The previous posts in this series covered both the qualitative and quantitative components of token value. These two components may be weighted differently by investors but are both equally important to understand and use to your advantage as a founder when trying to raise funds or promote your product’s strengths.

This piece will be taking a look at how all these data points can be utilised to evaluate one of the most popular and well known DeFi protocols Sushi Swap, and its governance token $SUSHI. Although we will be looking at what gives the $SUSHI token value, none of the information in this article is financial or investment advice. It is purely educational and aims to demonstrate how the information in the previous articles can be utilized when evaluating a project or token by investors.

Sushi Swap Case Study

Sushi Swap is a popular cross-chain decentralized exchange that lets you swap a vast array of tokens in a permissionless manner. It has no centralized authority and relies on smart contracts written in code to automate the process of buying and selling tokens. Sushi Swap was originally a fork of Uniswap and has grown to be one of the biggest decentralized exchanges (DEX) in the DeFi space.

We have chosen to analyze Sushi Swap for this case study for a few reasons:

1. Sushi Swap is an established, respected protocol with genuine users and real revenues.

2. Sushi Swap’s governance token $SUSHI has revenue distribution via a buy-back and distribute mechanism.

3. Sushi Swap has clear competitors to compare its metrics against.

4. Sushi Swap and the $SUSHI token have one of the largest historical data sets in the DeFi space.

Note: Sushi Swap has been conducting a governance vote to alter the token design for the $SUSHI token. None of this has been taken into consideration for the below analysis as the final design has not been decided upon by the community. To read more about the proposed token design changes, please see this governance forum discussion.

Qualitative Components

Community size

A loyal and vocal community is a key aspect to driving value to a token, whether this is for speculative reasons or with the goal of having high governance participation. Sushi Swap has in excess of 340,000 community members across Discord and Twitter alone. This amount of community members is substantial in the current landscape of decentralized exchanges, however work can still be done to increase the Sushi Swap community size via marketing and educational materials.

Unique token holders

The SUSHI token is held by over 217,000 unique wallets across Ethereum Mainnet, Polygon, Avalanche, Arbitum, BNB Chain and Fantom. With over 110,000 unique wallets holding SUSHI on Ethereum Mainnet alone.

One important factor to look at is that the amount of unique wallets is increasing on all blockchains. This is an important metric as it shows the SUSHI token is gradually dispersing into more hands, which will help to decentralize the protocol over the long term.

Source: Nasen – Ethereum unique SUSHI holders

Narrative

Narratives are something that are generally created organically within the market and its participants. As you can see in the chart below from Luna Crush depicting Sushi Swap, there is no clear relationship between the social media spikes (orange and blue lines) over a 3 month period and large price changes (green line).

It is not surprising however that social media engagements are low when the price is at its lowest and they pick up when price increases. This is just human nature of market participants getting excited by seeing the price of the asset they are holding increase, it is important to use this momentum for any marketing and announcements in relation to the future of the protocol.

Source: LunarCrush

Product and Token

Arguably the largest factor in token value derived from qualitative components is to do with the product, its future utility and how the token utility integrates with the product and captures value as success increases.

This area is the easiest to control by the team, building out a suite of products that solve a pain point for users, capturing value with the token and ensuring the user experience is as smooth as possible is imperative to your token value.

Looking at Sushi Swap through this lens we see a couple of things, some good, some not;

• Sushi has a TVL of around $500M, this is substantially less than its competition and leads to only 3% of the AMM market and 0% of the DEX aggregator market being captured.

• Sushi’s governance token, when staked as xSUSHI, captures value generated by the protocol which is distributed back to stakers in the form of more SUSHI tokens. This in turn captures more speculative value as this value capture mechanism will scale with the product as Sushi Swap grows and their product suite is innovated upon.

• Sushi Swap offers a range of products that their competition doesn’t. This range of products all drive value to the SUSHI token through the xSUSHI staking mechanism.

• Sushi Swap offers a standard UX with a familiar UI that DeFi users have come to expect from a decentralized exchange.

• The SUSHI token has no major remaining lock-ups or a large amount of token emissions remaining, this allows those valuing the token to know that there will be no large circulating supply increases in the future.

