Forgd || Velodrome Finance: Leading the New Iteration of DEXs with Innovative Tokenomics

Introduction: Liquidity Challenges in DeFi

Liquidity in DeFi is frequently mercenary, even going so far as to border on cannibalistic.

According to a leading blockchain data provider, nansen, more than one-third of liquidity providers stop providing liquidity after just 5 days, and half stop after 15 days, and sell their accrued tokens from emissions to the pool on the way out.

Essentially, retaining liquidity providers has been difficult in DeFi.

Liquidity mining incentives for the protocols/DAO’s pools have, so far, been able to mainly attract temporary liquidity.

This liquidity is literally waiting for incentives to dry up and run for the exits when these incentives are no longer lucrative.

As a result, liquidity mining programs are frequently short-lived and result in significant downward spirals for the native token of the protocol/DAO.

Over time, teams realized this and pondered, "How can we capture liquidity in a way that is sustainable over long periods of time without diluting existing token holders and sending our token price into the abyss?"

Enter the leading DEX on the Optimism network, Velodrome Finance.

The protocol has pioneered a revolution in AMM design and sustainable liquidity. It aims to solve this colossal issue in DeFi and become the liquidity base layer of the Optimism ecosystem by improving and fixing the issues with the technology put forward by Andre Cronje’s Solidly.

Tokenomics

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$VELO is the Velodrome protocol’s native token that is used to incentivize liquidity provision on the platform.

This token ($VELO) can then be locked for up to 4 years (the locking mechanism is akin to $veCRV, which you can read more about ) to receive $veVELO, which is the locked version of $VELO and brings with it the right to direct (govern) $VELO emissions.

This means that $veVELO holders can direct emissions to any liquidity pool of their choice.

And since $veVELO functions akin to $veCRV, as you get closer to your unlocking date, your $veVELO governance power gradually decreases as the lock reaches the expiry date.

$VELO Token: Incentivizing Liquidity on Velodrome

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So, for example, if you locked $VELO tokens for 4 years, 2 years later, the governance power would have decayed by half, and as your tokens are unlocked, you have no governance power at all.

To maintain your governance power (stop it from decreasing), you need to relock your tokens every epoch (1 week) or at any other time to maintain/get back your previous levels of governance power.

Furthermore, $veVELO holders can receive their share (pro-rata) of trading fees generated by the pool they direct $VELO emissions to.

You may be wondering why anyone in their right mind would lock $VELO, perhaps for many years, solely for governance/voting power over which liquidity pool $VELO tokens are emitted to.

Well, by locking $VELO for $veVELO, you are eligible to receive bribes from external protocols/DAOs if you direct emissions to their liquidity pools, and you will also be eligible to receive your share of trading fees generated by that pool.

This process is elucidated in the diagram below.

And why would DAOs/protocols bribe $veVELO holders to direct emissions to their pool?

It's simple, really.

It allows DAOs/protocols to deepen their token’s liquidity on Velodrome, as more $VELO emissions to their token’s pool means more liquidity provision for it (due to a higher yield).

Do not worry if you do not yet comprehend the significance of deep liquidity; this article will provide you with the necessary knowledge.

Furthermore, by incentivizing $veVELO to vote on their pool (to direct emissions to it), DAOs/protocols are also aligning $VELO emissions with liquidity as well as fees generated from those same pools.

This way, the ‘highest bribed’ pool wouldn't always capture all the emissions.

Therefore, this fixes the broken vote-escrowed gauge system where unproductive pools frequently receive the majority of emissions; to learn more about this, we recommend reading this.

Now, back to the $VELO token.

The token follows a vote-escrowed token model that is similar to Curve’s, as we mentioned above.

There are, however, two nuances you should be aware of.

First, $veVELO is contained within an ERC-721 NFT, allowing it to trade on secondary markets like , allowing lockers of $VELO to exit their position seamlessly without selling their tokens on the open market (and, subsequently, lowering $VELO’s price), as opposed to other vote-escrowed models like $veCRV, where the $CRV locker is in it for the duration of his lock and cannot exit it in any way.

