What Is a veToken & How Does veTokenomics Work?

One of the biggest reasons for the popularity of cryptocurrencies and blockchain technology is the innovation they bring to the realm of digital finance. Ever since the introduction of Bitcoin, there have been numerous novel ideas that have reshaped traditional finance as we know it. One such revolutionary concept is veToken, along with the accompanying veTokenomics.

As newcomers enter the space, they are generally first introduced to Bitcoin and then to more popular altcoins, like Ethereum and XRP. Over time, new terminologies appear, introducing individuals to worlds of possibilities. veTokens, for instance, contribute to the stability of the whole system. But how exactly, and what are the benefits?

Read this guide to learn about the fascinating ecosystem of veTokens and get the necessary knowledge to navigate the crypto space.

What Are veTokens?

The term “veTokens” in finance is short for Vote Escrowed tokens and represents cryptocurrency assets that gain functionality from being locked. In essence, users lock their native tokens (e.g., locked CRV (Curve) tokens become veCRV) to gain various capabilities, such as governance rights.

At their core, veTokens represent an evolution in staking mechanisms. Their purpose is twofold:

1. Governance. veToken holders can take part in protocol governance. Much like traditional cryptocurrency staking in proof-of-stake blockchains, users gain the ability to vote on changes and influence the future of the project.
2. Incentives. The longer the lock-up period, the more benefits and rewards holders can gain from the protocol. The lock-up feature promotes commitment and stability, enhancing the possibility of long-term success.

In simple terms, veTokens can be viewed as loyalty tokens that encourage holders to commit to the project’s future, preventing any sort of short-term manipulation or speculative behavior.

The accompanying term, veTokenomics, adds economic principles to the mix. You can think of veTokenomics as the framework that surrounds veTokens. veTokenomics are economic models that follow each veToken and have several goals to facilitate long-term thinking among participants while deterring short-term speculation tendencies.

DeFi Tokens

The introduction of DeFi tokens has been a game-changer in the world of cryptocurrency. The decentralization aspect, coupled with various features and use cases, made DeFi tokens the go-to financial instruments for trading, staking, yield farming, and more.

From a technical standpoint, veTokens represent a subset of DeFi tokens. All veTokens are DeFi tokens, but not all DeFi tokens are veTokens. Still, when comparing general DeFi tokens to specialized veTokens, there are some key differences, such as:

• Functionality. While many DeFi tokens offer governance capabilities, in addition to many other functionalities, veTokens almost exclusively focus on that aspect. Moreover, they come with a time-based element to facilitate commitment.
• Creation. DeFi tokens are issued and acquired through various means, including staking rewards, purchasing, and liquidity mining. veTokens originate from locking up primary DeFi tokens.

How Do veTokens Work?

veTokens work by relying on the concepts of commitment and incentivization to foster long-term user engagement with a project. Here’s an analysis of the entire mechanism behind veTokens, along with the foundational principles:

• Token lock-up. Users need to lock up the network’s native tokens to obtain their veToken variant. For instance, locking up PENDLE grants users vePENDLE tokens.
• Decay over time. Many projects feature linear unlocking of tokens called “decay.” That incentivizes users to keep re-locking their tokens if they want to earn maximum rewards and have the most voting power.
• Governance. Most veTokens are governance tokens. Holders can use them to participate in decision-making processes that deal with the projects’ future. An individual’s voting power is directly related to the number of veTokens that they hold and the lock-up duration.
• Incentive. Long lock-up periods not only increase the holder’s voting power, but they usually yield higher rewards. That way, project creators want to align their goals with investors’, fostering a stable and growth-oriented environment.
• Rewards and benefits. Apart from governance, many projects offer additional rewards to their veToken holders. These can range from paying lower fees to earning additional tokens.

The mechanics of veTokens are best explained by the example of Curve Finance, which established the concept in the first place. Curve Finance is a decentralized exchange (DEX) that, apart from trading, allows users to take part in yield-farming pools.

Users who add liquidity to their pools but don’t have veCRV tokens are only eligible to earn lending and trading fees. However, those who lock up native CRV tokens to obtain veCRV gain access to a plethora of new features. They can earn CRV, vote on DAO proposals, gauge weights, and earn governance fees in addition to yield farming.

3 Benefits of veTokenomics

veTokens and veTokenomics bring plenty of benefits to the world of cryptocurrencies, further improving some of the functionalities of DeFi tokens to allow for special use cases. Let’s find out exactly how that happens.

#1. Protocol Stability

veTokenomics creates a robust foundation for projects by introducing ways to encourage users to make long-term commitments. One of the main upsides to this approach is reduced token velocity, which is calculated by dividing the total transaction volume by the average network volume.

In essence, slow token velocity generally positively impacts the price. Tokens become less volatile and more likely to retain their price (or even increase) in the future.

Another way veTokenomics facilitates protocol stability is through the dampening of speculative behavior. Regular altcoins are susceptible to panic selling during times of high market volatility and downtrends. Locked veTokens remain illiquid and out of the circulating supply and are thus safe from price swings.

Finally, protocol stability fosters trust among both investors and developers. As a result, it can attract more users, which can help the project grow further.

#2. Goal Alignment

The introduction of time-based mechanisms into veTokenomics made veTokens perfect for users who want to be genuinely invested in projects. Since the governance weight shifts towards participants who lock up their assets for extended periods of time, the system is designed to improve the odds of long-term success.

This type of alignment means that both developers and investors are going to be more strategic and collaborative since they both benefit from sustainable growth. The decisions that they make are likely going to be more strategic.

On the flip side, this type of goal alignment further discourages short-term traders and speculators, who mostly join projects for quick profit. The low voting power that comes with a shorter lock-up period ensures that the project evolves in a manner that’s more beneficial to the core team and community.

