Optimism Ecosystem

VELO explained: decomposing the value-capturing of Velodrome native token

January 16, 2025
ValueVerse Team
12 min read
VELO explained: decomposing the value-capturing of Velodrome native token

Introduction

Velodrome Finance is a core liquidity layer for the Optimism ecosystem and the Superchain. It is a decentralized exchange (DEX) utilizing an automated market maker (AMM) design and serves as a primary trading venue for the OP ecosystem. Velodrome functionality combines ones from Curve, Convex, and Uniswap, making it a capital-efficient and user-friendly platform. Velodrome V2 features concentrated liquidity pools that maximize capital efficiency and a unique flywheel mechanism to drive $VELO emissions to sustain and bootstrap liquidity.

The protocol uses the veVELO token design to incentivize long-term user alignment and active governance, distributing emissions through an epoch-based voting system.

Figure 1

Figure 1. Adapted from the Velodrome Documentation
Figure 1. Adapted from the Velodrome Documentation

Outline of the $VELO token design

The operation of the ecosystem is driven by the coordination established between (1) Liquidity Providers who supply tokens, (2) Traders who generate activity and volume, and (3) ve$VELO Holders defining the protocol operation parameters through governance. The $VELO token is the core element of Velodrome's economic model. Its value originates from the future cashflow of rebase emissions, governance bribes and trading fees, general governance power, , risk exposure through token locking, and conditional action reflecting voting requirements. By combining these sources of value, the ve$VELO system aligns user incentives and balances protocol health.

Key Roles and Agent Coordination in Velodrome's Ecosystem

A diverse set of participants drives Velodrome's success, each playing a crucial role:

  1. Liquidity providers (LPs) supply liquidity (or tokens) that traders can utilize for trading. Using concentrated liquidity pools, they can make the most of their capital efficiency and earn fees and rewards by supplying that liquidity to where it is needed. Selecting the pools to supply wisely can allow LPs to grow and optimize their returns while at the same time reducing the effects of impermanent loss.
  2. Traders use the DEX for trading, creating trading volume in the ecosystem and generating trading fees for LPs; they are the life source of any market, continuously moving capital due to their pursuit of profit. Their activity, readiness to take risks for trading, or necessity to exchange assets make the platform a functioning, well-oiled machine.
  3. ve$VELO Holders direct the protocol's incentives distribution path through governance. Protocol incentives originate from the $VELO token emission. These actors ultimately decide which pools to incentivize, thus influencing the decision of liquidity providers to allocate their capital. To activate their voting rights, token holders must lock up their tokens to mint ve$VELO. This lock-up requirement can be seen as an opportunity cost and partial alienation of token ownership, as the tokens become non-transferable for a period of time.

Although identifying who Liquidity Providers, Traders and ve$VELO Holders are is paramount, an equally important part is to discuss the interaction of these agents amongst themselves within Velodrome's ecosystem. We've assembled an extensive role mapping table (See Figure 2 below) to better lay out the relationships, incentive structures and key actions making up this complex web.

Figure 2. Velodrome: the agents coordination outline

Figure 2. Created by Valueverse, 2024. Adapted from "Velodrome Documentation"
Figure 2. Created by Valueverse, 2024. Adapted from "Velodrome Documentation"

Some highlights we can draw from the above table are that of Velodrome agent coordination:

  1. Roles are complementary: traders perform swaps, LPs supply liquidity, and voters steer the allocation of emissions.
  2. Incentives are tailored to each role to coordinate specific behaviours. i.e. LPs are rewarded for staking their liquidity to encourage long-term commitment.
  3. There are interdependencies, such as traders requiring LPs for liquidity, and in turn, LPs need access to the trade flows brought by traders.
  4. Challenges include competition from other DEXs and impermanent loss risk for LPs.
  5. The structure aims to balance short-term gains with long-term sustainability despite potential conflicts, such as ensuring voting behaviour aligns with the protocol's long-term interests.

The value-capturing of VELO

This section uses a three-tiered categorization model to consider the fundamental value of the $VELO token from the perspective of the Value Capture Theory (VCT). The VCT framework introduces a novel approach to representing tokens by their function in value capture and the most important channels through which this value is manifested via the system.