Quantitative Components

TVL

TVL is one of the most important metrics for an AMM. Liquidity is everything when it comes to trading and attracting meaningful DEX aggregator volume in the highly competitive space. This is even more important now that concentrated liquidity market makers (CLMMs) have been developed, resulting in liquidity being much better utilised around the current price of a token.

Sushi Swap has a TVL of ~$440M across the 26 networks it is deployed on. In comparison to its competitors, such as Uniswap, Balancer and Curve which have $3.97b, $1.05b and $3,75b in TVL respectively. This lack of TVL and thus trading volumes impacts Sushi Swap as newer AMMs such as Balancer have surpassed Sushi Swap in both metrics.

Amount of users

Tracking the amount of users gives an indication of product market fit and adoption of the product. It would be expected that as the product matures, innovates and finds PMF the amount of users per week would increase also which would signify healthy adoption of the product and ideally drive an increase in revenues.

In the case of Sushi Swap this has not been the case. The amount of daily active users has been robust, even increasing since the ‘crypto winter’ of mid 2022. However, although Sushi Swap has seen an increase in the monthly average of daily active users since October 2022, revenues have not followed back to the previous highs seen in 2021. This could be due to multiple reasons, such as the average user of Sushi Swap is trading smaller position sizes and more users using DEX aggregators which may only route a small amount of the trade through Sushi.

Source: Token Terminal

*Purple represents the monthly average daily active users

*Green represents the monthly revenue captured

Revenues

As shown in the Token Terminal image above, Sushi Swap revenues have reduced from a monthly high of $14.1M in May of 2021 to a miniscule figure of $156,600 with an overall trading volume of $317M in June of 2023. Some of this may be attributed to the decline in overall market trading volumes, however, compared to competitor Balancer which managed to generate June 2023 monthly revenues over $378k from over $3.56b in trading volume.

Source: Token Terminal

MC/TVL (fully diluted)

With a ratio of MC/TVL it is important to compare the metrics to competitive applications to get a gauge of how they compare in relation to one another. When comparing Sushi Swap, Curve, Balancer and Uniswap we get the following ratios:

Balancer: 0.19

Sushi Swap: 0.28

Curve: 0.19

Uniswap: 0.99

These figures can be interpreted in different ways. It could be interpreted that the lower the MC/TVL ratio, the more undervalued the token is compared to its competitors or it could be seen that the higher the MC/TVL ratio, the more the token captures the TVL value of that DEX.

P/S

A price to sales ratio is derived dividing the fully diluted market cap with the annualized revenues. This ratio shows how a project is valued in relation to its revenues generated, which can then be compared to companies in the same industry. These revenues are then ideally captured by the token and result in a positive perception of token value.

When comparing the same four dominant AMMs we get the following ratios:

Sushi Swap: 66x

Curve: 112x

Balancer: 58x

Uniswap: –

Note: All of Uniswaps fees go to liquidity providers, none are captured by the token.

As shown by the P/S ratio of the above DEXs, it is clear that Curves CRV token is priced much higher than its counterparts. This could be interpreted as Sushi Swap and Balancers tokens being undervalued, CRV being overvalued or even that Curve is valued as a more important piece of infrastructure and warrants the P/S ratio it has. This could also be the case for Uniswap, which gives 100% of its trading fees to liquidity providers, thus doesn’t have a P/S ratio.

DCF

Previous attempts at DCF analysis on cryptocurrency tokens have primarily focused on infrastructure and network tokens, such as Bitcoin, with a focus of cash flows being on the increased use of that network. With the emergence of DeFi and revenue producing protocols that distribute a portion of these revenues to token holders, we can now attempt to conduct DCF on these assets.

The artform with DCF analysis is accurately assuming the variables, such as the growth factor year-on-year and the discount rate. These assumptions are made even more difficult due to the lack of historical data in the cryptocurrency markets, infancy of DeFi and decentralised exchanges along with the high volatility experienced during the notorious ‘crypto cycles’.