#3. Community Loyalty

At its core, veTokenomics revolves around loyalty. Everything, from the working mechanisms to the reward incentives, is tailored to benefit those who are willing to see the project through to the end.

For instance, one of the key elements of veTokenomics in many projects is enhanced rewards that increase the longer the lock-up period is. Add the governance rights and various other project-specific benefits, and you get a system that favors dedicated participants.

This approach attracts and retains a community of users who are often willing to invest more than just their monetary assets. The participants are more likely to engage in productive discussions that could lead to project improvements and development. That can also help the project better integrate into the overall cryptocurrency ecosystem.

Over time, strong loyalty can culminate in an ever-increasing and vibrant community of crypto enthusiasts. Their passion for the project can be a crucial element to its success in a decentralized space.

3 Disadvantages of veTokenomics

While veTokenomics features many benefits, there are also drawbacks to consider. Some of the downsides are important for investors, while others exist on a broader scale. Knowing about them is essential for any investor who wants to take advantage of veTokens.

#1. Lack of Liquidity

One of the biggest drawbacks of veTokenomics stems from a lack of liquidity and the potential issues that come with it. Since the main purpose of veTokens is to encourage users to lock up their assets for extended durations, the freely circulating supply is always going to suffer.

As a result, users who suddenly need liquidity won’t be able to access their funds until the lock-up period ends. Furthermore, there is a concern in regard to the opportunity costs. veToken holders need to be aware that the price of their assets can drop significantly by the time they’ll be able to sell them.

All that reduced liquidity can lead to an increase in price volatility. With fewer tokens hitting the market, even small trades can result in significant movements. That can also deter short-term investors. Users who prioritize liquidity and flexibility likely won’t invest in tokens that they won’t be able to sell for months or even years.

#2. Centralization Concerns

A system that incentivizes and rewards long-term holders comes with the inherent risks of centralization. As investors allocate more and more of their funds to a project, they gain more rewards in return. This process can scale over time, resulting in a disproportionate distribution of governance power among network participants.

Users or entities can then influence the decision-making process and steer the project in a direction that might benefit them specifically instead of the community as a whole. This can create a snowball effect where investors with substantial capital keep cyclically gaining more veTokens and more voting power.

If not addressed in time and balanced carefully, this can result in a scenario where just a few parties can have more influence on the protocol than the rest of the community. That undermines the entire decentralized ethos of the world of cryptocurrency and can have detrimental effects on the project’s future.

#3. Limited Adaptability

Robust veTokenomics and a focus on commitment result in rigidity and can, in some cases, have a negative effect on its flexibility and adaptability. That comes from the nature of veTokens itself.

Putting governance power in the hands of long-term stakeholders is great for the stability and steady progress of the entire system. However, challenges may arise when a decision needs to be made quickly.

First off, the veToken model requires participants to be ready and eager to vote at any given moment. Furthermore, that type of activity clashes with the true purpose of veTokens, which is strategic and thorough thinking.

Long-haul stakeholders can become resistant to fast-paced changes. That can be particularly concerning in the realm of cryptocurrency and decentralized finance, where adaptability can be vital for projects’ growth or even survival.

Price Performance of veTokens

The design and purpose of veTokens have a direct impact on their price performance; they aren’t created to be speculative assets, unlike many other cryptocurrencies.

For starters, veTokens have intrinsic value that stems from the importance of locked-up assets. The perceived value of veTokens further increases with all the benefits that they bring to holders.

Supply and demand dynamics can also push the price up. Since the tokens are locked, the circulating supply is lower compared to the usual DeFi tokens. That scarcity can lead to more demand, which influences the perceived value of the asset.

Another aspect in which veTokens differ from regular ones is volatility. Their locked nature and governance-focused design result in lower price volatility compared to more traditional crypto assets. They can be more stable and thus better suited for investors with low risk tolerance. All of that generally results in limited to no liquidity.

Finally, veTokenomics is designed to promote long-term appreciation. While that is not a guarantee, veTokens are more likely to organically increase in value over time, following the stable growth of the associated project.

The Future of veTokenomics

The future of veTokenomics is tightly connected to the development of cryptocurrencies in general. The current success of veTokenomics is a strong indicator of its wider adoption in the future. If ongoing projects see success, there might be more time-weighted governance mechanisms appearing across the entire DeFi space.

Moreover, it’s important for the community and developers to address some of the common concerns associated with veTokenomics. For instance, liquidity challenges may be solved by the appearance of secondary markets, leading to improved trading and lending structures.

All of that can result in increased and diversified utility for veTokens. The appearance of more staking options and reward incentives could draw a larger investor base, further facilitating project developments.

On the other end, there’s a chance of regulatory scrutiny dampening the implementation and adoption of veTokenomics. Regulatory attention usually brings centralization, conflicting with the core principles of cryptocurrencies, but it might be necessary to bring less knowledgeable retail investors on board.

The bottom line is that the future of veTokenomics appears bright, but there is still work to be done. As the DeFi space stabilizes, the need for lasting projects and dedicated communities is only going to increase, which can result in improvements to the entire space of digital finance.

Key Takeaways

As the DeFi landscape continues to expand, its core principles, like long-term stability and trust, are becoming more important. In that regard, veTokens and veTokenomics emerged as innovative solutions that address some of the biggest challenges in the cryptosphere.

By rewarding commitment and aligning the goals of investors and developers, veTokens represent a promise of a new era of decentralization—one where real objectives take the spotlight away from mere speculative investing.

Naturally, the journey of veTokens has only started, and there are plenty of challenges to be overcome. Still, while they are just a single thread in the tapestry of DeFi, veTokens’ contribution to decentralization may prove to be invaluable!