The Pillars of Tokenomics & The ve Token Model
Lots of coins are adding "ve" to their tokenomics, is this sustainable or just another trend?
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Token design is hard
Tokenomics is the science of the token’s economics
Designing the right tokenomics for a project is crucial, while also being one of the most difficult things to do. Think about it, you’re essentially creating an entire economic system from scratch, without fully understanding the real-life nuanced implications it will have once the project is released. A wrong nuanced design decision can rekt the entire project, even if everything else about the project was strong. This is further compounded by the fact that smart contracts are immutable. Once a contract is released, it will take a fork in order to make any updates to the protocol. As complex as tokenomics are, they are still governed by the two basic laws of economics, supply & demand. Any features that the developers build into a token are just methods to influence the short-term & long-term supply & demand. Ideally, the best designs are those that decrease circulating supply while encouraging demand, but this is easier said than done.
The four pillars
Before going into the complexities of the “ve” token design, this section will go over the basics of tokenomics. In my opinion, there are four basic tokenomic pillars that make up every cryptocurrency and it’s the first thing an investor should analyze before diving deeper into the economics of a coin. Any design flaws in these pillars are a clue that the foundation isn’t solid and may cause the house to come crashing down if it’s severe enough, or cause the project to slowly bleed, like an abandoned building rusting away.
It doesn’t get more foundational than the number of tokens in the protocol. We can split the supply up into:
Circulating Supply: The number of coins that are in the market.
Max Supply: Maximum number of coins that can exist for the protocol.
Total Supply: The number of coins that have been issued. This includes burned & locked up coins. These coins don’t have to be a part of the circulating supply.
A higher supply lowers the token price and this is something that lots of crypto beginners struggle with. I’m sure you’ve often seen comments such as “ Look at Cardano, it’s only $1, imagine how much money I will make if it only reaches 50% of Bitcoin’s price!” They fail to realize that Cardano has a 45B supply compared to Bitcoin’s 21M. This is why the market cap is a more accurate metric than looking solely at the price as it factors in the price & supply.
An area to look at for foundational issues is comparing the circulating supply to the total & max supply. If the circulating supply is low while the total & max are high, that’s a massive red flag as the value of your coins will get diluted away. Let’s take a look below:
This coin has a circulating supply of about 133M, with a 10B max supply. That’s about an 8x dilution risk to your coins which is a massive cause for concern. If all the coins were to be released tomorrow, the value of your coins will be worth 1/8th of what it was yesterday. Let’s say you buy in today at the 305M market cap expecting a 100x over 5 years. This would put the Marketcap at 30B (pretty high, but not unusual in crypto) but, the fully diluted valuation will go to 2.3T (higher than the crypto market cap is today). In addition, an increasing circulating supply by the periodic release of these coins will put downwards pressure on price, even if the market cap grows. This isn’t to say that everything about this coin is terrible and they may even have ways to counteract the supply pressure, but it’s a risk factor that long-term investors should be aware of. Short-term investors have less of a worry regarding the max supply as they won’t be around for most of the token unlocks.
Below is an example of the opposite, a circulating supply that is close to the max supply. This doesn’t mean that the coin is automatically a solid project, but its one less foundational risk factor for an investor:
The distribution of a coin is the next tokenomic pillar that investors should be aware of and it’s a pretty straightforward one. The distribution is the % of coins that each wallet holds of a specific coin. Think about it like this, would you want 1 person holding 70% of the coin’s supply? That project is now somewhat centralized and he can dump the coin endlessly, making us non-whales much poorer and destroying the project’s reputation.
A great distribution design is when no single person or group holds a large amount of the coin, instead, it’s distributed among many individuals. If someone wants out, their selling won’t have too much of a price impact. The best way to find out the distribution of a coin is by checking their whitepaper for the token allocation chart and checking the distribution among wallets on a blockchain explorer.
The monetary policy in crypto dictates whether a coin is inflationary or deflationary and by how much, as well as the overall consensus mechanism for the project. As mentioned earlier, high inflation will cause the asset price to go down over time. A low inflation rate combined with proof of work (such as Bitcoin) can be a great thing as it creates productivity within the ecosystem. Ethereum 2.0 and EIP 1559 which allows ETH to be burned during every transaction should theoretically allow Ethereum to become deflationary.
