bigger at ~12 times ($486m vs $40m) while TVL is bigger only at 3.75 times. Undoubtedly, the price takes into account everything — strategy of token distribution, speculative expectations, the value of the brand itself, liquidity sinks, and many more. It is important to note that such miscorrelation was also a reason to create an index in which token shares are defined by the community and not based only on projects’ market caps.

The token can be overvalued or undervalued, but it is the price established here and now. It reflects how all market participants value its governance power

The Internal Product Governance value creation pattern for PowerIndex is based on the same concept. The only difference comes to what is governed and how it affects the market? As it was mentioned before, CVP holders can entirely govern PowerIndex — the token set, weights, rules for liquidity provision, and fees. For PowerIndex with huge liquidity, it can result in real power. Being added into the index, liquidity in certain tokens is temporarily locked, contributing to the price discovery of these assets. If the token price drops for some reason, the index requires adding more tokens into it to maintain the desired token share, and vice versa. The index composition basically is maintained by arbitrageurs — profit-driven agents as in the case of any AMM-based pool. So, the project capitalization is certainly affected as the token is included in the index. It is applied to the CVP token as well.

Imagine that PowerIndex has $100m liquidity and each token has a 12.5% share. Changing weights or removing the token from the index can significantly affect its price and capitalization

The decision-making regarding any of the mentioned points is entirely in the hands of CVP token holders. When token holders decide to increase or decrease a share of certain assets, the special procedure is executed. The pool starts to migrate to a new desired state via many intermediate stages (it is done to make this process smooth). For example, changing Token1 share from 12.5% to 13.5% and Token2 from 12.5% to 11.5% is decided to execute in 3 days. As each day contains ~6500 Ethereum blocks, this process will be over in 19500 blocks changing 1/19500 or ~0.00513% in each block. These changes possess arbitrage and in case of available liquidity on the market arbitrageurs balance the pool back once the arbitrage gap is enough profitable for them. Basically, they would just buy one type of asset and sell another one for that (assuming that nothing else changed on the market during the specified period).

So, the Internal Product Governance value creation pattern applied to PowerIndex and CVP certainly provides governance value to CVP. The exact monetary value of this influence correlates with the index liquidity. The more liquidity is locked in the index, the more real power owned CVP token holders.

Meta-governance value creation pattern

Almost all Defi projects with implemented native token have an Internal Product Governance value creation pattern. Often it is combined with other value creation patterns, for example, indirect cashflows (MKR), active users’ cashflows (YFI), or synthetic assets creation (SNX).

In this article, we introduce a meta-governance value creation pattern. We define meta-governance as temporarily transferring protocol voting rights to a broad social consensus. Such an approach becomes reality due to Defi composability — voting rights are represented by digital assets, which can be pooled and managed together by the community. Our team selected the Defi index concept as an excellent approach to deliver this value creation pattern to the market.

All assets pooled in PowerIndex voting based on CVP token holders’ decisions. It means that if PowerIndex has $100m of liquidity in 8 governance tokens and each of them has 12.5%, the $87.5m worth of governance tokens is temporarily managed by CVP token holders. Note that the remaining 12.5% belong to CVP. These $87.5m worth of pooled governance tokens is based on prices, established by the open market according to Internal Product Governance value creation patterns in each of these protocols. So, it can be defined as the current meta-governance value captured by the CVP token.

Our current vision is to define meta-governance value as a sum of all pooled assets value (excluding CVP):

In the case of several indexes in the system (CVP holders can create an infinite number of indexes based on their needs) overall meta-governance value is the sum of meta-governance values of each index. Note, that some future indexes can be composed not only from tokens with governance functions, so the value of these tokens has to be excluded.

Thus, the meta-governance captures value to CVP based on the worth of governance tokens pooled in the index and used by CVP token holders for voting. The approach presented above is a simplified one. The real value is influenced by the actual stake pooled (the share of supply, eligible to vote — check out Jake Brukhman’s articles to understand it deeply), the number of proposals, and their significance. We are working on a more complex and accurate model and will present it to the public once it will be finished.

Future cashflows value creation pattern. This value creation pattern is easiest to understand. The value of shares on the traditional market is traditionally assumed based on future cashflows using DCF (discounted cashflows method). Or course, the actual value of shares is influenced by dozens of factors, including expectations, market cycles, and speculative components. In the blockchain industry pure “future cashflows” value creation pattern (when all token holders receiving certain cashflows regardless of their actions) is rarely used due to regulatory reasons. In this section “future cashflows value creation pattern” refers to the approach of rewarding active protocol users. For example, YFI users can receive cashflows based on voting attendance. The simple owning the token isn’t enough for that.

The most important question related to the application of this pattern is — what is the source of the rewards? Where does the money come from?

