Introduction

Reviewing the development of Decentralized Exchanges (DEX), they remained relatively dormant before 2020. However, from June 2020, there was an explosive increase in trading volumes within the DEX sector, to the point of an outburst. At present, DEXs have become the most important infrastructure in the DeFi space, with a daily trading volume reaching as high as 2 billion USD.

Initially, the transaction model of DEXs was the order book, but it gained little traction due to limited liquidity. It wasn’t until the rise of Automated Market Makers (AMMs) that trading volume and user numbers started to surge dramatically. Now, mainstream on-chain DEXs are primarily built upon the AMM mechanism.

The introduction of AMMs was a game-changing innovation for DEXs, but it comes with risks such as impermanent loss and low capital efficiency. Liquidity providers often face negative returns due to these risks. To compensate for the losses that market makers might face, protocols typically opt for liquidity mining, offering substantial token rewards as incentives to Liquidity Providers (LPs).

While this mechanism, with its abundant token rewards, attracts market makers and solves the cold-start problem for early projects, it also creates challenges. As tokens are continuously released, selling pressure gradually increases, leading to a decline in token prices. Consequently, market makers start to exit, resulting in a loss of locked liquidity in the protocol. This eventually pushes the project into a downward spiral of development.

In its mechanism design, Velodrome combines Curve’s veToken model and Olympus DAO’s (3,3) game theory, becoming the largest native DEX on Optimism in terms of Total Value Locked (TVL), surpassing other top-tier multi-chain DeFi projects on Optimism, such as Uniswap and Curve. This article will provide a detailed explanation of Velodrome’s product logic, economic model, and current development status.

Overview of Velodrome

Velodrome is a native AMM-styled DEX established on Optimism, launched by the team behind veDAO. It’s adapted from Solidly, a project initiated by Andre Cronje, with its token design combining the veToken model and Solidly’s (3,3) mechanism.

The development team comprises members from blockchain technology companies such as Optimism and ConsenSys. In January 2022, Andre Cronje’s team officially launched a Solidly Exchange project based on the Fantom public chain. This project combined Curve’s veToken economic model and Olympus’ (3,3) game theory concept. Its fundamental mechanism allows users to stake Solidly tokens, and vote for the platform’s liquidity pools, and the higher the votes a pool receives, the higher the mining rewards (SOLID tokens). Additionally, users who stake their tokens are compensated for inflation risk. Staking SOLID tokens allows users to receive a proportion of newly issued tokens based on the total circulation, thereby preventing the dilution of voting rights due to continuous token issuance. Non-staking users, however, face the risk of price decline due to ongoing token issuance.

The launch of Solidly sparked a frenzy in the DeFi industry, attracting approximately 2.6 billion USD in TVL in its early stage. However, subsequent issues such as frontend bugs, security vulnerabilities, and congestion on the Fantom chain, as well as Andre Cronje’s announcement to leave the DeFi industry, severely damaged the Solidly ecosystem, leading to its exit from the market. Subsequently, the veDAO team shifted its focus to the Optimism ecosystem and developed an optimized version of Solidly - Velodrome.

The Velodrome project was officially renamed and launched in April last year, accompanied by an airdrop of tokens. In November of last year, they announced initiating a 4 million OP incentive plan, set to last for 6-8 months, aiming to incentivize liquidity and veVELO stakers. The team is upgrading its core technology and is about to launch version 2.0.

Product Logic

At its core, Velodrome is an AMM-style DEX, providing users with an asset exchange function without additional mechanism design. The platform offers two types of liquidity pools: Stable Pools and Variable Pools. Stable Pools are specifically designed for assets with minimal or no volatility, using the liquidity formula x³y + y³x = k. In contrast, Variable Pools cater to assets with larger price fluctuations, employing the common AMM formula x × y = k. Transaction fees for both types of asset pools are 0.02%, with a maximum adjustment of up to 0.05%.