This brings up my next point on how each of these four pillars should be analyzed together and how they interact with each other. Let’s go back to our example of the highly dilutive coin from the supply section of this article. While it has a high fully dilutive valuation, let’s say it has a monetary policy of burning 7% of the circulating supply each year and a token release schedule of 5% a year. This comes out to a 2% DEFLATION rate year over year even though 7/8th of the supply is locked up and has inflationary pressure. Under this monetary policy, your coins will not face any of the inflationary pressure of the lock-up, but in fact, there’s negative supply pressure as the circulating supply is actually decreasing.
Looking for synergy/chaos between the interactions of the various basic pillars lets us figure out how well designed the tokenomics are. Taking one pillar and forming an opinion will give an incomplete picture.
(Note that there is a debate on whether burns are an efficient use of funds or not, I used token burns as a simplified example to explain the concept.)
The last and final pillar is how much value the protocol is capturing and how that value is distributed. In Web 2, all of the value captured went back to companies such as Facebook, Google, and Twitter. They make billions of dollars off of their users’ data and social media interactions while the users get zero dollars back. The most a user will get is a blue checkmark lol. Web 3 flips this on its head as the protocol captures the value they provide, and distributes it back to token holders. You can be a user of a protocol while getting a return at the same time.
Not all protocols capture value efficiently, and I would argue that there is still a ton of research and experimentation needed until we have a tokenomic architecture that can capture 100% of the value that a protocol provides.
The easiest example is to compare the Uniswap vs Sushiswap battle in 2020. Uniswap released their AMM (automated market maker) but, did not release a token. Sure they provided an innovative product with tons of value, but they captured 0% of value for network participants. Sushiswap then forked Uniswap and created the SUSHI token along with it. SUSHI holders are able to vote on governance issues as well as stake their SUSHI for xSUSHI and receive the transaction fees that the protocol generated. While this model is far from perfect, having token holders share in the revenue captures significantly more value than Uniswap’s model. If Uniswap came out with a token that captured value when the AMM was released, it would have been much more difficult for Sushiswap to gain traction.
Thanks for the basics, but what is ve?
ve stands for “voter escrowed” and is quickly becoming a popular tokenomics model with newer DeFi protocols. The interesting part is that the ve model was invented by Curve Finance, which is “DeFi 1.0”, according to the cool kids.
The way that it works is that you lock up your CRV token and it’s then converted into veCRV which has the governance power of the protocol. The lock period isn’t fixed though, the token holder can decide how long they want to lock their CRV for, up to a maximum of 4 years. As time goes on, the amount of veCRV that a holder has decays linearly throughout their lockup period. This incentivizes the holder to relock their CRV for veCRV periodically in order to maximize governance and rewards. The main innovation from this is how this creates weighted votes and weighted rewards. In addition, once you convert your CRV into veCRV, you’re locked in for that specified time period. There is no unstaking your bag early like in other protocols.
Let’s say Bill and Alice each have 100 CRV. Bill decides to lock his CRV for 2 years, while Alice locks her for 4 years. Even though they started out with the same amount of CRV, Alice will receive double the amount of veCRV than Bill, which means that she will have double the governance votes and rewards than him.
The effect of veTokenomics
One of the main problems that veTokenomics solves is the 1 token = 1 vote problem. under a non-ve model, big whales can buy large amounts of the tokens for short-term governance and yield rewards without having any skin in the game other than short-term price. A protocol can buy up millions of dollars of a competing protocol and vote in favor of terrible proposals and then dump the coin. Under the ve model, this type of whale manipulation is much less effective as their votes won’t be as valuable as a long-term holder. If a protocol or whale wanted significant influence on another protocol they would have to lock up their tokens for a period of time. Now that their tokens are locked up, this creates an incentive to act in a manner that is in the best interest of the protocol. The curve wars are the best example of this playing out.
