To ‘ve’ or not to ‘ve’ – What are veTokens?

3 NOV 2023 | RESEARCH | AUTHORED BY CALLEN

Summary

Innovations in decentralized governance have provided new ways to design voting, value users, and align stakeholders.

Token Weighted Voting and Vote-Escrow Voting are the most popular voting models, with the former leading by a large margin among top DAOs.

Token Weighted Voting weights a user’s voting power proportional to the number of tokens they hold. In contrast, Vote-Escrow Voting weights a user’s voting power based on how long they lock a certain amount of tokens for; this is typically denominated in ‘veTokens’.

‘veToken’ just means ‘vote-escrow Token’ – vote meaning the ability to participate in governance and escrow meaning the underlying protocol token has been locked into an escrow smart contract for a specified period of time.

Poorly designed governance systems fall prone to voter apathy, misalignment, human capital mismatch, and concentration of power. veTokens attempt to solve these issues by attaching a coordination mechanism that enforces requirements on behalf of users in exchange for governance participation and benefits.

veTokens were pioneered by Curve Finance in 2020 with the launch of veCRV.

Users were given veCRV for locking their CRV tokens for a minimum of 2 weeks and a maximum of 4 years. In return, they would receive trading fees, liquidity provider reward boosts, and voting rights.

In conjunction, these requirements and benefits attempt to create buy-in and user demand by providing a genuine sense of ownership which is typically not felt with the basic 1-token-1-vote model.

veCRV has seen success in generating demand for locking CRV and creating user buy-in with 44.77% of its circulating supply locked for an average of 3.36 years. However, it faces decentralization issues with 82.51% of the total veCRV supply controlled by 4 entities.

Voter apathy remains present for operational-type governance votes, while voter turnout is much greater for votes that determine where CRV emissions are sent due to tangible monetary incentives.

Introduction

Blockchain and Smart Contracts have reshaped governance, diverging from traditional corporate models, thanks to their virtually boundless design space. The DeFi ecosystem and specifically Decentralized Autonomous Organizations (DAOs) have iterated over various forms of voting mechanisms including Quadratic Voting and Tenure-Based Voting in an attempt to improve governance efficiency. However, two core voting mechanisms continue to drive the lion’s share of DAO governance: Token Weighted Voting and Vote-Escrow Voting.

Token Weighted Voting or 1-token-1-vote as it’s commonly referred to, weights a user’s voting power proportional to the number of tokens they hold. In contrast, Vote-Escrow Voting weights a user’s voting power based on how long they lock a certain amount of tokens for; this is typically denominated in ‘veTokens’. The former offers a generalized and flexible approach to decentralized governance, offering a lower barrier to entry for voters but is more susceptible to voter apathy. While the latter attempts to reward long-term alignment in exchange for immediate tangible decision-making abilities and benefits.

Vote-Escrow’s voting popularity is the strongest amongst Decentralized Exchanges (DEXs), likely because it was pioneered by Curve Finance – DeFi’s second largest DEX with $2.14b in Total Value Locked (TVL), which allowed veCRV holders to direct CRV token emissions to liquidity pools and numerous other perks. Fast forward to today, DeFi has seen various adaptations to the Vote-Escrow model and subsequently the underlying asset of a veToken.

What are veTokens?

A typical veToken can be described as a receipt for locking a protocol’s native token into an escrow smart contract for a specified amount of time. In return, a user is granted a veToken balance that represents their voting power and voting ability within a DAO. Quite simply, the term ‘veToken’ just means ‘vote-escrow Token’; vote meaning the ability to participate in governance and escrow meaning the underlying protocol token has been locked into an escrow smart contract for a specified period of time.

For example, veCRV stands for vote-escrowed CRV, it is simply CRV locked for a period of time. The longer you lock CRV for, the more veCRV you receive.

You can think of it similarly to Term Deposits, but instead of fiat currency, you lock your shares away for a specified period of time in exchange for exclusive perks and a larger say in a company’s decision-making.

In summary, a veToken balance simply denotes a user’s alignment and long-term commitment to a protocol based on a combination of the amount and length of their token lock.

