The Rise of veTokens

Why traditional DeFi token models are flawed

While 2021 is a banner year for the crypto market, with TVL continuing to explode in parabolic growth across multiple ecosystems, most DeFi tokens have underperformed relative to the likes of ETH.

At first glance, this may seem puzzling, as many DeFi protocols have generated millions in revenue and seen a huge increase in the use and adoption of their products.

However, I think the main driver of the industry’s underperformance is token economics. Early models of DeFi token design were fatally flawed and led to massive value destruction at the expense of retail investors.

Let’s unpack this by looking at the supply and demand dynamics of the “TradToken” design.

Demand-side dynamics of DeFi tokens

For projects launching before mid-to-late 2021, a common pattern we see in DeFi token design is the “valueless governance token” model.

In this model, token holders have full governance rights. While this may be a way to avoid regulatory scrutiny, and governance is of course a very valuable right, it means holders cannot claim cash flow and the token does not provide any stake in the protocol Any utility or privilege; this means that there is no underlying demand for the token other than speculation.

Supply-side dynamics of DeFi tokens

As we all know, most of the growth in DeFi in the past year and a half has been driven by liquidity mining. While it is usually done at the product level, such as DEXs or money markets, many protocols also incentivize liquidity in their native tokens through token rewards. While it is important for the token to have deep liquidity, these schemes are often polarized to attract mining farmers, leading to inflation rates that make Powell blush and lead to perpetual selling pressure on the underlying token.

It doesn’t take a PhD in economics to see why DeFi tokens are underperforming: their supply has ballooned, and there is no demand to help offset that.

However, as alternative token models begin to gain traction and acceptance in the DeFi community, hope is at hand.

The rise of the veToken model

One such model is the “ve (voting escrow)” model. The ve model, pioneered by Michael Egorov of Curve Finance, involves token holders taking the risk of locking their tokens in exchange for specific rights in the protocol, such as governance rights.

Driven in large part by the “Curve War,” despite being a “DeFi 1.0” token, the price of CRV and its largest holder, CVX, bucked the trend and performed well in Q3 and Q4 2021 , returns were 265.4% and 1085.7%, a 12.2% increase relative to DPI.

Due to this outperformance, DAOs in DeFi have or are planning to overhaul their token economics to move to veModels.

This begs the following questions:

  • Why is this model so successful?
  • What benefits does it provide to the protocol?
  • What are the disadvantages of ve-tokenomics?
  • Does switching to the project of ve-tokenomics mean that its volume will increase?

Let’s find out.

First veToken – veCRV

To understand a little deeper, the ve model is relatively simple: holders are trading short-term liquidity for benefits in the protocol.

Let’s explore this in practice by looking at the model’s pioneer, Curve.

Curve is a decentralized exchange optimized for the exchange between “like assets” that have the same or similar prices. This includes facilitating transactions between stablecoins such as USDC and USDT, or tokens and derivatives such as ETH and stETH (ETH pledged on Lido).

Like Uniswap and SushiSwap, Curve is governed by its own native token, CRV. However, what sets this protocol apart from the previous two is its token model. In order to participate in governance and reap the full benefits of holding CRV, Curve holders need to lock up their tokens. Each holder can decide how long they want to lock up, which can be as short as one week or as long as four years, with governance rights proportional to the length of time they choose.

Lockers receive a veCRV (voting escrow CRV), which represents a non-transferable claim on the CRV, meaning their tokens are illiquid during the lock-up period. 

Although holders forgo liquidity, they compensate for this risk by gaining special privileges in the protocol, as veCRV holders have the right to share in the fees generated by transactions made on Curve, increasing CRV rewards when providing liquidity , as well as the aforementioned governance rights.

This last benefit is especially important because the rewards for Curve pools (called gauges) are determined by voting by veCRV holders.

As seen in “Curve Wars”, control over rewards is very valuable for protocols like issuing stablecoins because it determines the rate of return for a certain pool and therefore liquidity (and stablecoins as well) peg stability of the protocol).

The benefits of the ve model

Now that we have a solid understanding of the ve model through Curve, let’s dive into some of the reasons why this model can be beneficial for the protocol.

1. Encourage long-term oriented decision-making

A major benefit of the ve model is that it incentivizes long-term oriented decision making. This is because by locking their tokens for a certain period of time (usually 1-4 years), token holders make a long-term commitment to the protocol.

That way, they are motivated to make decisions that are in the long-term, best interests of the protocol, rather than their own short-term interests.

In a fast-moving and engaging industry like DeFi, developing the ability to target long-term holders is extremely valuable. Given the noise levels during bull markets and the pressure to raise token prices in any way necessary, creating an environment where the community can resist these temptations can help protocols make clear, rational decisions that put them on a more sustained path to success.

2. Greater incentive consistency among protocol participants

The second way the ve model has proven beneficial is that it can align incentives across a broad range of protocol participants and stakeholders.

Let’s explore this idea again using Curve as an example.

Like other DEXs, Curve uses third-party providers as its liquidity source. Like competitors with aggressive liquidity mining programs, Curve LP faces indirect exposure to CRV tokens, as CRV incentives form a portion of each pool’s earnings.

However, what sets Curve apart and the highlight of the ve model is that Curve LPs are incentivized to hold their CRV tokens rather than sell them on the open market. This is because, as mentioned earlier, if Curve LPs lock their CRV, they will earn up to 2.5x higher CRV yields than unlocked LPs.

Although this mechanism is reflexive as LPs are essentially locking a token to earn more of the same, it serves a valuable role as it has the potential to put more CRV into the flow in the hands of the sex provider. By doing so, it helps to align incentives between token holders and liquidity providers.

This alignment of incentives between protocol users and their token holders can be very valuable, as these two groups often have competing interests. 