This comes with unintended consequences, namely, the token locker feeling imprisoned during the duration of his lock, which may result in the locker not participating in governance (becoming apathetic towards it), proposing aimless or futile governance proposals, and overall contributing to governance in a meaningless manner, taking away from the decentralization of the DAO.

Consequently, this can result in governance fiascos or, worse yet, the failure of many DAOs that do not have a ‘rage quit’ option to exit locked positions like $veVELO does through a secondary marketplace.

The other (second) difference is that the NFT also receives additional locked $VELO (similar to ) every 7 days, which amounts to 15-25% of the NFT’s $veVELO position.

The additional locked tokens (rebases) are added to the NFT proportionate to how much $VELO is being emitted to liquidity pools. This is so that the $VELO locker’s voting/governance power dilution is hindered. More on this aspect later in the article.

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Advanced AMM Design

AMM Design

As you probably already know by now, AMMs are an integral part of DeFi.

Uniswap’s constant product AMM was optimized to allow for unstable/volatile cryptos to be exchanged at a low swap fee of 0.3%, while Curve’s stable invariant AMM was optimized to allow for stablecoins and other pegged assets to be exchanged at even lower 0.04% swap fees (and even lower slippage).

Velodrome Finance took the best of both of these ideas and engineered a DEX with a dual AMM design. The protocol has one automated market maker (AMM) for pairs that are correlated (stablecoin pairs such as DAI/USDC and synthetic/derivative tokens such as stETH/ETH) and the other automated market maker for pairs that are uncorrelated (pairs such as ETH/DAI or BTC/USDC), all the while achieving some of the lowest DEX fees in DeFi, ranging from 0.02-0.05% per trade/swap.

Having monumentally low fees like these can give Velodrome an edge against other DEXes, encouraging traders and market participants to route their activities through Velodrome and hence generating massive amounts of swap fee revenue for token lockers.

As we have already covered in the “AMM Design” section, Velodrome offers a way for traders to trade correlated tokens (like DAI/USDT) and uncorrelated token pairs (like BTC/ETH) at very low fees that range from 0.02-0.05%, and by having mechanisms in place to attract liquidity providers, low slippage for traders too.

Additionally, Velodrome houses most of the liquidity on the Optimism chain.

This coupled with the low fees and slippage offered to traders on Optimism, makes Velodrome a very attractive DEX for traders to trade on.

Apart from creating value for traders, though, Velodrome’s main goal is to create value for DAOs/protocols requiring liquidity. But for this, Velodrome needs to be capital efficient.

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Distribution & Unlocks

The distribution of $VELO at inception is based on the initial supply (400 million tokens). Below is the distribution of these tokens.

60% of the community rewards are distributed as follows:some text
1. 27% to $WEVE holders
2. 18% to $OP network users
3. 15% to cross-chain DeFi users (Curve, Convex, TreasureDAO, Platypus, Redacted Cartel, and Eminence Finance users).
  This allocation is akin to an airdrop.

In essence, this allocation is aimed at giving governance power over initial $VELO emissions to users familiar with ve(3,3) and some other protocols with good communities to get the Velodrome economy kick-started.

24% of the partner protocol/DAO rewards are distributed as follows:some text
1. 6% for grants to fellow protocols and DAOs in the ecosystem.
2. 18% for attracting and engaging 10-15 protocols most likely to contribute to Velodrome and Optimism's long-term success.
3. 10% of the distribution is going to the Velodrome team.
4. 5% of the distribution is going to the Optimism team.
5. 4% of the distribution is going to liquidity providers in the $VELO/USDC pool (to deepen $VELO’s liquidity).

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As for the emissions of the $VELO token to liquidity pools, we can see the ongoing emission schedule in the image above.

Weekly emissions to liquidity pools start at 15 million $VELO (3.75% of the initial supply) and decrease at a rate of 1% per week. 97% of these emissions will be going to liquidity pools (based on votes), and the other 3% will be going to the team’s wallet.

There is currently no supply cap for $VELO. This is due to the fact that trading fees, as we have learned, go directly to $VELO lockers, and the only other incentive to provide liquidity is $VELO emissions. And if these run out, liquidity on the platform will most likely be nonexistent. This aspect will be explored later in the article.

Considering 3% of ongoing emissions and 10% of the emission schedule go to the team, it is prudent that we look at the team's vesting compensation breakdown below.

