In the whole crypto-currency ecosystem, each of them has its token model (called “tokenomics”) in which its mode of issuance, its utilities, etc. are described.
A blockchain project does not necessarily need a “token” (native cryptocurrency of a project) to succeed. However, in case you want to decentralize a project and encourage people to cooperate with it, a token is vital.
This is especially true in the world of decentralized finance where the goal is to remain independent from states that would seek to restrict projects. Therefore, most decentralized finance projects have a token.
From the moment a token is created, the construction of the token is as important as the protocol itself, because the fundamentals of the protocol and its token work together:
A good project with a bad token can succeed painfully
A bad project with a good token can succeed at the beginning but cannot hold on to the duration
A good project with a good token is among the best contenders for long-term success
However, most tokens have recurring flaws: they don’t involve the community enough, they can generate conflicts of interest, and as soon as the token no longer seems interesting, the value of the associated project collapses.
Nevertheless, we see a significant number of recent projects that choose to adopt the “veToken”, an economic model in which the issuance of tokens and the monetary incentive use radically different mechanisms compared to a classic issuance.
It is therefore time to introduce this model, especially since most users are still unfamiliar with how it works. While understanding veToken is essential to understanding the main events of decentralized finance (especially Curve Wars).
To understand the concept of veTokens, we will take the example of Curve’s CRV, as it is the first and most representative veToken in existence.
As such, holding a CRV token in a wallet does not confer any utility. The CRV only serves to be bought and sold on marketplaces. To obtain the veToken utilities, we have to lock it:
On Curve, it is possible to lock the CRV tokens for a longer or shorter time. When they are locked for a certain period, we get a certain number of “veCRV”. It is these tokens that allow us to obtain the following properties:
Voting Power in Curve governance
Obtain 50% of the exchange fees charged by Curve
Enhanced returns for liquidity providers (in the case of Curve, returns can be up to 2.5 times higher than providers without veCRV)
In exchange for all these properties, the veCRV cannot be sold and cannot be transferred during the lock-in period.
The longer someone locks CRVs, the more veCRVs he obtains, which is particularly interesting to ensure a continuous incentive to keep one’s tokens. Indeed, actors who own veCRVs have an incentive to work on improving the protocol, and losing this voting power would mean losing revenue.
This is the basic operation for the Curve model, which will be adopted by all other veToken models. Depending on the project, the blocking period and some ratios may vary, but the tokens all keep the same properties.
One could somehow consider veToken as the “Proof-of-Stake” of Liquidity Mining(hoping the comparison is not too shaky 😁)
Given that veTokens allow for participation in governance and more returns, many big players are willing to put in the necessary resources to get as much as possible. Even if locked tokens cannot be transferred, players can still induce voting for them by other means.
In the case of Curve, we realize that there are a lot of veCRVs not used to vote. As a result, a system of bribes has emerged, where projects pay users to use the voting power of their veTokens.
Specifically, there are projects like bribe.crv or Votium that are marketplaces for bribes, in which users choose the project to which they wish to delegate their veTokens and receive money for it.
The bribe is an age-old influence mechanism. And so far, the veToken model is the only one that fully accepts this mechanism and appropriates it credibly.
Beyond the ethical aspect of the bribe (which can be the subject of a separate article), the fact remains that everyone can know who is offering what bribe, who are the users who accepted it and everyone obeys the same rules even if no one trusts each other. Only the blockchain (and the veToken by extension) allows this kind of thing.
As said at the beginning, the veToken found its origin on the decentralized exchange platform Curve with the CRV token.
When veCRV launched in 2020, the system was heavily criticized by the crypto community, as the token issuance was extremely large compared to other decentralized finance tokens, and Curve sparked controversy in August 2020, as Curve’s founder appropriated 71% of the protocol’s voting power in reaction to Yearn.finance’s growing dominance.
However, veToken will fully assert itself during 2021 in an event known as Curve Wars.
Rules are simple: accumulate as many veCRVs as possible to increase the revenue earned from Curve, and influence the governance of the protocol in its favor. Then repeat the cycle.
And Curve created the biggest power war in DeFi today: several dozen DeFi projects are involved in this veCRV race, and more than a dozen protocols have been created specifically to play a role in Curve Wars.
It is thanks to veToken mechanisms that there are so many actors involved in this power struggle, as it offers much more advanced governance mechanisms compared to the vast majority of decentralized finance tokens existing at that time.
