What is veTokenomics and how does it work?

All aspects of token production and management, including allocation to various stakeholders, supply, token burning programs and distribution, are governed by Tokenomics analysis. Tokenomics helps determine the potential value of decentralized finance (DeFi) projects. Since the law of supply and demand cannot be changed, Tokenomics dramatically affects the value of each non-volatile token (NFT) or cryptocurrency.

Related: What is Tokenomics? A beginner’s guide to the supply and demand of cryptocurrencies

However, there are various loopholes in the Tokinomics design, such as a high initial supply allocation for insiders, which can be a pump-and-dump warning sign. Also, there is no guidance on how founders, treasury, investors, community and protocol designers should optimally divide the tokens.

As a result, DeFi protocols such as Curve, MakerDAO, and Uniswap do not have a carefully planned initial token distribution, meaning that top contributors may not always receive the best allocation. To address these issues, the Curve protocol introduces voice-restricted tokenomics or vetochenomics. In this article you will learn the basic concept of veTokenomics; How veTokenomics works and its pros and cons.

What is veTokenomics?

Under the concept of veTokenomics, tokens must be tied for a certain period of time, which encourages long-term participation and reduces the market supply of tokens. In return, users’ veTokens are non-tradeable and non-transferable. That is, in order to participate in the management system, one must lock their tokens for a certain period of time, which will increase the value of the organic token over time.

In some DeFi initiatives, one can lock your tokens in advance to receive a portion of the protocol’s revenue. However, the veToken architecture differs in that the holders of these locked tokens increase the liquidity of a specific pool by controlling the emission flow.

The rate at which cryptocurrencies are created and released is called emission. The economic model of the cryptocurrency, especially if inflation or rejection, affects the emission rate. This leads to a better alignment between the success of the protocol and the incentives received by the token holders.

How does veTokenomics work?

Let’s see how Curve implements veTokenomics to understand how voice deposit tokenomics works. Like other DeFi protocols, Liquidity Providers (LPs) earn LP tokens to provide liquidity to curve pools. These LP tokens can be deposited into the Curve benchmark to obtain the Curve DAO token (CRV), which liquidity providers can upgrade by locking in the CRV. The liquidity meter calculates how much liquidity each user is contributing. For example, one can engage their liquidity provider’s simulations in each curve pool’s unique liquidity measurement.

Method of measurement of curve protocols

Additionally, veCRV holders and LPs share the fees generated by Curve Finance. One has to lock their CRV management tokens for a certain period of time (one week to four years) and give up their liquidity to get VCRV. This means that long-term stakeholders want the project to succeed and not just for short-term profit.

veCRV holders can lock in tokens for long periods of time, maximize equity rewards, decide which liquidity pools accept token issuances, and earn prestige rewards by ensuring liquidity through on-curve swaps. However, the length of time token holders lock up Vetokens affects how much influence they have on the voting process.

Consider Bob and Alex, who each have the same amount of CRV. Bob locked the tokens for two years, but Alex only for one year. The veCRV, voting power, and associated products double for Bob because he locked his signals longer than Alex. Such flexibility encourages long-term participation in decentralized autonomous organization (DAO) projects and ensures that token issuance is conducted in a democratic manner.

Other examples of veTokenomics include Balancer, which introduced veBAL tokens in March 2022 with a maximum lock-up period of up to one year. Frax Finance also pointed out that using veFXS tokens, owners can choose parameters that distribute FXS issuance in different pools on different decentralized exchanges (DEXs).

What are the pros and cons of veTokenomics?

From understanding the basics of veTokenomics, it is clear that token holders are rewarded by blocking the supply of veTokens, which reduces the supply of LP tokens and thus selling pressure. This means that token holders who own large amounts of tokens cannot manipulate their value. In addition, this popular Tokenomics model encourages more liquidity in pools, strengthening the ability to maintain a stable coin peg.

Since there was no market for liquidity providers’ tokens outside of the exercise and valuation of management rights, the original Diffie Management Tokens had no impact on the price. However, locked-in vetokens have a positive impact on supply dynamics as the community benefits from improved products, valuable management rights, and aligning the priorities of all stakeholders.

Despite the advantages of the vetoken model mentioned above, there are various weaknesses of vetokenomics that stakeholders should be aware of. Since everyone invests for the long term, a protocol that follows the Vetoeconomics model may not appeal to short-term investors.

Additionally, if tokens are locked for a long period of time, the opportunity costs can be very high as one cannot unlock them until the maturity date if they change their mind. Additionally, this model reduces long-term oriented incentives and weakens governance decentralization if the protocol providing such tokens has the majority of veTokens.

The future of the veTokenomics model

In the traditional tokenomics model, governance tokens that only provide voting power are considered valuable by Curve Finance (a pioneer of the veTokenomics model). Furthermore, he believes that there is little reason for anyone to be fully committed to a project when the question of “management” is the only reason.

Vetogenomics is a major development of the new togenomic system. Although it reduces supply, compensates long-term investors and aligns investor incentives with the protocol, the veTokenomics model is still immature.

In the future, in addition to developing new ways to build unique economic systems that use veTokenomics as a middleware foundation, we may find more protocols that incorporate veTokenomics into their design architecture. However, as the future is unknown, it is impossible to predict how the tokonomics models will improve in the coming years.

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