For example, in a DEX, both liquidity providers and token holders generate revenue by sharing the same exchange fees. This could create conflict within the DEX community as they could lose liquidity and compromise the quality of their products by passing some of the fees to token holders.

Without transferring fees back to their native tokens, projects can be unsettling and disengaging to core backers who want to benefit directly from the project’s success. Given the intense competition within DeFi, it is unlikely that any DEX will raise prices by increasing the fees charged to traders, meaning these two stakeholders are competing for a dwindling pie. 

3. Improve supply and demand dynamics

The final reason the ve model is powerful is by improving the supply and demand dynamics of project tokens.

While overemphasizing token prices can be dangerous to the long-term health of the community, tokens are the gateway into the community. Buying tokens is a way for people to participate, support and share the benefits of a project. Because of this, in order to attract and retain talented, value-added community members, it is important for a protocol to have sound, or at least not “fall and fall” token economics.

As previously mentioned, the first iteration of DeFi tokens, the “valueless governance token” model, creates perpetual selling pressure without underlying demand to help stop the downtrend.

While ve-tokens are not immune to market weakness from their current performance, they still help address supply and demand. It provides an economically sound basis for these protocol tokens.

For supply, voting locks are a mechanism to remove tokens from the open market. This helps to offset the high token release that some protocols generate, and we have seen existing ve-tokens being locked up at a very high rate.

velNh8ygX42quPaJX4ROZBeIUTomft7J9OWiaObY.pngAs shown above, on the three largest ve tokens by market cap, CRV, CVX, and FXS, an average of 54.1% of the circulating supply of these tokens is vote-locked.

Although somewhat reflexive, the ve model has also been shown to generate demand for the underlying token. Due to the utility required for voting lock-in to provide token holders with compensation for their risk of illiquidity, be it cash flow from fees or bribes, increased yields, discounts or governance rights, ve-tokens have successfully created some demand, as these are valuable rights that token holders want.

As discussed earlier in the article, this is also the driving force behind the Curve wars.

A rabbit hole that goes well beyond the scope of this article is that Curve wars are driven by the need between DAOs to control governance rights that can only be used through voting locks. Not only does this create demand for CRV and CVX, but it cements the DAO’s position as a long-term stakeholder in the protocol.

But veTokens are not a panacea. They have shortcomings.

Disadvantages of veTokens

While the protocol may implement the veToken model, hopefully instilling a perpetual “numba go up”, there are still some things to consider.

1. Lack of liquidity

While removing liquidity from token holders provides incentives for them to make long-term decisions, it can also challenge the protocol.

For example, it runs the risk of concentrating ownership on indifferent stakeholders.

If a locker loses confidence in the direction of the protocol, which is not impossible given the fast-moving and often years-long potential lock-up period, they will not be able to exit their investment. This can lead to misaligned incentives as apathetic stakeholders will be able to exercise governance power. The aforementioned lockers will be incentivized to make decisions centered on extracting as much value as possible from the protocol as quickly as possible, rather than emphasizing long-term value maximization.

2. (for a specific agreement) selling voting rights

The second challenge posed by the ve model is selling voting rights or bribery.

Bribes are all the rage in DeFi, with platforms like Votium and Hidden Hand (formerly Votemak) offering tens of millions of bribes to various protocols in the Curve, Convex, and Tokemak ecosystems, respectively.

Although they have proven useful because they provide the protocol a cheaper way to attract liquidity than traditional token-based incentive-based schemes, and increase by providing some kind of stable cash flow to token holders The appeal of voting locks, but bribery has the potential to introduce new systemic risks to the protocol, undermining the long-term incentives that voting locks provide.

For example, while not much of a problem for Curve and Convex, as they are simply directing liquidity flows rather than managing risk, bribery has the potential to disrupt protocols that do require active risk management to function properly. 

For example, if a single lending marketplace like Compound switches to a ve model that supports bribery, it is possible for projects to become collateral on the platform by purchasing voting rights.

Given that the security of the money market comes from its weakest collateral, this could lead to the listing of an exotic or extremely illiquid token, increasing the likelihood of a bankruptcy event and undermining the security, stability and users of the protocol of trust.

Price performance of ve-tokens

While it is one thing to examine the theory behind the ve model, it is quite another to see if it will lead to outperformance for tokens that are or plan to use the ve model.

In the table below, we examine the price performance of each token since the launch date of the implementation of ve-token or the announcement that they intend to switch to the model. We also measured the price performance of two benchmarks, ETH and DPI, over the same period.


As we can see, seven of the eight coins have outperformed both ETH and DPI since their launch or launch date. While this data may be biased in some respects, it does show the market and investors alike as several projects have made announcements in recent weeks deciding to move to the ve-token model and it is easier to beat benchmarks in a shorter period of time Optimistic about the ve model.

The future of ve-tokenomics

The ve-token model has become a popular alternative to the system of valueless governance tokens in DAOs, encouraging long-term oriented decision-making, aligning incentives among protocol stakeholders, and creating more favorable supply and demand for price increases dynamic.

Although we have yet to see clear trade-offs such as illiquidity and selling voting power, the ve model feels like a step in the right direction for DeFi token design.

We’ll also continue to see attempts to improve the model, such as Andre Cronje’s ve(3,3) Solidly exchange on Fantom, which utilizes iterations of ve-tokenomics that include elements similar to the Olympus DAO staking and rebasing mechanics .

While we have yet to see how ve(3,3) will play out, it is very encouraging to see some of the brightest minds tinkering with these token economics ideas.

Yes – DeFi token economics are already bad. But while ve-tokenomics is not a panacea, it appears to be a step in the right direction for DeFi protocols.

Posted by:CoinYuppie,Reprinted with attribution to:
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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