For the purpose of this monetary experiment the following logic has been applied to assume the discount rate and the growth rate:

• Discount rate: Historically, when completing DCF on an immature and early stage company one must discount that future cash flow to be in line with the risks associated with investing in early stage start-ups. With this in mind, a discount rate of 30% has been applied to account for the risks associated with attempting to predict future cash flows of an early stage DeFi protocol.

• Adoption rate: As one of the assumptions which has a large impact on the results of the DCF, the adoption rate was the most crucial yet difficult parameter to assume. With the lack of historical decentralised exchange volumes and revenues the comparison was made between historical centralised exchange volumes over a cycle and decentralized exchange volumes. Three different scenarios were assumed, one bearish, one neutral and one bullish in regards to adoption.

• Assumptions were made in the following order:

1. Historical CEX volumes were calculated from 2017 to 2022. The CEX volumes were then extrapolated out using ‘bull’, ‘neutral’ and ‘bear’ assumptions. These assumptions followed the historical 4-year crypto cycle.

2. Historical DEX volumes were calculated from 2020 to 2022. The DEX volumes were also extrapolated out using the same ‘bull’, ‘neutral’ and ‘bear’ assumptions. Although the DEX Y/Y volume data is extremely limited, it is clear that decentralized exchanges were capturing an increasing amount of volume market share from their centralized counterparts, which saw a 0.76% capture of market share in 2020 and a 10.62% capture in 2022.

3. The volumes of both CEX and DEX were aggregated and extrapolated out, with an assumption that decentralized exchanges continue to gain an increase in market share at the expense of centralized exchanges.

   1. This increase in market share can be seen in the % DEX Share of Aggregated Volume box, which shows DEX market share assumptions using the same ‘bull’, ‘neutral’ and ‘bear’ assumptions.

4. In regards to Sushi Swap specifically, assumptions were made on how much of this volume and market share increase Sushi Swap captured. The historical data shows Sushi Swap rapidly losing market share of DEX volumes, from 10% in 2021 to 4% in 2022. This decline continued, with Sushi Swaps total share of DEX volumes falling to 0.5% in 2027.

Due to the unique nature of monetary policy involved with DeFi capital assets some adjustments to the traditional formula must be made,  the DCF formula is as follows:

DCF=i=1nRevenuei-1AdoptionRateiCirc.Supplyi11+0.3i

Where:

• Revenues = 365d trading volumes sourced from Dune query. These volumes are then multiplied by the 0.05% fee that directs revenue to xSUSHI stakers. Resulting in the revenue that accrues to the token.

• Adoption rate = See above

• Circulating Supply = Total circulating token supply for that year of the DCF.

*n = *Year of DCF, i.e. year 5 will be ^5.

This equation may open up some debate whether it is correct or not, however for crypto capital assets some adjustments must be made to the traditional way of conducting a DCF. For example in the following portion of the equation, Revenuei-1AdoptionRateiCirc.Supplyi it is important to capture the circulating supply of tokens being emitted into the market over each given year. These additional tokens will dilute the future cash flows of the current token, thus must be considered in the equation.

The following discounted cash flows were conducted on the Sushi Swap protocol with different rates of adoption.

**Bearish: **

**Neutral: **

**Bullish: **

SUSHI price chart for reference:

*Source: *Defi Llama

Conclusion

This token value case study has covered a variety of influential factors that must be considered when trying to understand what gives a token value. Not all of these metrics will be applicable to all super assets, as covered in the first part of this series.

It is expected that the future of the super asset class we see in web3 will continue to be valued in an increasingly sophisticated manner. This is only natural as more money and investment flows into the space by larger and more sophisticated institutions.

The above case study on Sushi Swap has shown that Web3 is extremely cyclical and the metrics that are seen at each stage of the cycle give an entirely different picture. As a founder, it is important to remember that the cyclical nature of the industry, along with rapid innovation will mean that surviving multiple cycles is the key to long term success. It is important to build a rainy day fund when times are good that will allow you to out innovate when times are tougher.

It is important to understand that none of these metrics can be used in isolation to value tokens and should not be construed as financial advice. This series was written to educate on what aspects can be considered as giving a token value rather than assigning a particular value to a token.

