Original Author: levy
Compilation of the original text: The Way of DeFi
Image source: Generated by Maze AI tool
In this post, I will explore the Solidly veToken model in depth and review its core fundamentals, including high-level principled thinking, but also include some practical examples and demonstrate how various fine-tuned models operate under different conditions. I will start from the perspective of economics, involving Token rules, inflation and investment .
TLDR:
Solidly DEX needs to maintain a certain Tokne inflation to maintain the development of the economic system.
But inflation isn't all bad, it has a lot of positives in this model
The value of Token added by inflation will always be greater than the income of the agreement, but this does not mean that it is unsustainable
It would be a mistake to think of token releases as a "cost" of the system, since all token releases are prepaid.
Rebase or "anti-dilution" is more of a marketing term that doesn't add any value to the system and over time, kills Solidly's flywheel.
There is a huge market opportunity for DEXs, which means they can potentially match revenue growth even with high initial inflation.
From a long-term perspective, the Solidly economy is sustainable as the inflation rate gradually drops to zero.
Solidly DEX provides a huge opportunity to develop new products on this basis, which will further enhance the value proposition of Token and strengthen the flywheel.
Solidly Economics
Before we start the discussion, let's first briefly introduce the economics of the Solidly veToken system, namely the incentive framework model that keeps its flywheel spinning.
There are four main actors involved in this economy:
Trader: The trader performs the swap from Token A to Token B from the Liquidity pool and pays the relevant fees. (income #1)
Liquidity Provider: They put idle related Tokens into the Liquidity pool, and get Solidly DEX's new token release rewards. The Swap transaction fees collected through this Liquidity pool will be sent to veToken voters who vote in this Liquidity pool.
Other Project Party Protocols: Some projects require Liquidity so that users can buy/sell their tokens. To incentivize Liquidity Provider, projects can “bribe” veToken holders to vote for their LP pairs (Revenue #2). The project party itself will also be highly motivated, and the veToken obtained by itself will guide the release and serve as a long-term solution to their Liquidity requirements, so that they do not have to spend bribery costs all the time.
veToken voters: Voters or voters refer to those who stake Solidly DEX native token and hold veTokens. They will vote according to the rate of return on the meter and affect the new allocation of Solidly DEX native token. They will select the Liquidity pool with the largest profit according to the incentive voting, and get the income of "transaction fee + bribe" from the mining pool they vote for.
We can see that "fees + bribes" will go to veToken voters, and the income from new tokens will flow to LP providers. A simple description of this flywheel is: the more veToken’s bribery income, the more attractive it is as an investment, which can attract more people to buy pledged DEX native token, absorb the new DEX Token rewarded by LP, and Reach a certain transaction size and transaction fee.
This system will continue to grow throughout the cycle of absorbing external Liquidity, and the accumulation of Liquidity will generate more and more transaction fees, which is also called Liquidity"vacuum". We know that nothing can rise in a straight line for a long time. Although it is effective in the growth stage, I want to evaluate the long-term sustainability of the model, which will be described in detail later. First, let’s start with the new release of tokens. , look at the mechanisms and principles behind your economic model.
freed
Emissions are an important part of the system; because the Solidly model incentivizes LPs through new releases, no matter how you build it, there will be Token inflation. Typically, these models start with an initial high release to bootstrap the project, then taper off. In any case, if the release of tokens is blocked, LPs can no longer be incentivized, and the entire economic system will stop, so this is a very important part of the entire flywheel.
Therefore, as a starting point, we must admit and accept the occurrence of inflation. While inflation is a bad word, especially when macro inflation is also high, I hope to explain why it works from an economic perspective and how we should think about it, inflation is a feature, not a bug.
Generally speaking, the released value of Token is often greater than the total income obtained in return. Here is a comparison of the 3 highest paid Solidly projects (Velodrome, Thena, and Equalizer ):
The graph below shows the revenue generated per $1 of new releases.
