Vote Escrowed tokens (veTokens) are a unique concept in the world of cryptocurrencies, offering token holders the opportunity to lock their tokens for a specific period in exchange for governance rights and additional benefits. Unlike regular tokens, veTokens are often non-transferable and come with exclusive privileges, serving as a solution to address liquidity and engagement challenges faced by protocols.
The ve(3,3) model operates on the principle of rewarding early token lockers, leveraging the rebase method to prevent dilution. Those who lock their tokens promptly enjoy the benefits of early incentive yields and typically experience price appreciation in the native token. Users often opt to lock their tokens for extended periods and continuously relock them to maximize their yields.
Protocols strive to attract deep liquidity and establish long-term user engagement. While short-term programs like liquidity mining can attract users temporarily, ensuring their commitment to the protocol's mission and turning them into "sticky liquidity" has proven to be more difficult. This is where veTokens come into play, with VeTokenomics designed to convert users into long-term participants.
The basic veTokenomics model revolves around users locking their tokens and, in return, gaining voting rights and a share of protocol fees. The concept of ve(3,3) is a fusion of vote escrow (ve), where voting rights are granted through token locking, and the game theory principle of (3,3), which suggests that collective staking leads to mutual benefits, whereas universal selling results in shared losses. This idea integrates various elements such as swap fees, incentives, and anti-dilution mechanisms (ranging from 0-100%), along with control over emissions. The design of ve(3,3) aims to harmonize the interests of farmers, stakers, and protocols with those of the decentralized exchange (DEX) itself, creating a more cohesive and mutually beneficial ecosystem.
In recent times, revenue sharing has become a fundamental mechanism for value accrual in tokens. Investors now seek governance tokens with economic incentives, as the collapse of value in DeFi 1.0 tokens highlighted the importance of aligning governance with economic benefits. Additionally, veTokens can offer boosted yields to token holders.
By locking their tokens, users not only gain governance rights but also earn a percentage of protocol fees and enhanced rewards within the ecosystem. It's worth noting that veTokens are typically non-transferable and cannot be sold. While variations exist, such as the use of NFTs within Solidly forks, the core concept remains the same.
The driving force behind veTokens lies in addressing two critical issues: liquidity and engagement. This model aims to foster active participants who are aligned with the long-term success of the protocol. When users commit to locking their tokens for extended periods, it demonstrates their belief in the protocol's sustainability and functioning at the redemption date. This alignment of interests creates a sense of ownership and personal investment, transforming mere capital into dedicated protocol supporters.
From a user's perspective, locking tokens allows them to earn a percentage of protocol fees and enjoy boosted yields. It is helpful for users to view locked tokens as an investment for future profits. For instance, Curve Finance offers yield boosts up to 2.5X, incentivizing participants with significant holdings to hold veCRV. Similarly, Solidly and its derivatives direct trading fees and additional incentives to token lockers, encouraging users to lock tokens and unlock higher earning potential.
From a protocol standpoint, restricting governance participation to users with locked tokens encourages a more long-term outlook when considering governance proposals. Users are more likely to consider the long-tail effects of decisions, promoting thoughtful decision-making. Moreover, a lower circulating supply facilitates better price discovery, benefiting the protocol. Price stability and enhanced liquidity are additional advantages for protocols that successfully encourage a large percentage of users to lock their tokens.
Token emissions primarily go to users holding escrowed token versions, promoting responsible profit-taking. In liquidity mining models, users tend to acquire as many tokens as possible and swiftly sell them before moving on to the next opportunity. However, in the veToken model, users who quickly sell their emissions put selling pressure on their own token holdings. This issue has led to various forks proposing minor adjustments to the economic model pioneered by Cronje's Solidly.
In conclusion, vote escrowed tokens (veTokens) offer a compelling solution to enhance liquidity and engagement within protocols. By incentivizing users to lock their tokens, protocols can create a dedicated community of long-term supporters aligned with the protocol's success. Users benefit from governance rights, a share of protocol fees, and enhanced rewards, while protocols enjoy increased stability, price discovery, and responsible profit-taking. The veTokenomics model introduces a novel approach to address the challenges faced by protocols in the ever-evolving cryptocurrency landscape.
Instability Concerns
The reliability of the (3,3) model in the context of cryptocurrency and game theory is a complex issue, with several factors contributing to its instability. The (3,3) model refers to a scenario in game theory where participants have the option to choose between cooperative strategies that could lead to mutually beneficial outcomes. However, this model has inherent flaws that question its reliability:
- Asymmetry in Contribution: In the (3,3) model, there is often an imbalance in contributions and benefits among participants. For instance, if one participant contributes 5 ETH while another contributes 0.1 ETH, the fee contribution of the former is significantly higher compared to the latter. This asymmetry leads to disproportionate benefits and costs among participants.
- Short-term Stability in Bullish Cycles: Historically, the (3,3) model may appear stable over short periods, especially during bullish market cycles. During times of growth, participants often overlook the potential exploitation of expected value (EV). However, this perceived stability is misleading and does not hold up in the long term or in more neutral or bearish market conditions.
- Instability in Multi-Participant Environments: The model becomes increasingly unstable with more participants. While it may exhibit stability with only two participants, akin to a prisoner’s dilemma scenario, the introduction of more players leads to unpredictability. This instability is explained by evolutionary game theory, which posits that in a sufficiently large group, individuals are motivated to alter their strategies for personal gain. Such behavior disrupts the equilibrium and fosters mutual suspicion among participants.
An additional risk to consider in veTokenomics is duration risk, which stems from traditional financial (TradFi) markets, particularly in relation to bonds. Duration risk refers to the sensitivity of bond values to changes in interest rates. Recently, banks have suffered significant unrealized losses due to the presence of large amounts of long-duration bonds on their balance sheets. Soaring interest rates have greatly diminished the value of these long-dated bonds.
In the cryptocurrency space, duration risk poses a significant danger to investors who lock their tokens for extended periods. While the crypto asset class is maturing, reducing the overall time-duration risk in the space, investors still need to assess the individual risks associated with each token they choose to lock up.
In conclusion, while the (3,3) model may offer short-term benefits in specific scenarios, its long-term reliability is questionable due to inherent asymmetries, the dynamics of evolutionary game theory, and the instability introduced by multiple participants. These factors collectively make the model unsuitable for reliable and stable cooperative strategies in the context of cryptocurrency and decentralized finance.