It initially started with liquidity mining, where protocols would incentivize mercenary liquidity by offering out emissions of their governance. This did indeed attract liquidity, some pools even received significantly deep liquidity…for a short time. However this liquidity can decide to pull their LP, withdraw and walk away after dumping all of the governance tokens they earned to try and cover their IL.

Liquidity mining is expensive for the protocols, damaging to the governance token price and results in nothing positive being captured when the big bad bear comes and liquidity dries up.

Enter OlympusDAO. Olympus knew liquidity mining was expensive, damaged the token price and resulted in liquidity that evaporated at the first sign of a better deal. Knowing this they tried to at least get something out of it that they could keep. By buying (instead of renting) their liquidity off market participants in exchange for enormous emissions of their governance token they were able to own 99% of their own liquidity, that wouldn’t just disappear when the next fork appeared and offered even more ridiculous APY. This model is still extremely expensive to the protocol (in regards to emitting governance tokens) and absolutely wrecks the token price but they will forever own that liquidity.

With the first two steps of solving the liquidity problem in DeFi we have got warmer, but it is still expensive and destroys the token price. We still have a long way to go.

Enter Liquity Protocol and Chicken Bonds.

This new concept proposed by Liquity in July ’22 is extremely confusing, but once the penny drops it is an interesting proposition that could solve the POL problem.

So how does it work?

The first thing to understand is the three ‘buckets’:

1. The pending bucket — This is where a depositor’s funds go when they first bond to the protocol. These funds are invested by the protocol in ‘safe’ DeFi pools that incur no impermanent loss. This is important because at any stage the bonder can withdraw their initial amount and walk away aka ‘chicken out’, only suffering opportunity cost and smart contract risks.

2. The reserve bucket — The reserve bucket is the bucket that is the most important to all the actors interacting with the system. This is the bucket that all of the yield generated by the bonding process will flow into and will produce the amplified yield.

3. The permanent bucket — This is the bucket that is owned by the protocol. The bonders will not have any claim to these funds, however the yield generated by them will flow to the reserve bucket.

The process:

A user can bond any amount of TKN (token) at any time in exchange for a position called chicken bond which is represented by an NFT. The bonded TKN is then added to the pending bucket and earns yield for the system’s reserve bucket.

A chicken bond accrues a virtual balance of bTKN (boosted token) over time, according to a curve that asymptotically approaches a “cap” ensuring the redemption price never falls.

As a depositor sits in the pending bucket they are slowly accruing a portion of bTKNs, this means that they have to wait until it is profitable to either ‘chicken in’ and claim their bTKNs or ‘chicken out’ and walk away with their principle only, forgoing the yield that has been earned on their funds in the pending bucket. In both cases of ‘chicken in’ or ‘chicken out’ the NFT is burned and the funds are either sent to the protocol or returned to the user.

It is also possible for the NFT to be sold on a secondary NFT market and the buyer has the same rights against the protocol as the original bond holder.

If the depositor decides to ‘chicken in’ their funds are split between the reserve bucket and the permanent bucket. They will then receive their position of bTKN that had accrued during their time in the pending bucket.

The holder of bTKN has a few options, they can either sell it on an AMM through a bTKN/TKN pool or they can redeem for the underlying TKNs within the reserve bucket. As all the yield from the pending, reserve and permanent bucket accrues to the reserve bucket and thus the bTKNs, the bTKN will index higher and higher against the price of TKN allowing the holder of bTKN to redeem more TKN as time goes on.

This is where the game theory begins.

It is profitable to bond when the amount of bTKNs earned is enough to break even on your investment (this takes a long period of time, up to to 20 weeks in the below example) via redemption from the reserve bucket or the secondary market price of bTKN is high enough to bond and sell through the liquidity pool.

Bonding is only profitable if pf > pr (fair price > redemption price).

Game theory conundrum:

If you sit in the pending bucket for too long waiting for your bTKN amount to increase to a level where you can break even on your investment and ‘chicken in’ you miss the opportunity to potentially sell your bTKN through the liquidity pool and compound your position. You are also incurring opportunity cost risks while you wait. You can always ‘chicken out’ and walk away with your principle, forfeiting the yield that has been generated off your funds which raises the floor of bTKNs for everyone else.

