As a participant in crypto & digital asset markets, you might have heard of veTokens. In this newsletter, we will examine vote escrow protocols, how they work, the merits & demerits, and vote escrow protocols that you can take advantage of.
What is Vote Escrowing
Vote escrowing is the process of locking the governance tokens of a protocol for a predefined time. The locked votes are weighted depending on how long they will be locked. Vote escrow protocols facilitate the process of vote escrowing. The most popular Voting Escrow protocol at this time is Convex. The entire point of the voting escrow system is to consolidate votes and enable better governance as participants delegate their tokens to other institutions they trust.
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Vote escrow protocols receive a protocol’s governance token from an investor. Upon receipt of the governance token, the voting escrow protocol issues veTokens to the investor representing a commitment to return the original governance token at a specified time. The voting escrow protocol then distributes more rewards — from protocol fees, token emissions, and other sources to investors than the protocol issuing the original governance tokens. veTokens are used primarily to vote on liquidity/trading pools on a protocol that will receive the most trading fees or governance token emissions.
Let's illustrate the above image using the Vote-escrowed CRV(veCRV) - for the Curve protocol. Firstly, the veCRV token cannot be transferred; thus, the only way to obtain the veCRV token is to lock the CRV token into a vote escrow protocol like Convex. The maximum lock time for veCRV is four years; this means that one CRV token locked for a period of four years will provide an initial balance of one veCRV.
An investor’s veCRV token decays linearly based on the time left to unlock the locked CRV tokens. For example, 2000 CRV tokens locked for a year will provide the same amount of veCRV as 1000 CRV tokens locked for two years and the same amount as 500 CRV tokens locked for the maximum period of four years.
Merits of Voting Escrow System
Increased incentives to ensure the success of the protocol - Once governance tokens of a protocol have been locked, they cannot be unlocked until the specified time has elapsed. This often means that investors are stuck and must ensure the growth of the protocol. For example, seeing nearly $5bn worth of tokens locked on convex, we can infer that there is a lot of economic incentive that will make investors ensure that the Curve protocol continues to be successful.
Wealth creation amongst governance token providers - Vote escrow protocols distribute more incentives to investors than they would have received by simply locking or staking the governance tokens elsewhere.
Aligned incentive between token holders and liquidity providers - The vote-escrow system creates an aligned incentive between the governance token holders and liquidity providers and improves the capital efficiency of the Decentralized Finance(DeFi) protocol. Voting escrow protocols incentivize the most economically viable liquidity pools and ensure that locked governance token holders(veToken) holders receive the highest rewards.
Demerits of Voting Escrow System
Introduction of bribery and other enticement practices - Bribery is rising in the vote-escrow protocol space. For example, the bribe protocol dedicated to bribing Curve token holders allows wealthier market participants to derail the voting process on proposals made by retail investors. There are several schools of thought that encourage the rise of quadratic voting systems to counter skewness in voting patterns.
Popular Voting Escrow Protocols Across Different Chains
Convex Finance - This is the biggest vote-escrow protocol with more than 5bn in total value locked on the Ethereum chain. It is a voting protocol primarily targeting Curve governance token holders.
PlutusDAO is another vote escrow protocol. Plutus is primarily targeted at providing vote escrow services for Dopex governance token holders. PlutusDAO is available on Arbitrum - an Ethereum Layer 2 scaling solution.
Vote escrow protocols will continue to be a vital source of cash flow in the near future as there is a need to incentivize liquidity providers across DeFi. While bribery may encourage elitism, it also creates enormous wealth for governance token holders. We encourage all our readers to understand veTokens and take advantage of yield generated.