Thanks to Curve Wars, several dozen decentralized finance projects have now adopted veToken. Among them are Balancer, Frax finance, Yearn Finance, StakeDAO…Some projects are even considering modifying their governance token to adopt this model, like the exchange platform DYDX or the stablecoin issuer MakerDAO.
The reason why so many projects are adopting veToken is that it has so many advantages compared to a traditional governance token.
First, it increases long-term commitment to the protocol. The simple fact of locking one’s tokens for a period of up to several years encourages users to favor decisions in favor of the protocol rather than in their interests.
In addition, owners of locked tokens are financially incentivized to vote on protocol decisions. In this case, votes called “gauges” are held regularly in which users vote for DAOs to receive allowances on the issuance of new tokens. Meanwhile, veToken holders who don’t vote receive nothing.
In most decentralized exchange platforms, tokens can divide the interests of token owners and users. For example, on Sushiswap, SUSHI token stakers as well as liquidity providers all get revenue from the fees charged by the protocol.
This division causes a problem: if everyone chooses to stake SUSHI, the protocol has no liquidity, and this makes it unusable. On the other hand, if everyone prefers to provide liquidity, the token has no value and a large investor can buy all the tokens at once to have a monopoly on governance.
With veToken, owners receive income without being able to sell their tokens, and liquidity providers receive more returns if they have veTokens. To sum up, it is in the interest of absolutely all users to have veTokens to make the most of them.
As you have seen with Curve Wars, not all players involved can sell their tokens and the number of tokens available for free exchange is very limited.
Therefore, it is almost impossible to buy more than 50% of the tokens and make a governance takeover.
In the event of a disaster scenario (a huge crash for example), some tokens are simply defenseless against a takeover. The latest example is Terra with its LUNA token that had such a low value that a 51% attack could be achieved with just $180 million in LUNA.
Most existing governance tokens are also vulnerable to this kind of attack, but the veToken design makes it ineffective.
Even if some actors are dithyrambic towards veToken (for genuine reasons), this model presents some defects that could already be noticed in practice.
At launch, there are few tokens in circulation and they are very cheap. For an aggressive player, this is the best opportunity to establish a monopoly on governance from start to finish.
This is typically what happened to Curve in August 2020 when Yearn Finance had accumulated far too many veCRVs. Without the intervention of Curve’s founder, Yearn would have a virtual monopoly on Curve, hence the right to life and death over all protocol decisions.
For a veToken to be launched correctly, it is imperative to have a good starting distribution with a sufficient number of diverse players who all have an interest in getting involved.
Today, Yearn does not control Curve, but there is a protocol that has a monopoly on veCRVs at this very moment: it is Convex.
Even with a good starting distribution, its long-term evolution needs to be monitored because the more tokens a participant has, the more control it will have over the protocol in the long term. This is truer with the “bribe” mechanism, which accelerates the domination of players with a lot of means.
It is thanks to this process that the Convex protocol managed to have a monopoly on Curve. And today, the DeFi protocols are fighting to control Convex.
We could end up in an endless loop in which the protocols would fight each other to control who controls the main protocol when we are supposed to disintermediate finance in the first place…
Token blocking is a double-edged mechanism: while the ecosystem tries to get as many veTokens as possible, it is becoming very difficult to find substantial self-service reserves
As a result, price manipulations are very easy to carry out, and anyone with locked veTokens is literally at their mercy
Some protocols like StakeDAO offer a solution to this problem as "Liquid lockers" : you stake a veToken on the platform and get a counterparty with the advantages of the locked veToken, but it can be withdrawn at any time. A very interesting solution, but far from being without risk
That’s all for the veTokens overview. The presentation was mainly made around Curve because it is the most representative example. Even if there may be different workings on other protocols like Balancer or QiDAO, the mechanisms remain similar.
Even if veToken is far from being a panacea, it remains a much more elaborate model than most existing tokenomics. On the one hand, the veToken’s utilities allow to align the interests of absolutely all participants, and on the other hand, the veToken offers mechanics much more adapted to the real finance world.
If veToken models are appearing by the dozen in decentralized finance at the moment, it is proof that it solves key problems in the governance of a DeFi protocol. That said, make no mistake: the wish of any protocol that has adopted the veToken is to reproduce Curve Wars on it.
It would not be surprising if the Average Lock Time of veTokens became a unit of measurement in its own right or even a marketing argument. And the abuses that go with it, like making a veToken where you can only lock for 25 years, and then you can say “look, our ALT is 25 years, people trust us!”
I’ll finish with this: even if veTokens are solid, you should also be interested in tokenomics in general, because there are alternative models like GMX or Platypus which base their mechanics on time and which also work very well.