If you ‘chicken in’ too early, you receive less bTKN. This means that you will have to wait longer for the amplified yield to accrue to your bTKNs to break even via redemption, however you could make use of a high bTKN/TKN price and exit via the liquidity pool and potentially compound your position.

As it will be profitable for people to buy and hold the bTKN (due to the amplified yield) from the bTKN/TKN liquidity pool, the price of bTKN should trade at a premium to TKN. This will then entice the people sitting in the pending bucket to ‘chicken in’ early so that they can sell their bTKNs on the secondary market to then rebond and do the whole round again. As people chicken in early, more of the bonded tokens are in the permanent bucket rather than the reserve bucket. Meaning the protocol is owning more and more liquidity.

The chicken bond mechanic also has the option to take a fee off each position that decides to ‘chicken in’ (instead of sending it to the permanent and reserve buckets) and direct this to incentivise the bTKN/TKN liquidity pool to attract LPs with sustainable yield and increase the depth of this pool, thus allowing bigger actors to compound their position with rebonding.

This flywheel effect of people bonding tokens to then sell their bTKN for a profit through the liquidity pool amplifies the yield generated by the pending, reserve and permanent buckets. This in turn increases the backing of bTKN to TKN through redemptions further incentivising actors to join in on the system due to a higher APY.

The optimal re-bonding time is explained in the white paper through some complex mathematical equations, but essentially when the amount of bTKNs earned is enough to ‘chicken in’ and either redeem from the reserve bucket or sell through the liquidity pool for a profit.

Due to these game theory mechanics bonders will be trying to front run one another into compounding their positions or exiting the ponzi all together. All of this impatience results in more of the bonded TKN flowing to the permanent bucket. This will allow the protocol to build more and more POL at no expense to them or their token holders through inflation or other expensive measures.

Where does the yield come from?

If you can’t explain the yield, you are the yield.

In the case of chicken bonds the people who ‘chicken in’ and ‘chicken out’ before and after you are the yield. The protocol could bootstrap the yield generation by bonding a large amount of TKNs but never ‘chicken in’ essentially resulting in them giving away that yield to the subsequent bonders that come after them.

This is just one giant POL creating ponzi where the last person will have to wait the longest to break even.

If you are the last person to bond, you can either ‘chicken out’ and receive your principal back or you ‘chicken in’ and have to wait for the yield amplification to increase the ratio of bTKN/TKN for you to redeem and exit.

Building ponzis is a specialty of DeFi. However this particular ponzi is too complex for anyone other than the most experienced DeFi actor. This will allow those people to take advantage of late comers to profit off their funds and inexperience. Although even if you’re late to the party, you can wait out the storm underwater until the sky clears out and eventually leave with your initial funds.

Chicken Bonds in theory allow the protocol to bond their own POL at no cost to them (apart from giving away the yield generated from their owned POL), however I think it’s too complex for the average DeFi participant to understand and will limit its growth. I will keep an eye on it for some good arbitrage opportunities especially as LUSD bonds will be the first to be implemented.

This piece outlines proposed mechanisms to eliminate these issues and return vote-escrow back to completing its initial vision of rewarding loyal supporters, facilitating governance and paving the way for more decentralisation.

ve_v2 aims to do this by leveraging some of the following mechanisms:

1. RageQuit

2. Base protocol liquid staking

3. Loyalty boosts

4. Reward token vesting

5. ve(3,3)

ve_v2:

1. RageQuit:

One central feature of the ve_v2 token design, pioneered by MolochDAO, is the RageQuit feature. RageQuit allows lockers to exit their lock early if they are dissatisfied, or their long term evaluation of the project changes, for a haircut of course. This allows disgruntled lockers to leave who may be harming governance decisions or not contributing like they once were. RageQuit will also lower opportunity cost risk for those who may decide they are prepared to commit to an extended lock at the beginning, but know they can exit in the future.

Some ideas for a RageQuit feature are:

• Decaying penalty for RageQuit the longer that the user has been locked. This punishes those that wanted to leave early in their lock; it is less of a punishment for those who have stuck by the protocol but may have other priorities now.