What’s the point of veTokens?

Decentralized protocols need to instill social coordination within a community such that operations are carried out in a decentralized manner. This is often achieved through the creation of a cryptocurrency (e.g., UNI, AAVE, COMP) with attached governance rights. However, without a well-designed coordination system, many DAOs fall prone to:

1. Poor Participation – A poorly designed governance system is susceptible to voter apathy, free-riding, social & financial costs, and complexity, decaying voter participation and inhibiting advancements

2. Misalignment – Without sufficient incentives a classical principal-agent problem arises between contributors/team and token holders. Introducing inefficient resource allocation and a lack of drive towards protocol and token value maximization.

3. Human Capital Mismatch – Uninformed or inexperienced decision-makers whether that be the community or team members lead to inefficient outcomes.

4. Concentration of Power – Threatens the decentralization of a project as decisions are controlled by a small majority of stakeholders with large sums of tokens.

veTokens attempt to solve these issues by attaching a coordination mechanism that enforces requirements on behalf of users in exchange for governance participation and benefits. To fully understand how this works let’s go back to the origin of veTokens – Curve Finance.

The Origin of veTokens: Curve Finance

Curve Finance launched in 2020 as a decentralized exchange focused on facilitating efficient swaps between stablecoins and pegged assets. Alongside its launch, was the birth of the Curve DAO, the CRV token, and the Vote-Escrow Model.

From the very beginning, the main purpose of CRV was to 2-fold:

1. Incentivize Liquidity Providers – Through CRV emissions as swap efficiency is proportional to the amount of liquidity in a pool.

2. Governance Participation – Get as many users as possible involved in the governance of the protocol.

The former is relatively straightforward to achieve but the latter requires more than just putting CRV in the hands of potential governance participants; you need to create user buy-in and demand. Curve attempts to achieve this through veCRV.

Introducing vote-escrow-CRV (veCRV)

veCRV is a mechanism that allows users to lock their CRV tokens for a minimum of 2 weeks and a maximum of 4 years. In return, the user is granted a veCRV balance equal to the amount of CRV they’ve locked and how long they’ve locked them for, which determines the magnitude of benefits a user gets within the Curve ecosystem.

For example,

1 CRV locked for 4 years = 1 veCRV, and

1 CRV locked for 2 years = 0.5 veCRV.

This can be calculated using the formula below, which takes the amount of CRV a user is locking and how long they are locking it for:

veCRV Balance = CRV * Length of Lock / (Max Lock = 4)

Lastly, a user’s veCRV balance decreases linearly over time from the day that they lock until they’ve reached the full length of their lock-up period, at which point they can redeem their CRV tokens. However, at any time during a user’s lock-up period, they’re able to relock their tokens to increase/maintain their veCRV balance.

In exchange for locking their CRV, a user is granted many benefits such as:

1. Trading Fees – 50% of all trading fees generated on Curve is distributed to veCRV holders.

2. Liquidity Provider Reward Boosts – veCRV holders who provide liquidity can receive up to 2.5x more CRV emissions and rewards than non-veCRV Liquidity Providers.

3. Voting Power – veCRV holders are able to vote on proposals, gauge approvals, and most importantly, direct CRV emissions to eligible liquidity pools.

In conjunction, these requirements and benefits attempt to create buy-in and user demand by providing a genuine sense of ownership which is typically not felt with the basic 1-token-1-vote model.

Does it work?

Since Curve’s inception, 1.69b CRV has been minted & released to stakeholders of which 758.73m (44.77%) has been locked as veCRV for an average of 3.36 years. A rather impressive feat when comparing it to Aave – DeFi’s second-largest protocol, with 19.9% of its circulating AAVE supply staked.

Furthermore, with the significant and persistent daily lock rate of CRV as indicated above. One could infer that the veToken mechanism successfully generates user buy-in and demand for the token.

However, when looking at the distribution of veCRV holders it’s evident that there is a concentration of power. The top 10 holders of veCRV account for 85.10% of the total veCRV supply and a staggering 82.51% of the total veCRV supply is controlled by 4 entities. This opposes Curve’s goal of diverse governance participation and undermines the decentralization of the protocol.

