Yearn Finance, a leading DeFi yield aggregator, is set to introduce a transformative veToken model for its native governance token, YFI. This upgrade aims to strengthen the alignment between long-term token holders and the protocol's success by leveraging vote-locking and vault gauges. Here’s a detailed look at how this new system works and its potential impact.
Understanding Yearn and YFI
Yearn Finance manages around $500 million in assets through its yVaults, which execute dynamic, community-developed yield strategies across DeFi. While initially driven by individual users, Yearn’s partner program has made other protocols a significant part of its user base.
YFI was launched in mid-2020 via a "fair launch" liquidity mining event, distributing all 30,000 tokens to liquidity providers without any pre-mining for developers or early supporters. Since then, YFI holders have governed the platform through Yearn Improvement Proposals (YIPs) and have rights to protocol earnings.
Key changes in 2021 included:
- A new fee structure for yVaults: 2% management fee and 10% performance fee.
- A shift from staking rewards to buybacks (YIP-56: Buyback and Build Yearn, or BABY).
- An increase in total YFI supply by 22% to 36,666, with one-third allocated to contributors and two-thirds to the treasury.
These changes enabled Yearn to build a treasury and use earnings for YFI buybacks, with $22.4 million used so far to acquire 1,111 YFI (about 3% of circulating supply).
The New Tokenomics Model: veYFI
YIP-65, passed in late 2021, outlines a four-step plan to enhance YFI tokenomics:
- Staking vault (xYFI): Distribute bought-back YFI to vault stakers.
- Vote-locked YFI (veYFI): Implement Curve-style vote-locking, where voting power and rewards depend on lock duration (up to four years).
- Vault gauges and voting: Use gauges to allocate YFI rewards based on veYFI holder votes, with incentives for yVault depositors.
- "Useful Work" functions: Expand veYFI’s role to include protocol-controlled rewards and compensation.
Development has progressed directly to Step 3, integrating elements from all steps.
How veYFI Works
Holders can lock YFI for veYFI, with weights linear to lock duration (e.g., 100% weight for four years). Locked YFI is non-transferable, but early exits are possible with a penalty:
- 75% penalty if remaining lock duration exceeds three years.
- Proportional penalty otherwise (e.g., 25% penalty for one year remaining).
veYFI holders receive:
- Governance rights, including veto power and gauge voting.
- Rewards from bought-back YFI and early exit penalties.
- Boosted yields on yVault deposits and gauge rewards.
This system incentivizes long-term alignment, as larger and longer locks increase governance influence and reward share.
Gauge Weights and Boosts
Every two weeks, veYFI holders vote to distribute protocol earnings (buyback YFI) among vault gauges. Depositors can stake yTokens in gauges to earn rewards.
Boost calculations use Curve’s formula, with a maximum 10x boost (vs. Curve’s 2.5x). The boost determines the share of rewards retained by stakers:
- No veYFI lock: 1x boost → 10% rewards retained.
- With veYFI lock: 5x boost → 50% rewards retained.
- Maximum 10x boost → 100% rewards retained.
Rewards not retained are distributed to veYFI lockers.
Additional Applications and Developments
YIP-66 simplifies contributor compensation using veYFI locks, replacing vesting contracts and performance fees with locked YFI based on commitment duration. This aligns incentives for strategists and other contributors.
Future "Useful Work" ideas include using veYFI for insurance provision, vault parameter configuration, and fee setting, further integrating community contributions.
Potential Impact and ecosystem Dynamics
DAO Treasuries and veAggregators
Large depositors like Alchemix have already voted to lock YFI for veYFI, aiming to maximize boosts. The 10x boost opportunity cost may drive many users to veAggregators and bribe protocols, similar to Curve’s ecosystem.
Simulations suggest:
- With 50% of circulating YFI locked (18,333 YFI) at an average three-year duration, veYFI supply would be ~13,750.
- Annual buybacks of 1,193 YFI could yield ~8.7% APY for lockers, excluding penalties and bribes.
- Protocols like Alchemix could achieve 23% APY on locked YFI by maximizing boosts.
veAggregators and Bribes
The high boost opportunity cost will likely foster a robust veAggregator ecosystem. While Yearn won’t whitelist aggregators, one dominant platform may emerge due to vote-locking dynamics.
Bribe protocols could become a major income source for lockers without deposits, particularly from large depositors seeking gauge votes.
Risks and Considerations
- Reflexivity: TVL declines could reduce earnings and YFI buybacks, creating a negative feedback loop. However, Yearn’s established role may mitigate this.
- veAggregator dependence: Dominant aggregators could introduce external risks and shorten alignment horizons from years to weeks.
- Bribes and governance: Expanding veYFI’s scope to vault parameters might exacerbate principal-agent problems if bribes influence decisions.
- Earnings distribution: Allocating cash flow early may hinder growth investments in a rapidly evolving industry.
Conclusion
Yearn’s veToken model represents a significant shift from value capture to value creation. By incentivizing long-term commitment and integrating community contributions, it aims to enhance protocol utility and YFI value. While risks exist, the potential for a win-win outcome for Yearn and its stakeholders is substantial.
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Frequently Asked Questions
What is veYFI?
veYFI is vote-locked YFI that grants governance rights and reward shares based on lock duration. It aligns holders with Yearn’s long-term success.
How do gauge boosts work?
Boosts increase the share of rewards retained by yVault depositors. A 10x boost allows 100% reward retention, while lower boosts distribute unused rewards to veYFI lockers.
What are the risks of veYFI?
Key risks include early exit penalties, dependency on veAggregators, and potential governance influence from bribe protocols. Long-term locks are essential to maximize benefits.
How does Yearn’s model differ from Curve?
Yearn uses protocol earnings (buybacks) for rewards instead of emissions, offers a 10x max boost (vs. 2.5x), and focuses on yield aggregation rather than DEX operations.
Can small depositors benefit from boosts?
Yes, but achieving high boosts requires significant veYFI locks. Smaller users may benefit through veAggregators that pool resources for better rewards.
What is the future of veYFI?
Future developments may include "Useful Work" functions like insurance and parameter setting, further integrating veYFI into Yearn’s ecosystem.