-The team will lock 35% of its initial allocation in the form of $veVELO and will use their voting power to vote for $VELO liquidity pools (to deepen liquidity) in perpetuity.

38.8% of the team’s initial allocation has a cliff of 6 months. After that, a vest linearly for 6 months. Ex- ⅙ unlocked in January, ⅙ in February, and so on.
18% of the team’s initial allocation has a cliff for 12 months. After that, a vest linearly for 12 months.
8.2% of the team’s initial allocation will be unlocked from the inception of the protocol and will be added to the treasury. The use of these tokens will be specified by the core team.

Out of the 3% of ongoing emissions streaming to the team’s wallet, 0.6% will be paid to team members. The other 2.4% of ongoing emissions are to be used for discretionary purposes, such as overhead costs, other expenses, and additional locking of $VELO in perpetuity.

Overall, it looks like the team has constructed a solid distribution plan, ensuring community engagement is present and incentives between them and other projects are aligned. This will aid in the formation of connections that will be beneficial to Velodrome and the community in the long run.

The Velodrome team also has a solid runway, and a percentage of all the emissions streaming to them will ensure they are well-incentivized to grow the protocol and ship out new features and products. However, a percentage of emissions streaming to the team in perpetuity introduces a point of centralization - as these tokens do not accrue to a DAO-controlled treasury.

Another negative about the emission plan is that the emissions for liquidity providers start off very high; this, in the early stages of the protocol, can result in heavy selling pressure on the $VELO token and would require significant demand to keep emissions off the market, something we have explored earlier in the article.

Let's finish off this section by looking at the $VELO token holder segments.

Source: Optimistic Etherscan

As seen in the image above, most of the $VELO tokens are locked as $veVELO, more specifically 73% of the total $VELO tokens.

Of these $veVELO tokens (locked $VELO tokens), governance power (over $VELO emission) is sufficiently distributed over 7380 wallets, however, the top 15 $veVELO holders ($VELO lockers) control 47.52% of governance power over $VELO emissions at the time of writing, introducing risks of centralization and thus censorship resistance and possible subjection of the $VELO token to market manipulation risks and thus even being called a security by the SEC.

The data referenced above can be found here.

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Value Creation for Traders and DAOs

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Additionally, Velodrome houses most of the liquidity on the Optimism chain, as seen below.

Source: DefiLlama

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This coupled with the low fees and slippage offered to traders on Optimism, makes Velodrome a very attractive DEX for traders to trade on.

Apart from creating value for traders, though, Velodrome’s main goal is to create value for DAOs/protocols requiring liquidity.

But for this, Velodrome needs to be capital efficient.

If protocols/DAOs can bribe lockers and receive more $VELO emissions in dollars than what they have paid in dollars to bribe (acquiring more capital with fewer capital costs, i.e., capital efficiency), there will be a constant desire for protocols/DAOs to bribe lockers to direct emissions to their desired pool.

The downside of this for the DAO/protocol is that they need to place bribes each week (epoch) that they need liquidity and will also not be able to accrue trading fees from their pool since they’re not directing emissions to it (they don't hold $veVELO).

To counter this, DAOs/protocols can accumulate $VELO and lock it in perpetuity.

This way, they’re constantly directing $VELO emissions (every week) to their respective pools - all this while receiving trading fees from their pool.

The latter (locking $VELO in perpetuity themselves) is the most optimal option for DAOs/protocols looking to acquire liquidity, as locking is a one-time cost (as opposed to bribing each week) and can thus secure emissions to their pool in perpetuity.

Furthermore, it allows the DAO/protocol to capture their share of swap fees generated by their pool, allowing them to earn a yield/passive income.

Whichever option the protocol/DAO chooses to deepen their token’s liquidity (bribing or locking themselves), $VELO lockers benefit (either from the bribes or the appreciation of the underlying $VELO tokens they locked, as the DAO/protocol has bought them off the open market).

How will Velodrome be capital efficient, though, you ask?

1) Not all $VELO will be locked for the same time period, so each locker will have sufficient governance power to be able to direct more $VELO to the desired pool than the actual locked amount they have.

2) Not all locked $VELO will be locked in perpetuity (max locked), this further ensures capital efficiency will always be present.