These projects can earn between $0.26 and $0.41 in return for every $1 of Token released. This is also where many people reject the entity model or the curve model. They regard this dynamic behavior of token release as a project cost and analyze it in the profit and loss statement of release (cost) > revenue. If so, is a DEX like Solidly just an unsustainable Ponzi farm? If viewed from a limited, incomplete perspective, it is easy to see why this is a problem, essentially a problem of fairness.
Curve is a recognized traditional veToken model (only veCRV is charged 50% of the fee, no stack is integrated with Convex, etc.), and the current inflation rate has not yet reached zero. In fact, Curve's price performance is doing relatively well across the broad market, even though we're going through a prolonged bear market with many asset prices down 90% and some TVL wiped out.
As you can see, the price of CRV roughly follows the performance of the broad crypto market (chart shows CRV vs. total crypto market cap), there may be periods of good or bad performance, but with the coin's infinitely inflated Ponzi farm chart The trend is different.
In the past year, CRV 's TVL has dropped from a peak of 25 billion to about 5 billion now, and CRV 's price has remained good during this time. Theoretically, if the flywheel is interrupted, a downward death spiral can occur. (lower TVL > lower volume > lower APY > lower CRV price > lower TVL). How is this possible? All the way through, they released more value than they took in, and during a secular recession, that model was also thought to collapse, but that doesn't seem to be happening.
Since voting escrow is a novel and relatively complex primitive, we need to study token release and inflation in different frameworks. I feel Solidly models are more powerful and cohesive than Curve, and I hope it performs better than Curve. Curve was chosen as an example because it was the first veToken model and also the most mature.
The value of released tokens is always greater than the revenue, because the value of released tokens itself exceeds the strictly accrued revenue value, including:
1. The governance value of direct token release
2. Value as an LP pair
3. Pricing future growth
4. Speculative trading
5. Other use cases built on top of it (take crvUSD as an example)
These factors create a premium over the strict 1:1 accrual of income. For this reason, the value generated by Token release will be greater than the income. It is this dynamic that makes the economy work and makes the Solidly veToken model an efficient market for projects to access on-chain Liquidity.
It is for this reason that efficient protocol bribes are allowed, i.e. $1 in bribe > $1 in LP reward. Next let's also talk about why it is wrong to define token release as a "cost".
The reason token releases are not "costs" is that they are prepaid prior to release.
If you want to influence the release of Token by metering weight, you need to vote. There are two ways, (1) buy more Token and lock it as veToken and then vote; (2) bribe veToken holders to help vote, no matter what Either way, you need to spend Token.
Since other projects prepay each Token on Solidly DEX as a Liquidity cost, it is more accurate to see their Token release as the project cost of maintaining Liquidity on the chain, not necessarily the cost of veToken itself. Projects must continually reinvest to support this Liquidity by purchasing and locking up more tokens.
In the above simple release > income equation, the money for purchasing Token and the time value of locking veToken are not considered. For example, more than 70% of the issued EQUAL DEX is currently locked, mostly permanently, which also forms an integral part of veToken economics.
Therefore, in addition to bribes and transaction fees, projects also prepay for the release of Tokens by purchasing and locking more DEX Tokens. This is their on-chain Liquidity cost. To maintain Liquidity, they must continue to increase them over time. position.
Summarize:
Tokens must be issued to maintain the Solidly economy, and inflation will occur.
The value of token releases is greater than revenue, as the use cases for tokens are increased in addition to strictly accrual revenue, a dynamic that makes this model an effective place to maintain on-chain Liquidity.
Token release is not the cost of veToken holders, but the cost of maintaining Liquidity on the chain, because all released tokens have been prepaid.
Because token release is not strictly a cost, we must use a better research method than the release > revenue equation.
inflation
In the cryptocurrency industry, inflation is often viewed as something that isn't very good. But economically, it's not a bad thing, it's necessary, and it's an important part of game theory that makes Solidly models work.
Inflation is a gradual process of wealth redistribution. In deflation, if every dollar is worth more than it was a year ago, it's fine, everyone makes money passively, then, people have no incentive to work hard, and capital stops producing because new entrants don't have a chance With access to capital, wealth is concentrated at the top and existing capital sits idle and cannot be used to fuel economic growth.
