Velodrome Finance: The Return of ve(3,3)

Enter VeDAO, an early entrant into the Solidly Wars. After the collapse of Solidly, VeDAO took the lessons learned and used Andre’s open source code to create their own take on a ve(3,3) AMM. Thus, Velodrome was born, and the experiment continues on a new chain: Optimism.

Velodrome’s goal is to provide a public good for the Optimism ecosystem by offering swaps with deep liquidity and low slippage. While Solidly was primarily designed to benefit large stakeholders who offered their liquidity to the AMM, Velodrome attempts to democratize these rewards, not unlike what Convex did for Curve. Velodrome is an AMM, but a more apt description is a liquidity marketplace, built in such a way that liquidity flows towards the pools most valuable to the overall health of Optimism.

This project is a Solidly fork, but it’s also quite a bit more. In order to understand it, let’s first examine the fundamentals of Solidly, then we can look at the key changes implemented that make Velodrome unique. With a little luck, maybe they could help the “Velodrome Wars” get off the ground where Solidly never did.

Back in February 2022, Solidly launched with plans to create a new type of AMM. What made it unique was its synthesis of two prominent DeFi mechanisms: a vote escrow (ve) model drawn from Curve Finance and a system of incentives based on game theory, which it drew from Olympus DAO’s (3,3) model. After combining these elements, Cronje dubbed the system “ve(3,3).”

Unlike most AMMs, where the majority of swap fees go to LPs, ve(3,3) AMMs distribute fees to ve token voters and the voters receive rewards for the pools they voted for. As for the LPs, they receive emission rewards from the weekly token mintings. This separation aligns emissions with actions the protocol wants to incentivize, as the pools generating the most fees for voters will receive the most votes, in turn deepening those pools and rewarding LPs. This is the essence of ve(3,3).

These basic principles have been adopted by Velodrome, but the VeDAO team recognized some key issues with Solidly’s mechanisms and UX. The issues they identified were:

• An imbalanced token distribution
• Inefficient bribe systems
• An unregulated whitelisting process
• A lack of support from the dev team.

The idea was that if these issues were tuned up, it would make for a smoother and more capital efficient liquidity marketplace than ever before. Let’s see what changes VeDAO made in each of these departments to give us the Velodrome of today.

The token distribution was the first issue to be addressed, both the initial distribution and emissions schedule. Solidly’s initial distribution went out to the top 25 Fantom protocols based on a TVL snapshot. This method actually allowed for the creation of VeDAO, which sprung up with the sole purpose of capturing enough TVL to receive an allocation.

Velodrome wanted to have more say over the recipients of their tokens, and opted for a targeted airdrop picking out protocols and DAOs which they and the Optimism Foundation felt had the most to contribute to the Optimism ecosystem. The percentage of tokens going directly to protocols was lowered significantly, with the majority of the airdrop going to wallets that had a history of participation within Optimism, VeDAO, and several other major DeFi projects.

The other main distribution correction was a less front-weighted emission strategy. Solidly emissions were done on a rapidly decaying schedule, which was quite rewarding for early entrants, but didn’t leave enough room for newcomers post launch. Velodrome keeps the same principle of diminishing emissions to reward early adopters, but adjusted the decay rate to allow for meaningful participation from protocols that weren’t included in the airdrop. Here’s a look at the initial distribution, as well as the emissions schedule.

The airdrop period began on June 1, 2022, hot on the heels of Optimism’s May 31st airdrop, kickstarting what some have deemed OP Summer. The majority of the initial 400 million token supply was distributed among the defi community, in stark contrast to Solidly’s protocol-only allocation strategy.

Among the eligible recipients were holders of VeDAO’s WeVe token, Optimism users, Curve and Convex lockers, as well as users of a few other DeFi protocols selected by the team. These wallets received more than twice the amount of VELO in total as the handpicked Protocols and DAOs. This inclusion of retail participants was done with the purpose of leaving room for new protocols to accumulate VELO in the future, as well as onboarding members of the wider DeFi community onto Optimism.

After the June 1st launch of Velodrome, the first emissions epoch began, with each epoch lasting one week. Upon the completion of each epoch, the weekly emissions are distributed to LPs as rewards for filling the pools and to veVELO voters as an anti-dilution rebase. The total amount of weekly emissions started at 15 million and decays by 1% per week. The percentage of those emissions going to veVELO voters is calculated by the formula:

$Rebase =(veVELO.totalSupply ÷ VELO.totalsupply)³ × 0.5 × Emissions$

Similar to the OG (3,3) protocol, OlympusDAO, the higher the percentage of lockers, the more emissions they receive. This formula, however, leaves the lion’s share of emissions for LPs, with the rebase hard capped at 50%. It’s important to note that before the rebase calculations are done for a completed epoch, a flat 5% of the emissions are taken off the top, 2% of which go into the VELO/ETH pool and 3% of which go to VeDAO to fund continued development and maintenance of the protocol.

Over the first five epochs, the percentage of VELO locked has gone from 49% up to the current 63%, a healthy level that suggests the 3,3 mechanic is working as intended. At current levels, the emissions breakdown is going 12% to voters and 88% to LPs.

Bribing voters to incentivize certain pools is hardly a new concept in the world of AMMs. Whether it’s a newer protocol looking to bootstrap liquidity for their native token or an established project expanding across a new chain, bribing creates a viable avenue to acquire voting power.