3) DAOs/protocols with locked $VELO will always vote on their pools (regardless of bribes on pools and swap fees generated by them), i.e., these lockers (the DAOs and protocols) are indifferent to external factors (such as bribes and fees), further enhancing the capital-efficient nature of Velodrome.

The only exception to the aforementioned (where capital efficiency isn’t present) is when all the $VELO in circulation is locked in perpetuity and for the maximum lock time of 4 years.

In that case, $1 of bribes will result in $1 of incentives/emissions.

Even if $1 in incentives results in $1 in bribes (highly unlikely), protocols and DAOs needing liquidity will still have a turnkey solution for their needs.

In other words, Velodrome will probably still be able to interest most liquidity providers in the Optimism ecosystem.

Since not all $VELO will be locked (or locked for the maximum duration), and some votes will be indifferent with regards to the bribes (DAOs/protocols with locked $VELO will always vote for their pool), capital efficiency will almost certainly be present.

This opens up a convenient way for DAOs/protocols to attract liquidity in a capital-efficient, sustainable way, even when the locked percentage of $VELO approaches 100%.

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As you can see in the image above, capital efficiency is present to a high extent, wherein on average, DAOs/protocols bribing on Velodrome get 2.1 times more (in $VELO emissions denominated in dollars) than the bribed amount (in any token denominated in USD).

This means that every dollar used to bribe $veVELO holders ($VELO lockers) results in 2.1 dollars in $VELO emissions received to that liquidity pool.

Talk about capital efficiency.

This is the primary reason why the Velodrome wars (akin to the Curve wars) are heating up and are currently valued at a whopping 57 million USD at the time of writing, as seen below, and why a ton of DAOs and protocols are bribing or locking $VELO tokens to drive emissions to their pools.

We will explore the details of this later in the article.

Source: Defi Wars

Until now, we've talked about the value created for traders and even DAOs/protocols looking to acquire or deepen their token's liquidity.

But we haven't yet looked at who captures the majority of the value from the Velodrome protocol.

Hint: you probably already know this.

Yes, it is in fact $veVELO holders ($VELO lockers).

Looking at the image below is a good way to visualize the inherent utility (direction over $VELO emissions) and the value accrual mechanism (bribes and swap fees) of the $veVELO (locked $VELO).

We can clearly see that the beneficiaries of DAOs/protocols placing bribes and traders utilizing Velodrome’s liquidity are $veVELO holders ($VELO lockers), as locking $VELO for $veVELO, as previously mentioned, grants the rights (governance) over $VELO emissions, which in itself is governance as value accrual, as this allows an opportunity to accrue your share bribes and swap fees for the liquidity pool voted on.

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Another utility of the $VELO token is the ability to provide liquidity for it.

Currently, as seen above, some $VELO liquidity pools on Velodrome pay as high as 140% APR, which is not bad at all.

The $VELO token is also integrated into many DeFi protocols such as Overnight, dHedge, Tarot, Reaper Farm, OpenX, Beefy, 1Inch, and others, unlocking a myriad of utilities for it.

As seen above, currently, on average, $veVELO holders ($VELO lockers) yield a handsome 48.64% APR, with around 82% of that yield (40% APR) being real yield (i.e., yield not denominated in $VELO; no rebases, only yield from fees and bribes).

Compared to other protocols, Velodrome has some of the highest real yields paid to token lockers in DeFi right now.

The Velodrome protocol, on the other hand, does not accrue (capture) any value directly at the time of writing.

Indirectly, however, the protocol captures some value through the $veVELO governance power amassed through treasury allocations and the team’s locked allocations, subsequently generating a yield through voting on the main $VELO liquidity pool, VELO/USDC, capturing its share of the bribes and swap fees from the pool.

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$VELO Demand Drivers

The Velodrome team currently runs an incentivisation program called Tour de OP funded by Optimism ($OP) grants wherein new $VELO lockers, DAOs and protocols bribing receive rebates or additional incentives in $OP tokens, as seen below.

Source: Dune Analytics

The image below elucidates the details of this incentive program. You can read more details about the program, its implications, and its outcomes here and here.