Uniswap v2’s constant product formula, x*y=k, creates a liquidity curve where liquidity is uniformly distributed, leading to a significant impermanent loss for market makers and low capital efficiency. Uniswap v3 revises the AMM model by introducing the concept of active market making. It allows LPs to aggregate assets within a customizable price range, thus increasing the customizability of liquidity positions. LPs earn transaction fee revenue only when the price of the trading pair falls within a fixed range. Once the price exceeds the chosen range, no earnings can be made. This design enhances capital efficiency.

Image Source:https://app.velodrome.finance/swap

Beyond conducting asset trading and exchanges, users can also participate in the platform’s external Bribes mechanism. This involves offering additional financial incentives to selected trading pairs, attracting more veVELO token holders to vote, thereby earning more token release rewards.

Image Source:https://app.velodrome.finance/liquidity

Image Source:https://app.velodrome.finance/bribe/create

Token Model

Curve proposed the veToken economic model to address issues in the AMM mechanism, encouraging liquidity providers to lock up CRV tokens to gain veCRV, which boosts their mining rewards. The number of veCRV determines the voting weight held, guiding more LP rewards to their preferred liquidity pool. On this basis, to continuously earn more LP rewards, liquidity providers will pledge the CRV tokens they have acquired again to increase their voting rights. The veCRV mechanism aligns the long-term interests of liquidity providers with the platform while alleviating the selling pressure on CRV tokens. However, drawbacks in this mechanism - such as the non-transferability of veCRV, apparent first-mover advantages in veCRV competition, and the high costs for new projects to hold a large amount of pledged CRV to increase voting rights - have prompted other DEX projects to optimize for these issues.

Olympus DAO proposed the (3,3) game theory, in which the official sells OHM to users below market price in the form of bonds. The official receives assets paid by users such as USDC, and ETH, thus allowing the treasury to be backed by valuable assets, and creating OHM to distribute to OHM stakers through the Rebase mechanism. If more users enter the market to buy OHM tokens, the treasury will issue more OHM tokens by distributing them to stakers, creating a positive feedback loop of high APR for stakers when the OHM price keeps rising. However, this is based on the premise that market users do not sell OHM, but choose to continuously pledge tokens, a.k.a. “Stake, Stake,” encouraging users to constantly participate in staking to enjoy the right of continuous issuance of OHM tokens, and to reduce the risk of token dilution.

However, this mechanism cannot be maintained in the long run because a high APR - that is, the production of a large amount of OHM tokens - means that the subsequent market selling pressure is huge. Once whale users decide to cash out, a large amount of OHM tokens will be sold, the price will drop quickly, the attraction of obtaining OHM tokens by purchasing bonds through the official will decrease, and the treasury will lose its capital growth. At this time, the (3,3) concept will enter a downward spiral stage.

As we can see, from basic LP mining to the introduction of the veToken model and the innovative (3,3) mechanism of OHM, DEX protocols are continuously improving and innovating their economic models to optimize on-chain liquidity and management efficiency, combining the bilateral needs of traders and project parties. But the core is still to release incentives through tokens.

Velodrome combines the veToken model from Curve and the (3,3) game theory from Olympus DAO in its mechanism design. Its ecosystem involves two types of tokens, VELO and veVELO. VELO is the protocol’s ERC-20 governance token, rewarded to liquidity providers. After locking VELO, one would obtain veVELO, an NFT-form ERC-721 governance token, also known as veNFT. The lock-up period (also known as voting custody period) of the VELO token can be up to 4 years. The longer the lock-up period, the higher the voting rights and rewards obtained by veVELO.

In Velodrome, LPs receive weekly VELO token issuance rewards, while veVELO holders receive protocol handling fees, bribes, and governance rights. LPs can guide veVELO holders to vote in the corresponding liquidity pool via the Bribes mechanism to obtain more VELO tokens. VeVELO, on the other hand, can only receive the fee income from the liquidity pool where it votes, making veVELO more inclined to vote for liquidity pools with better trading volume performance, forming a positive cycle for the platform.