The highlights of Velodrome’s bribe system:

• Fully contained within the application, no reliance on third party platforms
• Bribes go to voters rather than LPs, creating stickier liquidity
• Bribing protocols can bootstrap liquidity with a relatively small amount of capital

Anyone can deposit bribes in the form of any whitelisted token, essentially renting votes without having to risk locking their tokens on the veVELO marketplace. This avoidance of risk also creates a VeVELO premium which dictates the effectiveness of bribes at any given amount. With bribes going not to LPs but to voters who have locked their tokens for an average of three years, this system combats the problem of mercenary LPs who can pull their liquidity and move elsewhere after earning the rewards. This makes the liquidity more sticky, retaining capital within the Optimism ecosystem.

There are also a few key mechanics involved in the bribe system that create an interesting tradeoff for voters. The bribes accrue only to voters of the pool for which the bribe is offered, proportional to the amount of voting power each voter holds. The bribe accrual also occurs immediately after a bribe is deposited. This means early voters receive a larger share of a bribe, as there are less total voters to share it with. However, late voters have the ability to see which pools are receiving the most bribes and opt for those to secure a smaller share of a larger amount of bribes.

Another issue that sprung up with Solidly was the emergence of hostile pools created to sybil farm the emissions, with one entertaining example being a pool of Spiderman and Batman tokens. In order to avoid a repeat of this scenario, Velodrome opted to handpick the protocols whose tokens would be whitelisted initially and give these protocols the ability to request that additional tokens be added.

The team does plan to evolve whitelisting into an on-chain governance process, allowing voters to propose and decide on tokens to add. Recognizing the potential risk of this change allowing an extractive pool to be created, the team set up an emergency DAO, the Commissionaire, which could step in if another Batman/Spiderman situation were to arise. The Commissionaire is composed of seven Velodrome and Optimism team members, and can disable any pools engaging in malicious behavior, acting as both a solution and a deterrent to this issue.

Velodrome offers two distinct types of pools: stable pools for correlated asset pairs like USDC/DAI, and volatile pools for uncorrelated asset pairs such as VELO/USDC. Each type uses a different pricing formula to maintain balance. Volatile pools use the constant product formula $xy≥k$, and stable pools use the formula $x^3y+y^3x≥k$ to allow for lower slippage at high volumes.

When a swap is initiated, the router will use a 30 minute TWAP to execute, protecting pools against flash loan attacks. Swap fees are set at .02%, but can be increased up to .05% depending on the pool. APR for pools varies significantly, but stable pool APR is generally under 20% while variable pools can get up to several hundred percent depending on asset volatility and depth of liquidity.

While Velodrome solved some of the problems that plagued Solidly by improving on the token distribution, bribe mechanics, and whitelisting process, the last major hurdle wasn’t as straightforward as rewriting a smart contract. The founders knew a committed and engaged team would be essential to achieving a lasting positive impact Optimism, which they continually incentivize with the 3% emission allocation.

Luckily, VeDAO already had a solid pool of talents who were committed to find a positive way to unwind after Solidly ended. The core team at Velo consists of Gabagool, VeDAO founder and the guy behind their biz dev/marketing strategy, Pooltypes, lead solidity dev who joined VeDAO during its unwinding, Tao, a former tradfi consultant who deals with tokenomics and strategy, and Alex Cutler, an ex-Apple employee with a consulting/marketing background who was brought on to facilitate the transition of VeDAO stakeholders to Velodrome.

The choice to build on Optimism came about through some connections from Gabagool’s Information Token DAO, which led the Optimism Foundation to give them a grant. Timing was also a major factor, as Optimism was just getting started during Velodrome’s inception and this presented the best opportunity to help protocols bootstrap liquidity.

Velodrome promotes itself as a public good for the Optimism ecosystem, and after looking at their first two months of operation, this certainly seems to be true. If you’re a protocol looking to launch on Optimism you’re going to want to partner with this team, as many of the top OP projects like Synthetix and Perpetual Protocol already have. They frequently work with newcomers who are bribing their way into the ecosystem, providing juicy OP token boosts to attract additional voters and subsequently LPs.

This willingness to work with new entrants, combined with beautifully orchestrated incentive alignment and intuitive UX, has led to Velo’s recent surge in market share among Optimism DEXs. As of July 20th, Velo has more than doubled its market share since launch, rising from 18% to 38% of swap volume. All signs are pointing towards Velo flipping Uniswap for Optimism’s number one DEX spot in the near future.

The Velo team has stated that their full focus is currently on the success of the core protocol and the mechanisms already in place, as they work with the Optimism Foundation to grow the ecosystem and major stablecoin providers to deepen essential liquidity. However, the team has hinted at some future additions including an integrated veNFT renting system which would allow voting power to change hands while lockers retain ownership and earn yield, as well as the potential for cross chain stablecoin swaps.

As someone who was hyped on Solidly’s design, it’s impressive to see the refinements made by the Velodrome team, which have really unlocked the potential of this style of AMM. It fills a necessary role on Optimism and is backed by a dedicated, experienced team that is committed to the long term success of the project and the chain as a whole. Over time, don’t be surprised to see Velodrome take over the top DEX spot on Optimism, and ultimately become a blueprint for similar liquidity marketplaces on other chains.

1. https://docs.velodrome.finance/
2. https://www.youtube.com/watch?v=0K2wuwq7HV4
3. https://www.youtube.com/watch?v=gjVov4AxZAs
4. https://dune.com/Marcov/velodrome-finance
5. https://dune.com/hildobby/optimism-dexs
6. https://twitter.com/VelodromeFi
7. https://medium.com/@vedao.alt/more-on-velodrome-fef8e9779758
8. https://medium.com/@vedao.alt/on-velodrome-2e9d6f9b9056
9. https://discord.gg/velodrome

1. Note: there are numbers on the X axis of this graph to denote the weeks, but they are quite hard to see, the graph ends at week 200 when it is estimated the final total supply of 2,000,000,000,000 Velo will be reached