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In a nutshell, this program has been a huge success, helping drive demand for the $VELO token in the short term and subsequently emissions of the market, heavily increasing the amount of bribed pools (the red bars are after the program’s inception), as seen below.

Source: Velodrome Finance

Soon after this airdrop program halts, though, we may not see $VELO being locked at the same rate as seen below, and the forthcoming supply of $VELO would need to be met with demand for the cash flow generated by locked $VELO.

Source: Dune Analytics

The cash flow generated would include: bribes from external protocols, swap/trading fees, and rebases.

And as we saw previously in the value capture section, these elements all come together to offer a very lucrative cash flow model to users locking $VELO – 48.64% APR at the time of writing.

One of the biggest demand drivers for the $VELO token is the sheer number of DAOs and protocols accumulating and locking it.

As seen below, there is a multitude of large DAOs and protocols such as Optimism, Beefy, Inverse, Millennium Club, Lyra, Alchemix, 200 Keys, Synthetix, Liquity, Thales, Frax, Hundred, Redacted Cartel, Perpetual Protocol, Tarot, MakerDAO, Angle, QiDAO, One Ring, and Hop currently holding/accumulating $veVELO (locking $VELO) and driving $VELO emissions to their token’s liquidity pool.

Source: Defi Wars

The crazy part?

This isn’t even the full picture of the extent to which DAOs and protocols are accumulating $veVELO (locking $VELO), as there are many more not mentioned below (the list above is only of the top accumulators/holders of $veVELO). You can find the extended list here.

It is also worth noting that many DAOs and protocols are also bribing existing $veVELO holders ($VELO lockers) on a weekly basis to drive emissions to their pools – you can find the specifics here.

Let’s also look at the traction the protocol is gaining.

Source: DefiLlama

As seen above, the Velodrome protocol has been gaining traction in terms of active users of the platforms and volume generated by trading.

Source: DefiLlama

It has also seen traction regarding new users onboarded to the Velodrome ecosystem.

As seen above, the traction the protocol is gaining is also clearly helping drive demand for the $VELO token.

Lastly, since Velodrome is deployed on Optimism, it has a direct correlation to the chain’s adoption, since after all, users on the chain need a DEX to trade on and yield farm on, and DAOs/protocols deploying on Optimism need a venue to deploy and deepen liquidity – something that we know Velodrome is very well suited to do.

Looking at the images below will give us a good understanding of Optimism’s adoption and user statistics.

Source: Dune Analytics

As seen above, there has been an increase in the monthly usage of the network – and at its highs in May, Optimism even had more usage than Ethereum itself (for further data, refer to this).

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Source: Dune Analytics

We can also look at the weekly and daily statistics in the image above, which clearly show an uptrend in the daily, weekly, and even monthly transactions on the chain.

Source: Dune Analytics

In the image above, another trend is shown, wherein Optimism and Arbitrum (the two biggest L2s on Ethereum by TVL) are starting to capture the majority of transactions as compared to the base layer, Ethereum, which further shows the adoption of Optimism and L2s, in general, are gaining – something that could be highly beneficial to the Velodrome protocol.

Furthermore, Optimism’s recent Bedrock upgrade has significantly improved the user experience on the chain, lowering the fees and deposit times on the chain – contributing to around half a million in gas costs saved post-upgrade, as seen below, which incentivizes users to bridge funds over to Optimism and interact with its ecosystem, and by extension, Velodrome.

Source: Dune Analytics

All these aforementioned factors – the Tour De OP program, the insatiable desire for DAOs and protocols to acquire capital efficient liquidity (and thus locking $VELO or bribing), the protocol’s traction, and Optimism’s adoption combined can help drive demand for the $VELO token.

Feedback Loops

We can also see the feedback loops at work that the protocol and token are subjected to.

It is important to note that both of the feedback loops analyzed below are both positive and completely hypothetical (so there is no guarantee that they will materialize).

The positive feedback loop above can materialize if the $VELO price drops substantially or incrementally over time.

A situation as seen above can be highly detrimental to the protocol and can even result in the $VELO token entering a death spiral.

For this reason, it is important that the bribe and swap fee yield be sustained or increased, something that will probably happen if Velodrome maintains its place as the biggest DEX on Velodrome.