On the other hand, inflation drives consumption, and people have to work to earn more money. In the process, capital wealth continually flows to the most productive people, firms, and investors, ultimately increasing aggregate demand (economic growth).
This is the process of creating wealth, and not only investors make money, but all relevant market participants also make money. In this way, wealth is "spread out" and new entrants to the economy have the opportunity to earn and get their fair share, allowing the economy to grow and benefit everyone. And in a deflationary environment, where everyone is hoarding their money, they don't have the same opportunity.
Economists generally agree that inflation has some positive effects. This kind of predictable and responsible inflation can help economic growth, even under the previous gold standard, there was a stable supply inflation rate of about 2.5% per year.
There are a lot of issues involved when it comes to the modern monetary policy that the western world is going through right now, the increase in the M1 money supply is by no means gradual and predictable, the uneven distribution of new mintage (the Cantillon effect), the currency The measurement of dilation is inconsistent and inaccurate, etc.
Non-gradual and unpredictable M1 money supply, uneven distribution of new mintage (Cantillon effect), inconsistent and inaccurate inflation measurement, etc. (Editor's Note: The Cantillon Effect means that when an economy issues a large amount of new currency, the people at the head get the money first and become richer, while those who get the money later get poorer).
The issue of inflation in the macroeconomy is well beyond the scope of this article. What I want to express is that we need to look at inflation from a balanced perspective and remove some negative preconceived notions in order to fairly evaluate token economics under inflation.
Related to token economics, inflation is the gradual process of redistribution of governance over time in favor of those who are more loyal and committed to the community, for this reason projects that aim to be truly decentralized need inflation. We also haven’t seen Bitcoin users complaining about having less of their tokens than they did a year ago, which is the nature of decentralization.
In the case of the Solidly model, loyalty is represented by the continuous accumulation of Token and the locking of veToken. This allows projects to maintain on-chain Liquidity and keep the flywheel spinning at a cost effective cost. The impact of token inflation mainly includes:
1) Decentralize voting rights and allow new participants (projects) to enter the economic system and obtain fair voting rights through bribery or direct lock-up.
2) Create a total demand for Token by incentivizing projects to accumulate more veToken to maintain their emission share.
3) Ensure that veToken voters spend their funds (votes) strictly on the most productive votes.
4) Maintain the Solidly flywheel by providing adequate compensation to Liquidity Provider.
So, inflation is not always evil. Under the right circumstances, it is an invaluable tool for incentivizing the economy in the right direction and spreading wealth around, and as long as inflation is fairly generated and predictable, it is healthy for the economic system.
In the early bootstrapping phase of Solidly-like projects, tokens are released at a faster rate to bootstrap the project and put tokens in the hands of as many people and projects as possible; in the long run, as the model enters a more mature state, these releases amount will gradually decrease.
This is no different from the release model of other Tokens such as Bitcoin. In the Solidly veToken model, the release amount has the same impact on Liquidity. All release amounts are generated and distributed fairly, allowing new participants to enter. It is the essence of decentralization.
Rebase mechanism
Now let's talk about the rebase mechanism for veToken holders.
The purpose of the rebase is to ensure that the veToken holders' shareholding ratio will not be diluted, and for each token issued, the veToken holders will increase their chips synchronously, which sounds good because it is protecting the holder's At the same time allow a certain amount of inflation, the best of both worlds. But while protecting investors from dilution sounds good, when you break down the underlying mechanics and the math, rebases to veToken holders break the flywheel if you take a long-term perspective.
Similar to the token issuance vs revenue discussion, we need to dig deeper to find out the truth. Various current Solidly fork projects adopt different methods to carry out rebase, which can be divided into three categories according to the proportion:
Solidly v2 = 100% Rebase
Thena, Velodrome, Velocimeter, Equilibre, SolidLizard= 30% Rebase
Equalizer, Sterling, Satin = 0% Rebase
In effect, Rebase is trying to eliminate or reduce inflation for veToken holders. But as we discussed in the inflation chapter, the system needs inflation to incentivize all participants to act in the interest of economic growth.
