Crypto protocols rely on active user participation to remain decentralized and autonomous. One mechanism for encouraging this participation is the use of vote escrow tokenomics. In this model, users lock up their tokens for a specific period to gain voting rights or other rewards. This mechanism incentivizes long-term commitment from users and helps to prevent short-term speculation and volatility in token prices.
In this post we explain Vote Escrow tokens and how they work to incentivize governance and attract liquidity in DeFi.
The Beginning of veTokens
Curve Finance was the first protocol to pioneer the vote-escrow model. CRV holders can lock tokens for a period of time ranging from 1 week to 4 years. The longer the lock-up period, the more voting power the user gains. The voting power is calculated using a formula that takes into account the number of locked tokens and the length of the lock-up period. By locking up their tokens, users signal their commitment to the protocol and its long-term success. This incentivizes them to actively participate in governance decisions, as they have a greater stake in the outcome.
As a veCRV holder, users get various benefits. They receive inflation in CRV tokens from the protocol, earn fees from the protocol (half of the .04% fee goes to veCRV holders), receive bribes (payment for voting rights) on secondary markets, and have weekly votes on where to direct emissions. They also get up to a 2.5x boost in emissions in CRV when LPing (liquidity providing) depending on LP size and the amount of veCRV held.
However, this model also has its downsides. For instance, there is a high concentration of votes in the system, with DAOs like Yearn and Convex owning a lot of the locked CRV. Additionally, there is no secondary market for locked veCRV as it is not transferable.
Another variant of the vote escrow model is the ve(3,3) model, created by Andre Cronje with the first version of Solidly. This model is designed to improve upon the original vote-escrow model. The longer the lock, the more votes you have in the ve(3,3) system. The veToken locks are represented as NFTs that can be transferred and traded on the secondary market. VeToken holders also get rebases in token supply, which means that maintaining a constant 4-year lock does not mean emissions are dilutive for voters.
Unfortunately, there were flaws in the Solidly system (vampire gauges, negative voting creating bad incentives, and some others), and Andre Cronje quit from the project, causing Solidly to fail.
However, some early users decided to fork the protocol and move it to Optimism, giving birth to Velodrome. Velodrome made additional improvements to the ve(3,3) model based on the issues with the Solidly launch and failure. The protocol has since become the largest DEX on an L2 and one of the largest DEXs in the space.
Fixing Voter Apathy with veTokens
The concept of on-chain governance has been around for a while in the crypto space, but it gained more attention with the rise of DAOs (Decentralized Autonomous Organizations) in 2016. DAOs are organizations that operate through rules encoded as computer programs on a blockchain. They allow for decentralized decision-making and transparent governance, with the power to make decisions resting in the hands of token holders.
One of the primary issues with on-chain governance is voter apathy. Most token holders do not actively participate in governance decisions, leading to low voter turnout and centralization of decision-making power in the hands of a few. This is where vote escrow tokenomics come in. By locking up tokens for an extended period, token holders signal their commitment to the protocol and its long-term success, thereby incentivizing them to participate in governance decisions. Often this comes in the form of direct bribes by protocols looking to attract liquidity.
Vote escrow mechanisms also prevent short-term speculation and volatility in token prices. This is because token holders who lock up their tokens are less likely to sell them in the short term, reducing the supply of tokens in the market and increasing their value.
The ve(3,3) model takes this a step further by allowing the transfer and trade of the veTokens on the secondary market. This provides more flexibility for token holders and enables them to trade their locked tokens for other assets without having to wait for the lock-up period to end.
What’s Next for the veToken Model
In conclusion, vote escrow tokenomics is a mechanism used by protocols like Curve Finance and Velodrome to incentivize long-term participation and commitment from their users. While there are benefits to this model, there are also downsides, such as the concentration of votes and the lack of a secondary market for locked veTokens. There are a number of projects working to address these issues and experiment with novel mechanisms based on the original ideas of vote escrow tokens. Nevertheless, these mechanisms have been successful in attracting deep liquidity and becoming some of the top DEXs on various chains.