OoVs (Origins of Value)

The $VELO token manifests value through five distinct Origins of Value

  1. Risk Exposure (7): Reflects the requirement to lock VELO for up to four years to convert it to veVELO. This lock-up period represents a significant opportunity cost as locked tokens cannot be transferred or sold during market movements. The lock duration directly affects voting power, creating a correlation between risk exposure and protocol influence.Centers on the token locking mechanism, where users must commit their $VELO tokens for extended periods (up to four years or permanently) to obtain ve$VELO, with lock duration directly affecting voting power.
[7]=F(LockPeriod,AmountLocked,PriceAtLocking,lock_time,token_nr,value_at_lock)[7] = F(\text{LockPeriod}, \text{AmountLocked}, \text{PriceAtLocking}, \text{lock\_time}, \text{token\_nr}, \text{value\_at\_lock})

LockPeriod\text{LockPeriod} is the length of the lock-up period set up by the user

AmountLocked\text{AmountLocked} is the amount of tokens locked up by the user

PriceAtLocking\text{PriceAtLocking} is the price of the locked token position when locking them. It defines the locked value (the upper bound of forfeited value) together with the locked amount

  1. Future Cashflow (22): Reflects the rebase distributed to veVELO holders for inflationary dilution protection. This mechanism ensures that long-term holders maintain their proportional ownership of the protocol through automated emissions, creating a sustainable value accrual system that rewards commitment to the protocol's growth.
[22]=F([7],veVELOSupply,VELOSupply,Emissiontotal)[22] = F([7], \text{veVELOSupply}, \text{VELOSupply}, \text{Emissiontotal})

In particular, the total rebase is determined according to the following formula:

rebasetotal=0.5×Emissiontotal×(veVELOSupplyVELOSupply)3\text{rebase}_{\text{total}} = 0.5 \times \text{Emissiontotal} \times \left( \frac{\text{veVELOSupply}}{\text{VELOSupply}} \right)^3

Where:

Emissiontotal\text{Emissiontotal} is the total token emission volume

veVELOSupply\text{veVELOSupply} is the supply of veVELO; that is, the totality of the voting power that determines the size of the locked portion of VELO

VELOSupply\text{VELOSupply} is the total supply of VELO. Acts as a normalising coefficient

  1. Conditional Action (8): Reflects the requirement to delegate or regularly vote to derive value from active VELO. This active participation requirement ensures that protocol governance remains dynamic and engaged, as value capture is tied to regular epoch-based voting participation rather than passive holding.
[8]=binary[8] = \text{binary}
  1. Future Cashflow (21): Reflects the pro rata rewards from trading fees and additional incentives for voters. This dual reward stream incentivizes strategic voting behavior by allowing veVELO holders to capture value from both organic protocol activity (trading fees) and external stakeholder interests (bribes/incentives), creating a market for governance power.
[21]=F([3],PoolFees,PoolIncentives)[21] = F([3], \text{PoolFees}, \text{PoolIncentives})

PoolFees\text{PoolFees} is the volume of cashflow derived from fees in the voted-for pool

PoolIncentives\text{PoolIncentives} is the volume of cashflow derived from extra incentives provided by the owner of the voted-for pool (cf. other bribe markets)

  1. Governance (3): Reflects the veVELO Voter's ability to affect weekly VELO emission distribution and potential governance through Emergency Council. This governance power creates a direct link between protocol value flows and voter preferences, allowing token holders to influence capital efficiency by directing emissions to the most strategically important liquidity pools.
[3]=F([7],[8],UserVoteAllocations,EmissionDistribution)[3] = F([7], [8], \text{UserVoteAllocations}, \text{EmissionDistribution})

UserVoteAllocations\text{UserVoteAllocations} is the allocation of voting power by the user, representing his overall allocation voting strategy

EmissionDistribution\text{EmissionDistribution} is the resultant distribution of epochal emissions, representing the actual voting outcome

These OoVs form an interconnected value capture system:

The foundation of value capture stems from Risk Exposure (7), as the conversion of $VELO to ve$VELO through locking is a prerequisite for accessing other value streams. Both Future Cashflow mechanisms (21 & 22) are tied to ve$VELO holdings, making them dependent on the Risk Exposure (7) component. The Governance (3) mechanism requires both Risk Exposure (7) through locking and Conditional Action (8) through active participation. The effectiveness of Conditional Action (8) directly impacts emission distribution and, consequently, the protocol's incentive structure.