First, if veToken voters’ voting power is not diluted, they have no incentive to vote for economic indicators (unproductive capital problem), which creates a sort of “Batman vs. Superman” problem in the original Solidly model. There, veToken voters can direct newly released Tokens into uneconomic asset pools, leveraging the flywheel for free or limited cost. With the protection of rebase, projects that do this may last for a while, but over time this mechanism breaks the economic system.
In a model without Rebase, veToken voters would not be incentivized for this behavior because while they could vote for uneconomic pools, their voting power would diminish over time. Assuming they want to maintain the ratio of token releases to non-productive asset pools, they will have to add funds back into the system through bribes or additional token lockups. This is not to say that under the inflation model, projects are doomed to continue reinvesting, if their LP pools are productive (generate large transaction fees), they will get votes from the market even without bribes or projects owning a certain amount of veToken .
It aligns the interests of all participants with the long-term health of the economy. If your pool is not economically viable, projects have to invest in that incentive, and under the rebase model, projects can make a one-time investment and incentivize their pool to be permanent.
Over time, through rebase, veToken rights are heavily concentrated among those early large players, making it difficult and ultimately uneconomical for new users to join. With Rebase, while effectively eliminating the inflation of veToken voters, all positive results of inflation are effectively canceled out:
Voting power is centralized and new participants (projects) cannot obtain a fair share of votes through bribes or veTokens.
Eliminates the total demand for Tokens by eliminating the need for projects to continually accumulate veTokens to maintain their emissions share.
It does not incentivize veToken voters to spend their capital (votes) strictly on the most productive and economical asset pools.
Liquidity Provider cannot be compensated enough to maintain the Solidly flywheel due to the reduced total demand for tokens.
Next, let's use an example to see the long-term impact of different rebase mechanisms on Solidly's economy.
Initial Supply: 500,000
Token Price: $10 (unchanged)
Release: 50,000 / epoch, decreasing by 0.5% every week
Lockup rate: 70% (unchanged)
Revenue: $50,000/epoch increases with inflation (token emissions)
You'll notice that in EPOCH 1, the APY at all three different rebase ratios is the same at 68%; however, as we project beyond 2 years (104 EPOCHs), the rebase ratio in terms of There will be no small difference between not being 0 and being 0.
Scenario 1: Rebase 0%
In this case, the actual APY remains unchanged at 68% as revenue grows in tandem with new releases of tokens.
The total supply is just over 4,500,000 after two years.
Scenario 2: Rebase 30%
Even with the same revenue growth as Scenario 1 under a 30% rebase, the APY would still drop to about 57% at the end of 104 weeks. Whilst the total supply is only around 5,400,000, you can also see that the total supply is larger than Scenario 1 because the Rebase has an effect on the locked veToken portion of the supply.
Scenario 3: Rebase 100%
Under the setting of 100% rebase, the actual APY will gradually drop from the initial 68% to 42% after two years, and the total supply of Tokne exceeds 7,300,000.
in conclusion
It can be seen that compared with the real APY of veToken, Rebase is negatively correlated with APY, the higher the Rebase ratio, the lower the APY. This means that a project performing a 100% rebase needs to grow revenue 38% faster than a project without a rebase, once ensuring equal rewards to veToken voters.
This happens because rebase adds more inflation to the system, not less, and while rebase was initially touted as "anti-dilution", over time it had the opposite effect.
Back to our question about the new release of Token, we need to release Token to LP to maintain LP incentive, which is the minimum incentive needed to keep the engine running, what Rebase does is add more currency to the locked veToken supply Inflation, which reduces the economic value of locked Tokens over time.
Specifically, it shifts the cost of inflation from veToken voters to new token buyers, and in doing so, it breaks the flywheel based on the token's high value proposition.