Image Source:https://docs.velodrome.finance/tokenomics

The total supply of VELO tokens is 400 million, of which 60% is allocated to the community; 18% is distributed to the protocol; 10% is given to the team; 6% is allocated to partners; Optimism official has been allocated 5%; and the original liquidity pool has been allocated 1%.

Image Source:https://docs.velodrome.finance/tokenomics

The current weekly emission allocated to Liquidity Provider (LP) rewards is decreasing, starting from 15 million VELO (3.75% of the initial supply), and decaying at a rate of 1% per week (epoch), approximately halving by 50% each year. Meanwhile, veVELO holders will receive rebase veVELO each week, proportional to the LP rewards and supply ratio, thereby reducing the dilution of voting rights.

Token Release Schedule, Image Source:https://docs.velodrome.finance/tokenomics

There are currently four types of rewards on Velodrome:

1. Liquidity Provider (LP) Rewards (Emissions): VELO is distributed to liquidity providers. The VELO allocated to each pool is proportional to the voting power obtained from voters in each period.
2. Transaction Fees: These are allocated to voters in the liquidity pool, with the proportion of transaction fees received proportional to voting rights.
3. Bribes: In addition to transaction fees, liquidity pools also permit the provision of external rewards from anyone (referred to as bribes). These rewards can be claimed after the epoch flip (after 23:59 UTC on Wednesdays), and are proportional to the voter’s voting rights (veVELO).
4. Rebases: Additional veVELO are issued and distributed to veVELO holders to mitigate the dilution of their voting rights.

Reward Collection Time, Image Source:https://docs.velodrome.finance/tokenomics

Development Status

Currently, the Total Value Locked (TVL) in Velodrome stands at approximately $21.79 million, generating a total transaction volume of $5.8 billion. The circulating supply of its token, VELO, is at 949,249,557, with 716,944,915 VELO tokens (veVELO) staked, which is about 75.52% of the total.

The team sets staking rewards weekly, with each week constituting an Epoch. Each Epoch begins at 8:00 AM Beijing Time on Thursday, and we’re currently in Epoch 52. While the supply of VELO is continuously being released, the newly minted VELO is primarily used for staking. Therefore, overall, the current situation regarding token issuance and staking is well managed, without a large influx of LP token rewards directly entering the market, which could potentially create significant selling pressure on the token.

Image Source:https://dune.com/Marcov/velodrome-finance

Looking at the distribution of veVELO, most projects and protocols in the Optimism ecosystem, such as Lyra, Synthetix, and Beefy, hold significant amounts of veVELO tokens. Among them, Beefy Finance holds the most veVELO, about 23.38 million, and has been accumulating veVELO since Epoch 20. Beefy is a multi-chain yield vault. Its beVELO Vault helps users automatically earn VELO rewards and reinvest for profits while charging certain fees. Following Beefy Finance is the Optimism official, with approximately 22 million veVELO, accounting for nearly 20% of voting rights.

Image Source:https://dune.com/0xkhmer/velodrome-vevelo-leaderboard

Conclusion

Velodrome is a DEX protocol within the Optimism ecosystem. It incorporates the veToken model and the concept of (3.3), with optimizations surrounding the “liquidity incentive issue.” The project’s design in terms of economic models demonstrates some innovation, and the overall issuance and lock-up situation of the tokens are performing well, without any severe token sell-off pressure. Currently, most projects and protocols in the Optimism ecosystem are accumulating veVELO, including Beefy, Optimism officials, Synthetix, and Lyra Finance, among others. However, in the long term, it is challenging for the protocol to maintain the platform’s TVL relying solely on liquidity mining rewards, and it needs to seek new breakthroughs. The team is devoted to developing version 2.0, which will undergo upgrades in user experience and basic contract optimization.