Value Capture Mechanisms (VCMs)

VELO possesses a single large VCM composed of two OoVs (Future Cashflow and Governance) conditioned on Risk Exposure-activated Conditional Action and one OoV (Future Cashflow) conditioned on Risk Exposure itself. It represents the material and immaterial benefits derived from exercising voting rights upon acquiring them by transforming the token into its active form (i.e., locking it) and the material benefit (the rebase) derived from merely possessing the active form of the token. The VCM operates through a dual-track value capture system where users first convert VELO to ve$VELO through token locking (Risk Exposure), unlocking two distinct value streams. The first stream requires active participation through voting or delegation (Conditional Action) to capture both governance benefits over emission distribution (Governance) and associated rewards from fees and incentives (Future Cashflow 21). The second stream automatically generates value through rebases (Future Cashflow 22) based solely on the locked position, creating a baseline reward for protocol commitment. This architecture creates a balanced system that rewards both passive commitment and active protocol participation, while ensuring that maximum value capture requires full engagement with protocol governance. This VCM is denoted Vote-Escrow Governance and possesses the following structure:

vegovToken={V={7,22,8,21,3}E={(7,22),(7,8,21),(7,8,3)}}\text{vegovToken} = \left\{ \begin{aligned} V &= \{7, 2_2, 8, 2_1, 3\} \\ E &= \{(7, 2_2), (7, 8, 2_1), (7, 8, 3)\} \end{aligned} \right\}

The sub-VCMs for the $VELO token are:

Equation 1

Governance Token:{V={3,7,8},E={(3,7),(3,8)}}\text{Governance Token}: \{ V = \{3, 7, 8\}, E = \{(3, 7), (3, 8)\} \}

Equation 2

Yield - Bearing Staking Token:{V={22,7},E={(22,7)}}\text{Yield - Bearing Staking Token}: \{ V = \{2_2, 7\}, E = \{(2_2, 7)\} \}

Contribution Analysis of Each VCM

Figure 3

Figure 3. Governance Token sub-VCM Model: Value Capture Mechanism Decomposition
Figure 3. Governance Token sub-VCM Model: Value Capture Mechanism Decomposition

Governance Token sub-VCM: This sub-VCM operates through a system where governance rights and their associated rewards are activated through token locking (Risk Exposure) and active participation (Conditional Action). The mechanism functions through a multi-step process where users first transform their VELO into ve$VELO through token locking, establishing their base voting power. This locked position then enables participation in governance decisions over emission distribution.

Figure 4

Figure 4. Yield-Bearing Staking Token sub-VCM Model: Value Capture Mechanism Decomposition
Figure 4. Yield-Bearing Staking Token sub-VCM Model: Value Capture Mechanism Decomposition

Yield-Bearing Staking Token sub-VCM: This sub-VCM represents a more passive value capture pathway centered on the protocol's anti-dilution mechanism through rebasing emissions. This mechanism captures value through a Future Cashflow (22) stream that is activated solely through Risk Exposure (7), creating a baseline reward system for protocol commitment. The mechanism operates by automatically distributing rebase emissions to ve$VELO holders based on their proportion of the total ve$VELO supply. This process requires only the initial action of token locking, with no further active participation needed to capture value. The yield generation is calculated through a relationship between the locked ve$VELO supply and total VELO supply, ensuring that long-term holders maintain their proportional ownership of the protocol.

Vote Escrow Governance VCM: The $VELO token implements a VCM that integrates multiple Origins of Value into a unified value capture framework (See Figure 5). The primary VCM represents a comprehensive governance-yield hybrid mechanism that operates through the interaction of multiple OoVs:

  • A Future Cashflow (21) stream combined with Governance rights, both activated through a combination of Risk Exposure (token locking) and Conditional Action (voting)
  • An additional Future Cashflow (22) component that requires only Risk Exposure through token locking This structure creates a cohesive system where value capture is primarily achieved through the transformation of $VELO into its active form (ve$VELO). The VCM strategically layers different value streams, with some requiring active participation through voting and others rewarding mere possession of locked tokens. The mechanistic unity of this approach is particularly noteworthy, as it creates a natural alignment between governance participation and yield generation, while maintaining a base level of value capture for locked token holders regardless of their governance activity.

