Layer 2 Review Issue #0
Layer 2 Season Is Finally Here, Really! | Layer 2 Review
Quick Reads and Hot Links Covering the People and Projects Who Are Scaling Ethereum
Dear Frens,
Welcome to Layer 2 Summer (or Winter if you’re in the Southern Hemisphere!) Although these words were first written nearly two years ago by one of the founders of BanklessDAO, Ryan Sean Adams, it’s safe to say that this time, it really is Layer 2 Season.
And it’s not the time for Layer 2s just because zkSync recently went live on Mainnet with its Era rollout, nor is it because Arbitrum dropped its much-awaited token a month ago. And no, it’s not because Coinbase is building Base on Optimism, promising to help onboard its 100 million users to DeFi. But with all the Layer 2 news, you would certainly be mistaken for thinking so.
It’s Layer 2 Season because people are finally using Layer 2s in droves. In fact, daily activity has been outpacing Mainnet all year, and it’s been by an almost 3:1 margin for the last two months.
So it’s a bit of an understatement to say it’s due time for us to launch a newsletter focused on the Layer 2 ecosystem. We’re going to focus on governance, new projects, ecosystem updates, hot takes, and offer up a short editorial on something happening that’s unique to Layer 2s. With over 20 Ethereum scaling solutions (a number that is up only), we’re going to have a lot to talk about.
For this issue, HiroKennelly offers us a short(ish) article on Velodrome Finance, a revolutionary AMM that combines the best of Curve and OlympusDAO to create low-slippage trading and a way for projects to attract liquidity. In the future you may see articles on governance models, NFT projects, public goods funding, or how traditional businesses are using Layer 2 to connect to their customers and users.
If you have any hot tips or just want to let us know how we’re doing, please DM HiroKennelly on Twitter or Telegram. We’ll be shipping monthly to begin with, but expect fortnightly issues in the near future. Thank you for being on this journey with us, and we’ll see you next month.
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✅ Action Items
🗳️ Vote: If you’re an Optimism Delegate, be sure to vote on current proposals. Voting closes in ten days.
🏛 Governance
⭐ Featured Proposals
Optimism introduces Collective Intents, a new way for its ecosystem to align on its short-term goals. For Season 4, the intents include progress towards decentralization, innovate on novel applications, spread awareness of the Optimistic Vision, and increase governance accessibility. Optimism has proposed allocating 11 million OP for Season 4 Intents.
In line with Collective Intents, Optimism’s Token House has introduced Token House Missions. The Missions help Optimism achieve its Intents, and must be completed within one season. The Mission structure is an alternative to the working group model found in most DAOs. Missions can be proposed by a group of contributors, called an Alliance, or these Alliances can apply to accept a Mission pre-defined by the Optimism Foundation.
🗳️ Active Votes
💬 Proposals in Discussion
Arbitrum:
Optimism:
Polygon
📈 Data
Total Value Locked on L2s is nearly $10 billion!
Top ten projects by Total Value Locked:
🔭 Project Watch
Arbitrum
New projects joining the Arbitrum ecosystem:
Optimism
Top NFT collections:
Top projects by TVL in the last seven days:
What projects are users flocking to?
Velodrome Finance Upcycles the DEX
The Curve and OlympusDAO-Inspired AMM Is on Track to Finish First in the DeFi Race
Author: HiroKennelly
If you’ve ever watched indoor bike racing, you’ve seen Velodromes: those beautiful race tracks with banked sides at the turns, made so that cyclists can focus on racing – speed, tactics, desire – rather than on steering. A velodrome is a race track designed and optimized for a single purpose: make cyclists the best racers they can be.
Velodrome Finance is doing the same thing for DeFi users and protocols as a velodrome does for cyclists: providing an arena where crypto enthusiasts, traders, and builders can do their best work without worrying about things like high slippage, poor liquidity, and misaligned incentives. How does it do this? By combining two of the best elements of DeFi: Curve Finance’s time-locked voting (ve) and the game theory incentivization engine created by OlympusDAO (3,3). Best of all, it’s built on Optimism, a rollup-powered Ethereum scaling solution that enables users to access DeFi for a fraction of what it costs on Ethereum Mainnet.
