Introduction
Horiza, a forward-thinking decentralized exchange built on Arbitrum, has introduced several groundbreaking features, including concentrated liquidity, ve(3,3) tokenomics, and active position management via DeFiEdge integration. A notable advancement involves the implementation of oTokenomics to enhance the veTokenomics component. In this article, we will provide an overview of the progression of major DEX tokenomics designs and delve deeper into the concept of oTokenomics.
Evolution of DEX Tokenomics
Traditional Tokenomics
Traditional DEX tokenomics typically involves rewarding liquidity providers (LPs) with the native protocol token. However, this model mostly failed to align interests and often led to immediate token dumping, resulting in significant price drops of the native token. This, combined with an excessive focus on rewarding LPs for accumulating Total Value Locked (TVL) rather than generating fees, often caused these protocols to operate at a loss, meaning the expenses incurred by the protocol in emitting reward tokens surpassed the revenues generated from fees. Furthermore, excessive token issuance would dilute the protocol's native token, reducing incentives for LPs and requiring a continuous increase in token emissions and rewards. These dynamics would create a perpetual cycle of debt for DEXs, exacerbated by early governance structures that allocate excessive power to initial stakeholders with a vested interest in maintaining high token emissions.
Introduction of vote-escrowed tokenomics, or veTokenomics
To limit token dumping, Curve Finance first introduced veTokenomics. This new design would still reward LPs with the protocol's native token but would transfer most of the utility to a vote-escrowed version of the token, generally called veToken. The protocol would then let LPs choose whether to sell the native Tokens immediately or lock them to receive veTokens on a 1:1 basis. veTokens provide LPs with true utility, including capturing trading fees, participating in governance, and voting to direct emissions to specific pools. The core idea of veTokenomics is to establish a stronger relationship between rewards and loyalty, giving LPs more rewards the longer they lock their tokens.
veTokenomics represented an intermediate step in the evolution of DEX tokenomics, and a fundamental component of future designs.
The ve(3,3) Mechanism
The ve(3,3) mechanism, designed by renowned developer Andre Cronje and first implemented in its DEX Solidly, intends to strengthen the interests alignment among protocol participants further. This design combines Curve's vote-escrowed mechanism with elements from Olympus DAO's rebase and (3,3) game-theory approach, which incentivize behaviors beneficial to the protocol's long-term stability and growth, such as locking and holding tokens for extended periods.
Participants who lock their tokens as $veToken holders gain access to various rewards and privileges, including protocol fees, bribes, and governance power. In this context, Bribes denote arbitrary incentives offered by third-party protocols to DEX's veToken holders in exchange for directing emissions to their pools.
The ve(3,3) design initiates a self-reinforcing effect as voting and directing emissions toward well-performing pools attract more liquidity providers. The resulting increase in liquidity attracts additional users and generates more fees, thereby magnifying the returns for veToken holders. In other words, this approach incentivizes fee generation over TVL, a crucial paradigm shift in DEX tokenomics. At the same time, the (3,3) component ensures protection against value dilution thanks to rebase mechanisms. Finally, the bribing system partially enables newer protocols to counterbalance larger pools' strong network effects.
Despite these notable improvements, ve(3,3) DEXs may still face challenges, primarily related to the dominance of mercenary liquidity and the lack of protocol-owned liquidity (POL) to make the DEX financially independent from liquidity providers.
Understanding oTokenomics
Options token design, or oTokenomics, represents a relatively new approach in DeFi and DEXs tokenomics. This model was first proposed by developer Andre Cronje and found early applications in the Options Liquidity Mining by the Bond Protocol, launched in 2022 to empower sustainable treasury growth for crypto projects. A predecessor of the idea of options tokens can also be found in Olympus DAO's bonding mechanism, whereby the protocol sells its tokens at a discount to buyers, who would pay with another token (e.g., DAI).
The concept of options tokens evolved, and oTokenomics gradually became an integral component of DEX tokenomics to incentivize token locking further and achieve long-term sustainability. The idea is simple: instead of issuing liquid tokens as liquidity incentives, oTokenomics rewards LPs with call option tokens (oTokens), which can be used to:
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Convert 1:1 into veTokens. By locking oTokens, LPs receive veTokens, which grant them governance rights, voting power to direct emissions, a portion of swap fees, and bribes. For example, veRETRO holders receive 90% of trading fees from the gauge they vote for, and 85% of the rebase for the pairs they vote for in the form of autobribes.
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Buy native Tokens at a discount. Assuming that 1 Token is equal to $1 and there is a 60% discount rate, LPs can buy 100 Tokens by burning 100 oTokens and paying just $40 worth of another currency (e.g., MATIC, USDC, CASH). Here lies the most considerable difference with previous veTokenomics designs: users must pay a fee to convert the reward tokens into native tokens and cash out. This fee, which partly accrues to veToken holders as extra bribes and partly to the protocol as part of its treasury, makes it even less convenient for LPs to farm and dump immediately.