Figure 5

Figure 5. Votes Escrow Governance (Simplified) Token VCM Model: Value Capture Mechanism Decomposition
Figure 5. Votes Escrow Governance (Simplified) Token VCM Model: Value Capture Mechanism Decomposition

Value Capturing Implementation Patterns (VCIPs)

The implementation of $VELO's value capture is primarily achieved through the ve$VELO system, which manifests through several interconnected smart contracts:

  1. Core Mechanism:
  • The Voting Escrow contract (0xFAf8FD17D9840595845582fCB047DF13f006787d) serves as the central point for token locking, position management, and delegation functionality
  • Token holders interface with this contract to convert $VELO into its active form (ve$VELO)
  1. Governance Implementation:
  • Voting occurs through the Voter contract (0x41C914ee0c7E1A5edCD0295623e6dC557B5aBf3C) on an epoch basis
  • The system includes gauge creation mechanisms and associated reward pools (managed through the Rewards Factory contract: 0x756E7C245C69d351FfFBfb88bA234aa395AdA8ec)
  • Each gauge has dual reward pools: one for fees and another for bribes
  1. Reward Distribution System:
  • The Minter contract (0x6dc9E1C04eE59ed3531d73a72256C0da46D10982) handles emissions and rebases based on voting outcomes
  • The Distributor contract (0x9D4736EC60715e71aFe72973f7885DCBC21EA99b) manages the actual distribution of rebase rewards
  • Rewards become claimable via Voter contract functions after epoch completion

This VCIP differs in its approach, tying governance and yield-bearing mechanisms into a single token-locking event to create an all-encompassing system of incentives that rewards long-term commitment and operational involvement within protocol governance.

VCM-Derived Health Metrics: $VELO

The Value Capture Theory framework can be used to derive helpful health metrics, such as the four shown in this section. These metrics capture the performance of Velodrome's vote-escrow governance, which was the primary value-capturing mechanism (VCM). This simplified version of the vote-escrowed governance VCM will combine multiple origins of value (OoVs): Governance (3), Future Cashflow (2), Risk Exposure (7), and Conditional Action (8).

Please Note: "An epoch is 7 days. It starts every Thursday at 00:00 UTC and ends Wednesday at 23:59 UTC" (Velodrome Finance, 2024).

Bribes Distribution Concentration (BDC)

  • Class (OoV): Governance (3)
  • Aspect: OoV-specific
  • Tier: Tier 1 (Primary)
  • Description: Measures the concentration of bribes across gauges using the Gini coefficient.

Rationale:

  • Measures the competitive dynamics between gauges by tracking bribe concentration patterns
  • Resistant to manipulation (unlike raw bribe counts)
  • Provides insight into governance preferences and voting power concentration

Vote-Conditional Reward per ve$VELO (VCR)

  • Class (OoV): Future Cashflow (21)
  • Aspect: OoV-specific
  • Tier: Tier 1 (Primary)
  • Description: Measures the total value of vote-dependent rewards (trading fees + bribes) distributed to active veVELO participants per epoch, normalized by total veVELO voting power.

Rationale:

  • Captures rewards tied to active participation rather than passive holding
  • Independent of the veVELO/VELO supply ratio that determines rebase rewards
  • Provides insight into the economic value of voting power

Total Locked $VELO to Circulating Supply Per Epoch (TLVTC)

  • Class (OoV): Risk Exposure (7)
  • Aspect: OoV-specific
  • Tier: Tier 1 (Primary)
  • Description: Ratio of locked $VELO (ve$VELO) to total circulating $VELO supply per epoch.

Rationale:

  • Gives insight into the collective risk appetite of $VELO holders
  • Indicates commitment level to the protocol
  • Reveals potential for governance participation

Number of Unique Voters Per Epoch (NUV)

  • Class (OoV): Conditional Action (8)
  • Aspect: OoV-Specific
  • Tier: Tier 1 (Primary)
  • Description: Count the distinct wallet addresses participating in voting for each epoch.

Rationale:

  • Measures active governance participation
  • Quantifies user engagement in protocol decisions
  • Demonstrates users' willingness to activate value capture through voting

These metrics contribute to forming a more comprehensive picture of whether the Velodrome V2 token system is in high-quality health by evaluating governance participation, reward distribution, incentives (bribe) concentration and user commitment. Tracking these figures helps assess the protocol's health and detect trends that signal impending issues or opportunities. Each metric is classified as OoV-specific, offering insights into individual value capture mechanisms within the protocol ecosystem. This enables us to pinpoint critical value-capturing functions and, simultaneously, helps provide a framework for understanding more intricate coordination-driven performance features in protocol and token.