• Tokens deducted when a user RageQuits are distributed to remaining lockers equal to their % of the ‘ve’ stake. This rewards the more loyal lockers with tokens of those who have exited their position early, lowering the rate of dilution and rewarding them for their loyalty at no extra expense to the protocol.

Adding a RageQuit feature to the current ‘ve’ design solves some of the obvious pitfalls with the current system; specifically:

• Lockers will be able to exit their position if they wish, weeding out less loyal members and resulting in a loyal community remaining.

• Loyal lockers are rewarded with the tokens slashed from those who RageQuit, resulting in more governance power in the hands of those most loyal.

• Lower perceived opportunity cost risk for those looking at undertaking an extended lock. By knowing they can RageQuit the lock early if they wish.

Although implementing a RageQuit feature seems like a net positive decision, there are some disadvantages:

• RageQuitting may seem like a more attractive option to disgruntled lockers as the price falls, which could add more sell pressure to the token as it falls.

• The RageQuit mechanism still does not solve the problem of meta-governance protocols accumulating all of the voting power and putting it in the hands of people with a much shorter lock time.

• Token allocations may become very centralised over the life cycle of the token if RageQuitting every cycle becomes common and a small number of lockers are rewarded with all of the slashed tokens

1. Base protocol liquid staking:

Base protocol liquid staking removes the main advantage of meta-governance protocols altogether and returns the value back to the protocol’s governance token.

In addition to implementing a RageQuit function, a liquid staking option should be available for those who aren’t prepared to lock for an extended period of time but want to govern and earn rewards in the short term (in a reduced capacity). The primary advantage and business model of meta-governance protocols is to offer a liquid wrapped derivative of the ‘ve’ token which offers liquid staking. By removing this use case, this then removes the need for meta-governance protocols which accumulate all of the voting power and centralise governance down to people with shorter lock periods.

The base protocol could adopt two levels of staking for governance and rewards:

• Liquid staking: This option would provide holders with reduced governance power and reduced protocol rewards, whilst providing them with a liquid position. The protocol could use revenue generated to buy back tokens from the market and distribute them to the stakers. Similar to the xSUSHI mechanism, these holders will still have governance rights over the protocol, however not as profound as the locked position holders. By providing a liquid option, stakers are less likely to deposit to a meta-governance protocol and centralise the voting power to that entity.

• ‘ve’_v2 token design: the second level of token staking would be a vote escrow extended lock token design incorporating some of the suggestions outlined in this section.

Some advantages of base protocol liquid staking are:

• Removes the main advantage of meta-governance protocols altogether and returns the value back to the protocol’s governance token.

• Offers investors an option that doesn’t seem as permanent as a multi-year lock.

• Removes the risks associated with maintaining the peg of the liquid wrapped alternative, as the asset could be redeemed directly off the protocol, including all rewards that have accrued.

• Further decentralises the protocol and puts more governance power in the hands of the ‘ve’ lockers, but also allows those with a more short-term view to have their say.

• Allows any type of investor to access some of the rewards generated by the protocol revenue, which in turn incentivises use of that product as more users benefit from its success.

Although this alternative brings some big advantages, there are some disadvantages:

• There’s no guarantee that it will stop meta-governance protocols from perpetually locking the ‘ve’ tokens and passing on the boosted rewards to their token holders.

• It adds another token which the protocol has to incentivise liquidity for, if they want to allow trading of this xToken.

• Creates an issue associated with governance attacks due to the liquid staked alternative having some governance power (although less than locked tokens).

• Adds complexity for newer market participants as there are now 2 stages of staking.

3. Loyalty boost:

Loyalty boost rewards have been used by protocols such as GMX and Platypus to encourage retention of users and leverage the game theory of keeping them involved with the protocol or they will lose their boost.

Although both protocols use different variations, both have similar underlying principles. Once stakers are involved in the network by staking their token, they earn conditional rewards that act as an equivalent of the staked tokens. This additional boost is earned if the user remains staked or compounds their earned rewards. If they unstake or start to vest their rewards this boost is lost.

Some advantages of using this mechanism are:

• The staker feels obligated to remain staked or continue to compound their rewards so that the boost is not lost.