But it’s important to note that Convex Finance, StakeDAO, and soon Yearn, pass on veCRV voting rights through some sort of derivative token alleviating some decentralization concerns.

One of the more interesting findings is the disparity between veCRV voter turnout for regular DAO votes and Gauge votes. The former focuses on operational changes to the protocol like adjusting liquidity pool parameters and adding new gauges, while the latter allows veCRV holders to direct CRV emissions to liquidity pools.

For example, 52% of DAO votes received votes from 11 veCRV holders or less with the most common voter turnout being less than 7 voters. In contrast, 51% of Gauge votes received votes from 80 veCRV holders or less, with the most common voter turnout being between 50-60 voters.

This highlights two important points from Cuve’s veCRV model:

1. Voter apathy persists for operational governance votes that provide no tangible monetary incentive.

2. Incentivizing lengthy token lockups to create long-term alignment does not solve point 1.

veToken Evolution

One of the major criticisms of veCRV as a result of its success, was the attrition of CRV’s on-chain liquidity. As more CRV get locked with a decreasing emissions schedule, fewer CRV are left in liquidity pools which hurts both new entrants and potentially forces veCRV holders to discount the value of their CRV emissions due to slippage.

ve8020

To combat this problem, Balancer – DeFi’s 4th largest DEX with $709M in TVL, introduced a new Vote-Escrow Model called veBAL with 2 key differences:

The maximum lock time for veBAL is 1 year instead of 4 years.

Users lock up a Balancer Liquidity Pool Token (BPT) with 80%/20% BAL/ETH, respectively, instead of just BAL.

The reduced maximum lock time makes the idea of veBAL more palatable for potential lockers, and requiring users to lock a liquidity pool token with 80/20 BAL/ETH instead of just BAL leads to sticky on-chain liquidity.

veBAL has seen great success producing $115.4M USD in 80/20 BAL/ETH liquidity locked for an average of 11.6 months, of which $92.4M USD is BAL (52.13% of its total supply). Thus, placing their total amount of BAL supply locked slightly higher than Curve’s ~45% figure and achieving such a number in a shorter amount of time. This could further support the idea that users are more willing to lock their tokens given shorter maximum lock lengths, but such a decision is arguably much more dependent on a user’s preference for a protocol.

When looking at veBAL voting turnout for Balancer, we notice the same disparity between voter turnout for DAO Votes and Gauge Votes with the latter receiving a much higher turnout. This once again suggests that users are much more likely to vote when there is a tangible monetary benefit attached to their vote. Furthermore, it’s evident that Balancer’s DAO Votes receive notably higher turnouts in comparison to Curve.

One possible explanation for this could be that Balancer’s DAO Votes take place on Snapshot which is an off-chain and gasless voting venue. In comparison, all of Curve’s DAO Votes happen on-chain which costs the user gas for every vote they cast.

As you can imagine, a user with a small amount of voting power will likely forego voting on a DAO proposal when 1) it costs them money, 2) there is likely no immediate monetary benefit, and 3) their vote won’t have a strong influence on the outcome of the proposal.

Conclusion

In the realm of decentralized governance and DeFi, veTokens have emerged as a game-changer. Born out of the pioneering work of projects like Curve Finance, these tokens represent more than just tokens; they symbolize commitment, alignment, and empowerment within a protocol’s community. As we’ve delved into the world of veTokens, it’s evident that they tackle some critical governance challenges faced by decentralized protocols. They attempt to incentivize long-term alignment and foster a profound sense of ownership that extends beyond mere token holdings.

However, veTokens are not without complexity and challenges. The concentration of power among a select few holders and varying voter turnout for different votes underscore areas for exploration and improvement. Innovations like veBAL from Balancer highlight the adaptability of veTokens, proving their potential for evolution. In summary, veTokens have reshaped the landscape of decentralized finance and governance, offering a glimpse into a future where commitment and empowerment drive the engine of decision-making.