Final Thoughts

One of many ways Velodrome Finance stands as a forerunner for decentralized liquidity provision is through its intricate tokenomics model, which can be decomposed and analyzed via the Value Capture Theory (VCT) perspective. This framework demonstrates that Velodrome V2 aligns the interests of traders, liquidity providers, and ve$VELO holders well through multiple thoughtfully designed mechanisms.

The value proposition of the $VELO token is built on a model that leverages four key concepts (the Origins of Value: Future Cashflow, Governance, Risk Exposure, and Conditional Action). These OoVs are combined into two core value-capturing mechanisms (VCM), The Governance Token and the Yield-Bearing Staking Token, and one joint Vote Escrow Governance (Simplified) VCM. The implementation of this unified VCM is the ve$VELO mechanism, which constitutes Velodrome's tokenomics core design. Below are key features promoting long-term commitment and active participation through the ve$VELO system.

  1. Token locking grants increased voting power and rewards based on lock duration.
  2. Rebase emissions, providing $VELO rewards to ve$VELO holders.
  3. Trading fee distribution, aligning holder interests with protocol activity.
  4. Epoch-based voting allows regular influence over emission distribution.
  5. Bribes and incentives create a dynamic marketplace for liquidity

These mechanisms collectively create a robust, self-reinforcing ecosystem that promotes sustainable growth and efficient capital allocation.

Metrics need to be designed in a manner that they should essentially link with the identified OoVs and VCMs. These could include things like total locked $VELO to circulating supply ratio (Risk Exposure), the number of unique voters per epoch (Conditional Action), or even your vote-conditional reward per ve$VELO (Future Cashflow). Velodrome can use these OoV and VCM metrics to track its economic well-being and perform informed decision-making based on the data.

Disclaimer: The content of this document is provided for informational, educational, or discussion purposes only and does not purport to be complete or definitive. It should not be considered as financial, investment or legal advice. While every effort has been made to ensure accuracy and completeness, the author does not guarantee that it is free from errors or omissions and may update, revise, or retract information without prior notice. Readers are advised to consult the most recent version for the latest details and to be aware of the inherent risks of cryptocurrency and blockchain technologies. The author does not make guarantees or representations regarding any discussed tokens or projects and shall not be liable for any direct, indirect, or consequential damages arising from the use or reliance on this content. Mention of any project, token, or protocol does not constitute an endorsement. By accessing this document, readers waive all claims against the author.

Acknowledgements

The authors gratefully acknowledge the financial support provided by Optimism during the Gitcoin Grants 21. This support enabled to conduct a research provide a comprehensive token design details for several selected Optimism projects, including Origins of Value (OoVs), Value-Capturing Mechanisms (VCMs), Value Capturing Implementation Patterns (VCIPs), and outline utility token metrics.

Bibliography

  1. Sumanov, V., & Desmarais, J.-L. (n.d.). Token Classification Framework by Consideration of Origins of Value and Mechanisms of Manifestation Thereof. Google Docs.
    Retrieved October 31, 2024, from https://docs.google.com/document/d/1I1T_ftDnt7E_y5C9mlqTomxd6WhYUh1r/edit?usp=sharing&ouid=116362223184273470428&rtpof=true&sd=true

  2. Velodrome. (2023a, June 1). Velodrome V2: A New Era. Medium.
    Retrieved from https://medium.com/@velodromeFi/velodrome-v2-a-new-era-1bd84509fa23

  3. Velodrome. (2023b, July 17). Velodrome V2: Just Getting Started. Medium.
    Retrieved from https://medium.com/@velodromeFi/velodrome-v2-just-getting-started-602009be5c4b

  4. Velodrome Finance: Documentation. (n.d.).
    Retrieved October 31, 2024, from https://velodrome.finance/docs

  5. Velodrome Finance: The Central Trading and Liquidity Marketplace on Optimism Network. (n.d.).
    Retrieved October 31, 2024, from https://velodrome.finance/

About Valueverse.ai

Valueverse is the first utility-centric token tracker. It complements other analytics platforms by providing a detailed view of the economic design, value capture structure, and utility metrics of digital assets.

Valueverse's mission is to provide fundamental economic metrics of digital assets, extending token analysis beyond traditionally used market metrics.

More updates at Valueverse X account.
Optimism Ecosystem