What is Aerodrome Finance - The driving force behind Base TVL?

Introduction

In the ever-evolving DeFi landscape, where innovation is the currency and competition is the driving force, the Layer 2 war rages on. DeFi enthusiasts and blockchain aficionados find themselves at the forefront of this dynamic battle, where solutions are forged, ecosystems are fortified, and the very foundations of decentralized finance are redefined.

The Layer 2 war is a battle of protocols vying to provide scalable, efficient, and cost-effective alternatives, ensuring that DeFi is not confined to the select few but accessible to all. Base is an L2 Optimistic rollup, developed by Coinbase, one of the major CEXs in the industry.

Aerodrome, an emerging name on the Base system, has just attracted the attention of the community as it is leading in the Total Value Locked (TVL) after only 24 hours of launching the $AERO token. Accumulating over $190 million in TVL within just a week of its launch has made Aerodrome the largest project on the Base chain and has doubled the TVL on this platform.

This article embarks on a journey into the heart of the Layer 2 war, where we encounter Aerodrome Finance, unraveling its core functions, tokenomics, and the profound impact it brings to the broader DeFi landscape.

What is Aerodrome Finance?

To grasp the concept behind Aerodrome, we must first delve into its origins, which can be traced back to Velodrome, a prominent protocol and liquidity hub on Optimism's Layer 2 chain.

Velodrome (VELO) emerged as a fork of Solidly, a well-known project developed by the “Dad of DeFi” - Andre Cronje. It aimed to combine elements from Curve Finance's vote-escrow model and OlympusDAO's (3,3) game theory to establish a liquidity hub for the entire blockchain without the poor execution of Solidity. Today, Velodrome stands as the largest protocol on Optimism, representing more than 24% of the chain's TVL. If you want to know more about Velodrome, check out Chainslab’s article here.

Back to Aerodrome, the twin brother of Velodrome.

Aerodrome is a ve(3,3) AMM DEX forked directly from Velodrome with the goal of becoming the main liquidity center on Base. It draws inspiration from the Velodrome V2 model to incentivize liquidity within the protocol.

• The protocol is designed to facilitate token exchanges and generate fees (from Traders) by attracting liquidity.
• After each Epoch, liquidity providers (LPs) receive $AERO tokens through the Emission mechanism, distributed proportionally to their shares in the Liquidity Pools.
• Participants can lock $AERO to vote in the next epoch and become veAERO voters.
• veAERO voters are rewarded (in proportion to the number of tokens locked) for their votes with 100% of the protocol's transaction fees from the previous period or any other incentive activities.

In simpler terms, users lock their $AERO tokens to receive veAERO, participate in voting pools, and receive corresponding rewards according to the emission schedule.

Aerodrome was launched on August 28, 2023, on the BASE network. Currently, the $AERO token has been launched and the process of distributing AERO rewards to Liquidity Providers (called Emission) is underway.

What Velodrome itself has done is that it is currently leading the Optimism system with more than $300M Total Value Lock (TVL). Aerodrome inherits the latest features from Velodrome V2.

AERO and veAERO:

The core of Aerodrome's ecosystem is the AERO token, which functions as both a utility and governance token. AERO holders can opt to lock their tokens in a vote-escrow mechanism for up to four years, receiving a veAERO Non-Fungible Token (NFT) that represents their commitment. The voting power granted to users is determined by the amount locked and its duration, following a linear relationship. To mitigate dilution from token emissions, veAERO holders also receive a weekly rebase corresponding to the emission rate and the amount of AERO they have locked.

As holders of veAERO NFTs, users can participate in weekly voting to influence the allocation of AERO emissions to specific liquidity pools. In return, these voters receive 100% of the trading fees generated by the pools they supported.

Bribes and Liquidity Incentives:

External protocols seeking to boost specific pools can also incentivize users to vote for these pools by offering additional token incentives, often referred to as "bribes." For instance, a newly launched protocol may use bribes to encourage liquidity provision for its token on a particular pool. These incentives can be provided in any of the supported tokens on Aerodrome. This mechanism allows protocols to generate more than $1 of liquidity for every $1 spent on bribes.

Currently, Aerodrome allows AERO holders to engage in token swaps and provide liquidity. The platform hosts over 100 pools and lists 31 different tokens.

AERO holders also have the option to lock their AERO tokens for veAERO NFTs, with lock durations of up to four years. This enables them to participate in the liquidity pool voting process. Additionally, the bribe system is open for deposits, allowing users and protocols to incentivize specific pools.

Aerodrome Tokenomic & Emissions

Tokenomic

Aerodrome's tokenomics were designed to ensure a fair token launch without pre-sales or external investors. The total token supply amounts to 500 million tokens, with 450 million allocated as veAERO.

The largest share of AERO tokens has been distributed to veVELO lockers, recognizing their contributions to the Optimism and Velodrome ecosystems, as well as their expertise in DeFi. 40% of the AERO total supply has been airdropped proportionally to veVELO lockers in the form of veAERO, enabling them to participate in liquidity pool voting.

Similar to Velodrome, Aerodrome allocates 21% of the supply to Ecosystem Pairs and Public Goods and 10% to Protocol Grants. An additional 5% is allocated to incentivize AERO liquidity pools to maintain adequate liquidity for the AERO token.

The team allocation constitutes 14% of the total supply, with a lock-in period ranging from two to four years.

The remaining 10% of the supply allocated to AERO will be distributed, with 8% allocated to voter incentives, used to match ecosystem protocol incentives or attract votes to crucial pools. The final 2% will be assigned to the genesis liquidity pool, initially paired with USDC.

AERO Token Emissions:

Regarding token emissions, Aerodrome plans to initiate weekly emissions at 10 million AERO, with a 3% increase each week during the first 14 weeks to encourage rapid protocol growth. After week 15, this emission rate will gradually decrease by 1% per week to reduce overall token inflation over time.

Ultimately, the protocol's monetary policy is designed to be controlled by veAERO voters, akin to how Velodrome's veVELO voters operate. This transition is expected when emissions drop below 9 million tokens per week, estimated to occur in the 67th week following the launch. Voters will have the authority to vote on maintaining current emissions or making slight adjustments by 0.01%.

Final Thoughts

Since its official Mainnet launch on August 9, 2023, Base has emerged as one of the most dynamically active ecosystems in the current market. Base is now in 4th place in terms of Layer 2 TVL, holding nearly $400M. Despite its recent inception, the Base ecosystem has already captivated over 100 projects and dApps in its development and growth journey. The hype is real with Friend.Tech and Aerodrome, and will likely continue.

On the other hand, Aerodrome itself is an interesting project, and so does the “Drome System”. IMHO, the ve(3,3) model will likely take over the DeFi landscape in the next bull run, with the “Drome” ecosystem leading the pack. My guess is the Drome will move on to other ZK ecosystems like zkSync or Validium ecosystems like Polygon 2.0.

Eventually, the key problem faced by decentralized exchanges is that rewards emissions are tied to total liquidity, rather than to trading volume, which generates fees for the protocol. The reward must come from real trading activities, AKA real yield. If one can address this problem, it will surely succeed in the future.

Such features create a flywheel of liquidity, as users are attracted to rewards, purchase more tokens, and keep the platform running by continually voting on which project’s tokens to support, add, and further reward.

And the approach of Velodrome or Aerodrome seems to be working pretty well so far.