Some will argue that I should include the value of the Rebase's veToken in the APY, but that would be disingenuous, the increased APY from the Rebase is just paper gain, it doesn't add any value to the economy. Also, since the actual APY is smaller, the secondary market for veTokens will reflect a lower transaction price, and you won't even be able to convert the APY into actual profit.
This can be seen with SOLID v2, which despite having 100% rebase has an actual APY of less than 5%. Even though all veSOLID holders are wealthy on paper, buyers will not buy their veSOLIDs at face value because 5% APY is not enough to justify the investment. Thus, veSOLID trades at a price peg of 0.1-0.3 through its wrapper asset, moSOLID.
This would break the system flywheel as buying SOLID to lock in now would also be illogical since you can get veSOLID in the aftermarket for 70-90% off, which would reduce the need for SOLID itself and thus make LP unsustainable in the long run.
Additionally, for a new project hoping to gain a significant share of the vote in the future, rebase will be more difficult due to the high concentration of voting power held by the earliest participants. This will make the exchange vulnerable to competition from other DEXs. If they add uneconomic factors later, the new platform can seize market share through new projects. In summary, the effect of the rebase was to add unnecessary inflation to the system, and over time, the increase in total supply made Liquidity tokens a worse value proposition, weakening the flywheel that drives Solidly's economy. Therefore, the new generation of Solidly forked projects such as EQUAL, STR and SATIN have better token economics and long-term sustainability.
sustainability
Since this system requires inflation, income growth must match or exceed inflation to be a good long-term investment, but is this constant growth possible?
First of all, as the release of Token gradually decreases, the demand for growth will also gradually decrease. The initial annual inflation rate of 200% will change to 10% in the 4th year. Therefore, revenue growth expectations of 10% or more in Year 4 only need to be maintained for investors to earn APY on their investment.
I believe this is sustainable. Because DEX is the heart of DeFi, their revenue growth should broadly reflect the overall growth of the market. So far, less than 0.1% of the Internet ecosystem has been connected to the blockchain.
As adoption increases, cryptocurrencies will continue to evolve, coupled with improved user experience and more transactions moving away from CEXs, so will the revenue potential of DEXs. Furthermore, in the existing cryptocurrency market, DEXs account for only 5-15% of trading volume, so there is a huge opportunity for growth in this space even without considering any future growth.
Using the numbers in Scenario 1, the figure below shows the annual revenue growth requirement curve to maintain veToken APY:
The amount released gradually decreases over time, being highest in the first year and gradually approaching 0% over the cycle. The rapid growth in the first year is the bootstrap mechanism, as Solidly DEX initially needs to gain market share over existing competitors, while in the mature stage, growth will slow down while maintaining investor returns.
This is also similar to what I expect for the growth of the overall crypto market, a lot of early adoption, which will gradually slow down as the space matures, as with any new technology adoption curve:
As the world joins this new global financial infrastructure, the growth of DEX revenue may far exceed the required percentage to maintain APY in the next few years. With appropriate monetary policy, this mode of operation will last for a long time to come Be sustainable.
These Solidly DEXs create a fantastic opportunity to build. Due to the large TVL captured, many innovative features can be built on top of it to increase veToken revenue and further promote sustainability, such as Curve's Stablecoin crvUSD.
The ability to build more value capture for tokens outside of DEXs is underestimated. Even an accrual of 10% would significantly increase the token's value proposition in the long run, and since the flywheel is already very strong, further increases in the token's value proposition would mean stronger TVL capture.
in conclusion
Solidly DEX needs inflation to keep the economy going.
Inflation is not a bad thing, especially in Solidly's economic model.
Just because a token unlocks more value than revenue doesn't mean it's unsustainable.
It would be a mistake to think of token emission as a "cost" of the system.
Rebase is more of a marketing buzzword that doesn't add any value to the system and instead damages the Solidly flywheel over time.
There is a very large market opportunity for decentralized exchanges, which means that even though the initial inflation rate may be high, revenue growth can match it.
In the long run, the Solidly economy is sustainable as the inflation rate gradually falls to zero.