The other feedback loop shown above is a flywheel that can affect $VELO’s price to the upside, therefore being a highly beneficial one to the protocol, as seen above.

1) As seen below, the amount of $VELO tokens locked for $veVELO and the amount of $veVELO relocked to maintain/increase governance power (explained at the start of the tokenomics section) is slowly decreasing with emissions; this is normal and expected (you can’t lock supply that hasn’t reached the market), but the portion of emissions being locked for $veVELO is decreasing from previous months.

Source: Dune Analytics

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While the rate at which $VELO tokens are being locked for $veVELO and $veVELO tokens are being relocked is relatively good in comparison to emissions, it is significantly lower than the levels seen many months ago.

While we cannot ascertain the cause of this, it may be attributed to the fact that external incentives (not cash flow or yield generated) to lock $VELO tokens for $veVELO, like the $OP rebates and bribe matching program, have scaled down significantly (around 65%), and the amount of $OP tokens in the treasury has been heavily depleted.

While the team is applying for another grant, the results of it cannot be predicted, and external incentives cannot fuel incentivization to lock $VELO for $veVELO and relock $veVELO forever.

So it is indeed possible that previous levels of locking and relocking won’t be achieved again due to this, which may consequently lead to more tokens hitting the market and more downside (sell pressure) for the $VELO token.

A lack of external incentives, however, isn’t an existential threat to the protocol, as lockers are still compensated well through the real yield generated by the protocol (fees and bribes), as mentioned previously in the article.

Further, if bribe matching (due to a depletion of $OP tokens) stops, it may decrease the capital-efficient nature of Velodrome, perhaps decreasing its attractiveness for DAOs/protocols looking to acquire capital-efficient liquidity, but it will still retain its ability to be capital efficient on average due to reasons previously explained in the Value Creation section.

It is also important to note that DAOs/protocols can always acquire capital-efficient liquidity through means other than bribing, such as locking $VELO for $veVELO themselves.

Overall, these external incentives do not put any selling pressure on the $VELO token, only on the $OP token, and these external incentives are merely a cold start mechanism for the protocol to gain adoption without putting extra, unnecessary potential selling pressure on the native $VELO token.

2) As seen below, many of the biggest DeFi protocols hyperemit their native token in relation to the revenue they generate.

Source: TokenomicsDAO

Velodrome, on the other hand, fares well in this regard as compared to the protocols above, requiring 3.2 dollars in $VELO emitted for every dollar in revenue generated, as seen below.

Source: Levi Saur

While this is not sustainable in the long run and perhaps puts selling pressure on the $VELO token in the short run, the incentivization program running currently (Tour de OP) negates the selling pressure to an extent as it gives external incentives to lock the $VELO token.

But as we previously mentioned, the program cannot run forever, and after it comes to an end, these concerns may materialize.

However, as most of the $VELO supply has been locked for $veVELO for a long time, it gives the protocol enough time to get back on a sustainable path before these concerns materialize.

Also, as seen in the same image above, Velodrome fares up well against Thena, a DEX with similar tokenomics but on BSC, so not exactly a competitor, in this regard, requiring fewer emissions to generate every dollar in revenue, but fares up very poorly against Equalizer (which, by the way, we did an AMA with – feel free to check that out here), also a DEX with similar tokenomics but on the Fantom chain, so again, not exactly a competitor, which is significantly better in this regard (two times better almost–needing two times fewer emissions to generate every dollar in revenue).

3) The vast majority of other DEXs and liquidity-as-a-service platforms incentivizing liquidity provision with emissions (in their native token) will fail in the long run since their emission plans have a supply cap and fees are never enough to retain liquidity providers.

This, in the long run, will prove to be the death knell of many of these projects.

Velodrome, on the other hand, does not suffer from the same issue because of the way they structure their tokenomics.

Apart from the demand side of things that we’ve already covered, $VELO emissions to liquidity pools decay over time but never fully run out.

This ensures that there is always an incentive to provide liquidity on Velodrome.

But the hope is that the ever-decreasing/decaying emissions will become more valuable over time so as to not lose liquidity providers on the platform (retain them).

But this is always easier said than done, and due to unforeseeable market conditions/innovations/changes in narrative, the token price may not necessarily appreciate the decreasing emissions.