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Sell oTokens for native Tokens using dedicated pools. Generally, DEXs leave LPs free to sell their oTokens on the market to exit the position without exercising the call option and paying the discounted fee. This is only convenient if the peg is higher than the discount. Should the oToken peg fall below the discount price (in our example, one oToken < 60% of Token), it would encourage users to exercise their option instead.
Examples of protocols adopting oTokenomics include Ramses, Retro Finance on Polygon, and Velocimeter on Base, each implementing it with slight variations.
Benefits of oTokenomics
oTokenomics creates various positive externalities for all stakeholders, favoring those invested in the long-term success of the protocol:
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For users: Committed users who believe in and actively support the protocol's long-term growth can now seize greater opportunities. In addition to fees and bribes, veToken holders receive a share of the discount that liquidity providers pay when exercising their call options. In the case of Retro Finance, for example, the 'discount' paid by a user is divided at a ratio of 75/25. The lion's share is directed toward the top fee-earning pools as additional bribes, which veRETRO holders can earn by voting for those pools.
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For protocols: External protocols can more effectively bribe veToken holders with Token emissions without sacrificing their native token with excessive token emissions. The discount fee, partially directed to pools in the form of bribes, amplifies bribes' effectiveness in attracting liquidity, much like the case of CASH in Retro Finance.
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For the DEX: By imposing a fee on LPs to exercise their option and cash out, oTokenomics makes locking tokens more attractive than simply farming and exiting, discouraging mercenary behaviors and reducing selling pressure. Furthermore, by allocating part of that fee to the protocol's treasury, oTokenomics contributes to the protocol's financial sustainability. This Protocol-Owned Liquidity, similar to the POL mechanism of Olympus DAO, allows the protocol to accumulate capital, which can then be deployed to generate yields, provide liquidity, earn fees, and create a sustainable virtual cycle that makes the protocol financially independent.
In summary, oTokenomics' goal is to better align the interests of long-term users with those of the protocol by making it more advantageous to lock assets and reinvest them in the ecosystem.
Results for Retro Finance and Velocimeter
Thanks to oTokenomics and the dynamics just mentioned, Retro Finance saw 67% of oRETRO emissions from Epoch 1 being locked for two years, while the remaining emissions were utilized as options, generating over $13,500 in bribes and contributing $4,500+ to Retro's treasury. Following a similar mechanism, Velocimeter's LPs earned over $200,000 in WETH between the end of August and the beginning of September, thanks to the fees paid by users when redeeming their options.
A Potential Challenge
A potential limitation of oTokenomics is that LPs need liquidity in specific tokens to exercise their call option and buy the Token. Some protocols have devised unique mechanisms to address this concern. Transmute Protocol, for instance, helps users buy discounted RETRO without any upfront CASH capital requirement. This is achieved by creating a flash loan, borrowing the required CASH, exercising the call option, selling the RETRO tokens, repaying the flash loan, and returning the remaining proceeds to the user. If well designed, however, oTokenomics has the potential to self-sustain itself by including mechanisms to provide loyal users with the tokens they need to exercise the call option.
Horiza’s Relentless Pursuit of Innovation
Horiza is a novel DEX on the Arbitrum blockchain with an unwavering commitment to delivering value to its users through constant innovation. As part of its push toward excellence, Horiza has adopted oTokenomics to enhance its ve(3,3) tokenomics model's sustainability and effectiveness, combining veTokenomics with a (3,3) game-theory approach. As seen already, this model is a good starting point to incentivize stakeholders to stake native reward tokens, aligning interests and fostering active engagement within the ecosystem. oTokenomics will help Horiza strengthen these dynamics, delivering even more value to loyal supporters and ensuring the protocol's long-term sustainability and prosperity.
Besides oTokenomics, Horiza prides itself on the following winning features:
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Concentrated Liquidity: Like Uniswap V3, Horiza empowers LPs to contribute liquidity within specific ranges, optimizing capital efficiency and amplifying LPs' returns.
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Active Liquidity Management through DeFiEdge Integration: By integrating DeFiEdge, Horiza seamlessly offers its users access to active liquidity management provided by a network of professionals, thus maximizing LPs' returns and minimizing impermanent loss while saving users considerable time and money.
Conclusion
oTokenomics represents the latest innovation in DEXs' tokenomics, a mechanism crafted to secure the long-term protocols' sustainability while simultaneously optimizing returns for liquidity providers and token holders and facilitating liquidity creation for third-party protocols in a sound and viable manner. Horiza is excited to embrace oTokenomics as an integral component of its design and stand at the forefront of this advancement within the DeFi landscape.
While this article has provided a broad introduction to oTokenomics to explain the reasons behind Horiza's decision to adopt it, a comprehensive and detailed tokenomics framework will soon become available.
Stay tuned to Horiza's social channels for upcoming news, and check our Mirror page for the latest updates and ideas in DeFi.