• The perceived opportunity cost of unstaking during short term volatility or reduced protocol rewards may be perceived as too much, and if the stakers still believe in the mid to long term outlook of the protocol, they will remain staked.

The disadvantages of this mechanism are:

• Stakers with a large amount of loyalty boost rewards may be more likely to hedge their positions using perpetual futures contracts (if available) to avoid unstaking and losing their boost.

Compared to a ‘ve’ lock which is a forward-looking metric of the staker’s commitment into the future, a loyalty boost is a backward-looking metric; it indicates that past behaviour may be a predictor of future behaviour. Although this is not a perfect assumption, we can say that the longer that they have been staked, the greater the opportunity cost involved with unstaking. Thus resulting in a greater incentive to remain staked and accrue the rewards from the boost.

4. **Reward Vesting: **

Stakers are, in theory, more likely to compound their rewards, allowing them to continue earning protocol rewards rather than vesting these tokens which don’t earn rewards during the vesting period.

Another interesting model used by GMX is that governance token rewards are issued to stakers (and liquidity providers for their GLP token) as esGMX. esGMX is an escrow token that acts exactly the same as the regular governance token, however it is untransferable until it has been vested over a period of time. In the case of GMX, this vesting time is 1 year under certain conditions. If the conditions are not met, vesting stops.

The staker has two options with these esGMX tokens:

1. Auto-compound these tokens (and all the other rewards including loyalty boost) and earn the rewards as if they were regular GMX staked tokens.

2. Vest these tokens, in which time they do not earn any rewards. To vest these tokens, they must stake the average amount of tokens used to earn the esTokens.

This model brings several advantages:

• Stakers are, in theory, more likely to compound their rewards, allowing them to continue earning protocol rewards rather than vesting these tokens which don’t earn rewards during the vesting period.

• In the specific case of GMX, to vest the esTokens the user must have the same amount of tokens staked that was used to earn the esTokens. This mechanism ensures that if a staker wants to unstake and leave, it will take them an extended period of time (1 year in this case) to vest all of their rewards. Resulting in liquidity (GLP) or stakers remaining in the system or the esTokens remain un-vested and out of the circulating supply.

• Decreases immediate sell pressure. When issued, these esTokens cannot be sold, although they can be vested over time in which it’s hoped that the protocol will be more resilient to handle the sell pressure.

• Reward long term stakers with more protocol rewards. This method is especially powerful with protocols that generate revenue and want to distribute to committed participants.

• When the staker decides to unstake and sell their tokens for good, their esTokens continue to earn protocol rewards, which is fair to them as they earned them during their time contributing to the protocol. This also works as a connection between the protocol and staker, resulting in the staker potentially being more likely to return to either vest these tokens or earn more.

• Although unlike the previously mentioned loyalty boost, the esTokens are able to be vested and sold into the market once their vesting time has expired. If unvested they remain with the staker that earned them for life and will continue to earn protocol rewards, unlike loyalty boosts which are lost as soon as the staked tokens are unstaked from the protocol.

The disadvantages of vesting tokens are:

• This model is not applicable to all protocols, for example Curve could not have a successful gauge voting mechanism with a vesting mechanism.

• Protocol rewards are still accruing to people who have unstaked and left the protocol, extracting rewards away from the remaining participants.

5. Lock with no dilution – ve(3,3):

Andre Cronje saw the imperfections with the standard ‘ve’ token design and tried to better it with his ve(3,3) token design for Solidly. However, his implementation was poorly executed along with poor UI/UX, which ultimately lead to an implosion of the Fantom DeFi ecosystem causing a TVL loss of almost $7B.

Despite the poor execution, the idea was a good one, allowing users to lock their percentage of the supply as an NFT. For example, if you purchased 1% of the token supply and locked it as a ve(3,3) position, you would receive 1% of the emissions. Resulting in your position always being 1% of the token supply.

It was also proposed that if all circulating SOLID was locked as veSOLID, there would be no emissions released by the protocol. *“*If all participants lock, emission decreases to 0, if only 50% of participants lock, emission is 50%, however lockers increase proportionally to emission.”  This is obviously impossible as there must be liquidity provided but it was aimed at making it in the token holders best interests to lock, thus avoiding dilution.