If this concern materializes, the token price could enter a death spiral, as explained previously in the feedback loops section.

One potential mitigation of the aforementioned could be the forthcoming implementation of a “FED”, i.e., monetary policy controlled by $veVELO holders ($VELO stakers).

You can read more about this implementation here, but the gist of it is:

Changing $VELO’s monetary policies dynamically (decreasing, increasing, or maintaining current emissions) based on exogenous factors such as economic conditions or ecosystem growth while ensuring only long-term stakeholders ($VELO lockers, i.e., $veVELO holders) can have a say on the following.

4) While on the topic of new implementations, the Velodrome protocol will soon undergo a migration to a new version (v2).

You can get into the nitty gritty of this here and here, but let me save you some time by simply summarizing the significant upgrades to the protocol.

Better UI/UX

Custom pool fees

Yield optimizers for veNFTs (to generate the highest ROI through voting optimally)

Velo FED (which we have touched on above)

Improved governance and subsequent capabilities

These implementations/changes have the potential to better the protocol’s tokenomics and user adoption, which may consequently drive demand for the $VELO token.

5) Optimism is controlled by a 4-5 multi-sig wallet.

What does this mean for Velodrome?

Since Velodrome is deployed on Optimism, Velodrome’s treasury funds and all user funds in the protocol (locked $VELO, liquidity pool deposits, etc.) can be censored, frozen, or even taken away by any 4 people on that multi-sig.

Even an arbitrary amount of $VELO can be minted and sold into liquidity pools, effectively destroying the protocol and the $VELO token.

While this isn’t in Optimism’s best interests, nor is it legal, it is still a possibility, but the chances of it occurring are marginal – close to zero almost.

But then again, crazier things have happened in DeFi, and centralized projects like Optimism will do anything if asked to comply with a court order.

6) As previously mentioned, $veVELO holders ($VELO lockers) get 15-25% of their position rebased, so their dilution levels are hindered by that percentage (since there are $VELO tokens hitting/emitted to liquidity pools).

While that may seem like a good mechanism to incentivize locking, there is more to it than that.

We highly recommend giving this article a read because it explains the ramifications of such a mechanism, but we will be summarizing the important findings of the article below.

The mechanism centralizes voting power and doesn’t allow new participants (DAOs/protocols) to enter the economy and gather a substantial amount of voting power (as the barrier to entry is made much higher).

The mechanism lowers aggregate demand for the token (in this case, $VELO) by eliminating the need for projects to continually accumulate more of the token as they’re protected by this mechanism.

While this analysis is subjective and these mechanisms haven’t stood the test of time, it is hard to draw conclusions as to their ineffectiveness or effectiveness.

And it’s important to note that Velodrome’s rebasing mechanism is only 15-25%, limiting the potential consequences of the aforementioned.

Other similar protocols like Equalizer (which we’ve touched on before) and Solidly have different rebasing rates (0% and 100%, respectively), so we’ll have to wait and see to determine what works best.

Only time will tell.

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Summary and Conclusion

As crypto gains mainstream adoption and more TVL flows into DeFi, one of the most important things will be on-chain liquidity.

Therefore, for a protocol/DAO, securing liquidity for its native token will be crucial.

$veVELO is tokenizing liquidity and allows for all projects building on Optimism to have turnkey solutions to attract sustainable and capital-efficient liquidity.

The Velodrome protocol is also relatively new, so the tokenomics are novel and have not stood the test of time yet, so it is still a very speculative project.

Furthermore, the $VELO emissions to liquidity pools are still very high, and usage of the protocol is, to an extent, linked to the Tour de OP program, which cannot last forever.

So, as the program winds down, the forthcoming supply of $VELO will need to be matched with a significant incentive to lock it purely because of the value accrual mechanism for $VELO lockers.

If the protocol can generate a similar amount of value for lockers as it does now and Optimism continues to gain adoption at the levels it is currently, I have no doubt that future emissions will be locked up for the foreseeable future and Velodrome will have a bright future.

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Velodrome Finance: Leading the New Iteration of DEXs with Innovative Tokenomics

Introduction: Liquidity Challenges in DeFi

Tokenomics