How Velodrome Works
At its core, Velodrome is an Automated Market Maker, which means it was created to enable the swapping of digital assets. Uniswap may be the most famous of the AMMs, but there are many others. Anyone who has traded digital assets in pools without sufficient liquidity knows that slippage can eat into purchasing power, sometimes in amounts that leave us a bit shaken. Velodrome set out to solve the issue of how to incentivize liquidity in a way that is productive, sustainable, and aligned with the long-term success of Velodrome and its users, whether they be traders or other protocols.
The concept behind Velodrome was first proposed and developed by DeFi legend Andre Cronje through the Solidly project. Solidly was a DEX built on the Fantom blockchain, and it made use of both the vote-escrow model pioneered by Curve Finance and the staking/rebasing/bonding model developed by OlympusDAO. Andre Cronje coined the mechanics ve(3,3), but left the project shortly after launch, and it soon failed.
The Velodrome team previously launched veDAO to work within Solidly. They took the most successful parts of the Solidly ve(3,3) model and improved on the parts that didn’t work well in practice; specifically they started tying rewards to emissions and prolonging emissions decay. You can read about the improvement on Solidly in Veledrome’s docs. These improvements to the model have proved successful, as roughly a year after launch, Velodrome is far and away the most successful AMM on Optimism.
Velodrome makes use of two native tokens, VELO and veVELO, and its liquidity pools come in two types, those that are made up of like assets, such as pools that contain only dollar-denominated stablecoins, and those that contain more volatile asset pairs, such as wETH and a governance token, like OP. This method reduces the chance of experiencing negative slippage. But even more important than the pool division is Velodrome’s tokenomics model.
Protocol Emissions and Rewards
The tokenomics models derived from Curve and OlympusDAO work together to incentivize the flow of assets to the most valuable liquidity pools. To do this, Velodrome rewards users in four ways: token emissions, protocol fees, bribes, and rebases.
In terms of token emissions, VELO is paid out to liquidity providers to offset impermanent loss and provide yield on deposits. This is standard practice across DeFi. What is not standard practice is that these rewards are determined by veVELO holders, meaning VELO distribution to each pool is proportional to the number of votes that pool receives during each epoch.
To receive veVELO, VELO holders must time lock their tokens. Users who lock 100 VELO tokens for one year will receive 25 veVELO, while those who lock up VELO for 4 years will receive 100 VELO, a 1:1 ratio. To incentivize users to lock up their tokens, veVELO holders are entitled to protocol fees, voting rights, bribes, rebases.
- Protocol fees are basically trading fees, and these fees are streamed to veVELO holders in the pool’s native trading pairs, meaning that an USDC/OP pool will pay out USDC and OP to veVELO holders who voted for that pool to receive emissions.
- Voting rights are valuable because it’s these holders who determine the liquidity pool emissions.
- Bribes are rewards paid by a third party to incentivize a veVELO holder to direct emissions to a particular pool. Bribes are only paid out to those who voted to direct such emissions in proportion to their share of overall votes in a given pool.
- Rebasing fees are additional veVELO tokens paid to current holders in order to reward long-term stakers by offsetting the dilution in their voting power that occurs with additional token emissions.
In practice, this design incentivizes veVELO holders to vote for pools which they think will entitle them to the highest protocol fees and bribes, and they are also betting that others will do the same, because it’s in their own self interest to do so. Assuming everyone is acting to maximize their self interest, more VELO tokens will be allocated to those liquidity pools, attracting more liquidity and thereby reducing slippage. With reduced slippage, more trades will occur which will generate more protocol fees. And we’re back to the beginning of the flywheel.
Finishing First
ve(3,3) is proving to accomplish for DeFi participants what a Velodrome does for cyclists – it gives DeFi users and projects an arena to try out some of the best DeFi building blocks without losing focus on their core pursuit, whether that is earning fees or attracting liquidity. Directing VELO emissions to liquidity providers, designing a system than optimizes for low-slippage trades, giving vested community members 100% of trading fees and bribes plus additional voting power, and providing a platform that enables projects to attract liquidity through offering incentives is the antidote for the problems facing many AMMs.
Creating products that align the interests of users, protocols, and a platform is one of the great challenges in crypto, but Velodrome reminds us that if you build a great track, the racers will come find you. And in this case, they will be well rewarded for not only putting in the training, but just showing up for the race.
🗞️ Ecosystem Updates
⛓️ Two Weeks Ago, On-chain Volume on Arbitrum Surpassed Ethereum.
🤣 Memes
