as i understand it 1 - the flywheel effect

in #defi3 months ago

I am just thinking out loud throughout the entirety of this post, just in case anyone potentially finds this informative or helpful in any capacity. Nothing in here should be considered financial advice by any means. I would encourage anyone reading this to do their own research and check my work before accepting anything written here as fact. Don’t trust; verify.


DEXs need liquidity. In order to incentivize users to provide liquidity on their platform, DEXs can issue governance tokens and direct the token emissions to liquidity providers (LPs). Users can then provide liquidity and earn extra rewards in addition to the normal revenue they generate from trading fees. Aerodrome distributes their governance token, AERO, to liquidity providers on their platform. Roughly 10 million AERO are distributed to Aerodrome LPs every week, or epoch, as they call them.

For a detailed breakdown of AERO emissions, read their Medium post: https://medium.com/@aerodromefi/aerodrome-launch-tokenomics-30b546654a91


As I said, AERO is the governance token of Aerodrome. Users who lock in their AERO tokens receive a veAERO (vote-escrow, or vote-enabled AERO) NFT, which contains their locked AERO tokens. Holding a veAERO NFT allows you to participate in governing the protocol. The amount of voting power (veAERO) you possess depends on 2 factors: the amount of AERO tokens you’ve locked, and the amount of time you’ve locked your AERO tokens for.

AERO can be locked for a minimum duration of 2 days, up to a maximum duration of 4 years. If you choose to lock your AERO tokens for the maximum of 4 years, you will receive veAERO at a 1:1 ratio. The ratio declines at a linear rate as the lock time decreases. For example, if you deposit 100 AERO, you will receive the following amounts of veAERO at the beginning of your lock period:
4 years = 100 veAERO
2 years = 50 veAERO
2 days ~ .48 veAERO

Keep in mind, regardless of the lock time you select, your veAERO will decline over time unless you continue to manually extend your lock period (requires an on-chain transaction). The only exception would be Aerodrome’s “Auto Max-Lock” feature, which will keep your AERO locked for the max of 4 years, ensuring you continuously have maximum voting power, so long as you have it on. You can turn it off at any time, and your lock time will start to decline.

TO RECAP SO FAR:

  • Aerodrome wants people to provide liquidity.
  • Aerodrome distributes AERO tokens to liquidity providers (LPs).
  • AERO tokens can be locked in exchange for veAERO.
  • Users govern the protocol by voting with their veAERO.

Now, we know that ~10 million AERO tokens are emitted each week to liquidity providers on Aerodrome, in order to incentivize people to provide liquidity. Each liquidity pool on Aerodrome is allocated a certain amount of that 10 million AERO every week. Throughout the epoch, the AERO is distributed to LPs of that liquidity pool, proportional to the amount of liquidity they are providing, as compared to the total amount of liquidity in the entire pool.

Which brings us to the most important piece of the veTOKEN flywheel:

The amount of AERO each liquidity pool receives is determined by veAERO voters.

As a veAERO holder, you can vote to direct some AERO emissions to the liquidity pools you would like to see rewarded. Every week, all of the votes recorded by all veAERO holders are tallied up across all liquidity pools. The amount of AERO each pool receives is proportional to the total amount of veAERO votes it received, as compared to the total amount of votes recorded. So if 1% of all veAERO voted for WETH-USDC, that pool will receive ~100,000 AERO for that week to distribute to its LPs.


At this point, it’s important to note that there are various incentives for veAERO holders, as it pertains to voting for specific liquidity pools. First and foremost, veAERO voters receive a portion of the trading fees generated by the pool they vote for. So if you vote for the WETH-USDC pool, you’ll receive some WETH and USDC at the end of the epoch. If you vote for the WETH-TYBG pool, you’ll receive some WETH and TYBG at the end of the epoch.

The second incentive for veAERO holders comes in the form of bribes. Bribes are very intuitive: users can directly incentivize veAERO holders to vote for a specific pool by paying them to vote for the pool. You put up a $1000 bribe, and all veAERO voters split it at the end of the epoch, earning extra revenue in addition to their portion of trading fees.

Often times, you’ll see newer projects and tokens putting up bribes for their own token’s liquidity pools. The bribes incentivize veAERO voters to vote for their pool. More votes means that more AERO emissions are allocated to their liquidity pools. More AERO emissions means more rewards for LPs. That incentivizes more liquidity —> that creates a stronger market for their token —> that supports further bribes, etc etc. This is what people refer to as a “flywheel” effect.

That all brings us back to the tweet in question:

~~~ embed:1755544713900470289?s=46&t=suIt29Bap7F_pCpLrYTMhQ twitter metadata:bWVvd3BoYXNhdXJ1c3x8aHR0cHM6Ly90d2l0dGVyLmNvbS9tZW93cGhhc2F1cnVzL3N0YXR1cy8xNzU1NTQ0NzEzOTAwNDcwMjg5fA== ~~~

Let’s break it down:

-“Bribed $1k/$2.8k on TYBG-wETH LP.”
He provided $1,000 in bribes for the TYBG-WETH liquidity pool, of the $2,800 total amount of bribes put up on that pool for that epoch.

-“Total bribe generated approx $8.6k in AERO.”
Bribes incentivize veAERO voters to vote for a specific pool, so that pool will receive a greater portion of the 10 million AERO emitted for that epoch. He is concluding that $2,800 worth of bribes helped attract enough veAERO votes to reward the TYBG-WETH liquidity pool with $8,600 worth of AERO emissions.

-“Based on my weight within the pool, I’ll earn approximately $2k”
He is also providing liquidity in the TYBG-WETH pool. As an LP, he will earn a portion of that $8,600 worth of AERO emissions allocated to the pool for this epoch. If he is set to earn ~$2k from that $8,600 based on his “weight within the pool”, we can assume he accounts for ~23% of the total liquidity provided to the TYBG-WETH pool, and therefore will earn ~23% of the rewards.

-“Next epoch, I will bribe $2k and hope entire bribe amount is at least $4k. If my weight within the pool and bribe-to-reward ratio remain the same, I will earn approximately $4k next epoch.”
Bad math aside, as I understand it, he’s hoping that increasing the bribe amounts will increase the amount of veAERO votes the pool receives, which would increase the amount of AERO emissions allocated to the pool, which would increase the amount of AERO he earns as an LP. These are speculative assumptions.

-“Flywheeling the bribes drives more AERO to the pool, attracting more buy pressure on TYBG to acquire it to LP. Bribe amount also functions as marketing by acquiring attention of veAERO holders. As the liquidity pool increases in size, buyers experience less slippage and sellers impact the price less when dumping.”
More speculative assumptions, but that’s the general idea.

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Quite interesting, I haven't considered gov votes to decide on pool rewards before but not really sure how he's "bribing" people. Like just offering them cash to allocate more rewards on a specific pool which then brings more liquidity to it from others as well and makes selling the rewards he gets being a major LP there easy? Doesn't sound healthy.

I guess I don't have to personally worry about this much as the only LP's I have in mind for off-chain are bnb-zing, eth-zing and potentially other L1's and L2's, though one may wonder about the distribution of LP zing rewards between hive-engine, eth, bnb, etc, I'd say it's probably best to choose a different metric than letting stakeholders/gov decide on that.