In addition, die-hard supporters of a protocol who choose the maximum lock period will have a larger voice than under the 1 token = 1 vote model. These die-hard supporters are then rewarded with more yield and passive income than a short-term speculator. As long as the protocol continues chugging along, the stakers understand that they will be making passive income for the foreseeable future, instead of jumping from protocol to protocol with uncertainty.
Lastly, the ve model has a direct impact on 3 out of the 4 pillars, with distribution being the only pillar where the relationship is weak.
It impacts the supply through the long-term lockup of coins. Holders are incentivized to lock up their coins for a long period of time in order to maximize influence and yield. When these tokens are locked up, they’re taken out of the market for a significant amount of time which reduces selling pressure. There is less supply outstanding which should organically cause price appreciation over time. In contrast to the 1 token = 1 vote model, all of the circulating supply is outstanding and it’s as simple as unstaking and selling.
Holders of a ve token are the ones deciding the monetary policy of the protocol just like under the 1 token = 1 vote model. The difference is that veTokenomics is an upgrade as it aligns the long-term incentives of the protocol with the staker’s incentives. As mentioned earlier, this creates an environment where the holders with the most amount of vested interest are voting for beneficial monetary policies of the protocol instead of potentially malicious third parties, or third parties that only have their own interests in mind.
The last pillar that the ve model has a massive effect on is how the protocol distributes the value captured to its holders. This model distributes the value captured in segments based on how long you’re locked up for. The key thing to note is that veTokenomics decides on how the value is distributed. There is a ton of room on top of this model to innovate ways to maximize the amount of value captured.
Lots of protocols in the DeFi sector are working hard on implementing veTokenomics, which is great! It’s a step forward vs the legacy tokenomic models, but veTokenomics will not be the pinnacle of token design. This section will take a look at some of the innovative designs that projects are building using veTokenomics as the foundation.
(Note, I’m not saying to go out and put your entire net worth into the coins I discuss below, I’m only discussing the innovation in veTokenomics that they’re working on and it’s still an experiment with many unknowns.)
[REDACTED] Cartel is currently working on creating a ve version for their BTRFLY token, but with a twist. Instead of veBTRFLY, they plan to release blBTRFLY and dlBTRFLY which stands for bribe locked and DAO locked BTRFLY respectively. The blBTRFLY is the retail facing coin that maximizes yield for the holders, while dlBTRFLY is focused on DAOs and protocols that want to maximize their DeFi governance. To simplify:
blBTRFLY = Higher yield
dlBTRFLY = Higher DeFi governance
This is an interesting design decision using veTokenomics as a foundation and the DeFi space will be paying attention to how it works out in practice.
The next protocol that’s innovating in this department is Trader Joe. They released their new tokenomic model that introduces three Joe derivatives in replacement to xJOE. The tokens are:
-Staking JOE for rJOE lets rJOE holders to enter launchpad-like launches within the JOE ecosystem. (Rocket Joe is much more nuanced than this, but that’s beyond the scope of this article)
-Staking JOE for sJOE lets sJOE holders earn a share of the revenue that the platform pays out. This revenue is paid out in stablecoins, which lets users earn a passive yield without worrying about price action other than their initial investment in JOE.
-Staking JOE for veJOE lets the veJOE holder receive boosted rewards in Joe farms, along with governance rights.
The main takeaway from this section is that veTokenomics are currently in an evolution period. We are seeing protocols starting to create multiple derivatives of their main token, with each derivative having a specific use case. This allows users to maximize their investment strategy on the segments of the protocol that they want to be involved in the most.
In conclusion, tokenomics are hard. Really hard. Protocols need to make sure the four pillars are correctly aligned for the economic system they are trying to achieve within the protocol. In addition, they need to innovate on top of these four pillars in order to stay competitive.
veTokenomics are a great step forward and a massive improvement to the previous tokenomic system. It reduces supply, rewards long-term investors, and aligns protocol and investor incentives together. In 2022, more protocols will continue to add veTokenomics to their design architecture, as well as innovating to create unique economic systems with veTokenomics as a middleware foundation above the four pillars. It’s up to anyone's guess on how tokenomics will evolve and look in the coming years.
- Captain BTC
*A coin mentioned in the article is not an endorsement
frog's brain just got bigger
Great great article. Thank you!