In YFI commissions charged from Vaults usage act as a source of reward. In PowerPool the future cashflows value creation pattern is applied in the same way. As it was mentioned before, there are specific “community” fees implemented into PowerIndex design: entry fee, exit fee, and swap fee. Currently, these fees are set at 0.1%. It can be changed by community voting at any time. All charged “community” fees are collected into the special treasury contract and can be used for future payments for active CVP token holders. It is a simple transaction business, which can possibly collect millions of USD value in index composite tokens in case of big index liquidity. This token portfolio is protocol-owned and de-facto belongs to CVP token holders as it can be used based on community proposals.

The basic idea is to reward CVP holders, who locked their tokens into a special contract (necessary condition) and voted frequently (sufficient condition). Thus CVP became a cashflow-based token, but only in case of active participation in the governance process.

Value creation patterns powered by PowerOracle

PowerOracle is a truly decentralized cross-chain oracle based on Uniswap TWAP (time-weighted average price). Read more about PowerOracle here. Every person can become a Price Reporter or Fisherman and make a certain profit in case of correct operation.

The “work token” value creation pattern
The “work token” value creation pattern is one of the most known patterns on the market. It was developed as a solution to the Sybil attack problem constantly rising in pseudo-anonymous networks. The idea is simple — to perform some kind of work for the network, an agent is required to place a safety deposit (a skin in the game) first. In the case of performing honest work (correct operation) agent receives a reward, and in the case of misbehavior is punished (slashed) losing this stake completely or partly. This approach is successfully used in Ren, Filecoin, Livepeer, and many other projects.

The main economic idea behind the work token is that users can generate cashflows using a token stake and some external resources (for example, running a node). Tokens generate cashflow as a reward for correct operation (service provision) and are exposed to the risk of slashing at the same time.

In the case of PowerOracle users can deposit their tokens to the special contract and participate in the oracle operation taking Price Reporter or Fishermen roles. The work comes down to sign transactions pooling using the special software (script). Currently, Price Reporter receives 50% APY on his stake. Fishermen receive 20% APY.

The Internal Product Governance value creation pattern
The PowerOracle is entirely governed by CVP token holders. Stake requirements, APY, the set of supported assets, trading pairs, and even networks to deliver price feeds can be changed via governance proposals. The value of governing these variables is complex to measure as in every case of applying this value creation pattern. Value of adding or removing the desired asset, trading pair from the set of price feeds can be assumed only by certain groups of users (for example, dApp builders or users of protocols whose native asset is added to the price feed or removed from it).

The PowerPool lending market value creation patterns
For the lending market, it is evident that the same Internal Product governance pattern is used to describe the value for CVP token, derived from this product.

The composability of different types of value captured by CVP token

The PowerUniverse was initially designed to make value generated in different products composable.

This opportunity is based on the modularity of the PowerPool governance system. An end-user can use tokens in several products preserving value generated from each of them. Examples:

1. Users supply liquidity in PowerIndex receiving PIPT token for that. PIPT token can be used in the governance system for voting by staking it in the special contract. So, acting as liquidity provider users will receive meta-governance value, future cashflows value, and internal product management value (for all products from PowerUniverse). It works as PIPT is a derivative from CVP
2. Users supply liquidity to the Uniswap (CVP-ETH) pair receiving UniV2 LP tokens for that. These LP tokens can be used in the same way as PIPT tokens, collecting meta-governance value, future cashflow value, and internal product management value (for all products from PowerUniverse). It works as UniV2 is a derivative from CVP
3. Users bought a PIPT token on an exchange with the purpose to own a curated basket of Defi tokens. From this moment he can receive the meta-governance and future cashflows value from this basket of assets as well. As a result, owning PIPT is more attractive than owning a similar index token without this value
4. Users deposit CVP into a PowerOracle staking contract. These staked tokens can be used in governance, collecting all the possible values from it (meta-governance value, future cashflows, internal product governance)

Conclusion

PowerPool’s initial idea was a concept of the brand new value capturing mechanism, based on the aggregation of voting power in several protocols in a single token. It was named as “meta-governance value creation pattern”. During the idea development project expanded currently offering several products: PowerIndex, PowerOracle, and a lending market. Each product contributes to the value of the CVP token on the basis of implemented value creation mechanisms, which are discussed in the article.

All value flows are routed via the PowerPool governance system, in which modular nature allows users to combine them in any users’ scenario of product usage. It means that regardless of being a PowerIndex liquidity provider, PIPT token user, CVP token holder, PowerOracle worker, or liquidity provider to Uniswap every user can capture all types of value created by PowerUniverse products. The future research work is focused on establishing an advanced approach for assessing value, generated by meta-governance value capturing mechanisms and creating solid theoretical foundations for the design of the meta-governance value creation pattern.

Our vision is that meta-governance value creation patterns (accumulating voting power of several protocols into a single asset) are one of the possible ways of governance systems development. It can contribute to solving Voters’ Apathy problem, empower minority token holders, and lead to bigger engagement and participation rate in governance.

Acknowledgments

We are grateful to several community members for their valuable feedback and contribution:
Vasily Sumanov for value creation patterns contribution, token engineering consulting, and article review
Jake Brukhman for incredibly valuable articles helping to understand on-chain governance in a proper way