Cronje’s vision certainly does have some advantages:

• Allows lockers to ‘lock in’ their percentage of the locked supply, resulting in no dilution.

• Allows lockers to exit their positions by selling their veNFT on a secondary marketplace.

• Varying emissions that reduce as more tokens are locked allows for initial bootstrapping then possible price appreciation over the long term.

However, as shown by the implantation of ve(3,3) there are some disadvantages:

• It is extremely hard to implement.

• It does not fix the issue of meta-governance protocols accumulating and locking all of the base protocol asset.

The ve(3,3) design is very complicated and extremely difficult to execute, however this line of thinking is interesting and should be explored further. Incorporating non-fungible positions with protocol governance is a relatively unexplored area in DeFi and makes sense in theory with long term locks.

Improving governance participation amongst ‘ve’ lockers: a proposal

One of the current issues with ‘ve’ governance is that if participants are not financially incentivised (ie. bribed to vote for gauges), they are unlikely to participate in governance. This statement is true for veCRV holders. Out of the 10203 historic holders, only 1875 or 18.37% (as of 19/10/22) have voted on a governance proposal. This lack of governance participation is not new and shouldn’t be surprising. However, for a token design that is designed to attract long term thinkers and have strong governance participation, these sorts of numbers aren’t reflecting the initial hopes of the ‘ve’ design.

Conditional delegation:

• Similar to Optimism’s governance structure after the recent airdrop, users were required to choose a delegate to represent them in the governance decisions prior to claiming their OP airdrop. There was still the option to delegate to yourself, but the Optimism team knew that governance participation is generally low amongst token holders; so they required that people delegate to a nominated person prior to claim their airdrop allocation.

However, not every delegate is the best informed to make all decisions in all areas of the protocol. It could also be possible that if there is a large decision about a fundamental aspect of the product, the user may want to vote themselves. Conditional delegation will take more time to delegate to the appropriate delegate for each vertical that the user cares about, however over the long run this may lead to better governance decisions.

A delegated governance structure like the following would allow experts in their field to make the decisions suited to them:

• If decision involves privacy or censorship, delegate to person (x)

• If decision is related to DAO partnerships, delegate to person (y)

• If decision is related to the economic structure of the protocol, delegate to the user themselves.

Conditional delegation structures like this will allow the token holder to distribute their vote to people they believe are experts in their field, thus benefiting the overall governance of the protocol.

The ve-model is still developing:

The ‘ve’ token model will be a lasting token design amongst DeFi protocols, although not in its current form.

The vote escrow model is certainly a step in the right direction, especially compared to the liquid governance-only tokens that came before it. However, as market participants grow wiser to the impact of token design and the risks associated with holding illiquid positions, no amount of passive protocol rewards will make up for large drawdowns that have no certainty of recovering. If some of the ve_v2 suggestions above were implemented by protocols wanting to incentivise long term participants in their network, there would (hopefully) be much healthier markets, better governance decisions, and more decentralisation. The protocol and the community would be better off.

Although the token design for each project is very specific to who the stakeholders are, how revenue is generated, value flows and regulatory structure. At the bare minimum RageQuit and the base level liquid staking option, should be implemented, to avoid mass dilution on long term ‘ve’ lockers by meta-governance protocols. This will also alleviate the majority of incentivised voting and revenues being transferred to meta-governance token holders. The additional options would be beneficial on a case by case basis, adding extra benefits to the protocol if suited to its design.

The ‘ve’ token model will be a lasting token design amongst DeFi protocols, although not in its current form. It may be different to what has been outlined above, however it will focus on greater governance participation, decentralisation and more value being captured and retained by the protocol. Rewarding loyal stakeholders that participate in the protocol and its governance early should be at the forefront of the protocol’s mind. The aim should be to reduce dilution, reward these participants as much as possible, and offer them an exit if they want it in the future.

But we must keep in mind that this is a new technology trying to implement complex monetary policy; over time it will become more clear, and as we all like to say:

“We are still early”.

The below article will focus on:

• What is the vote escrow token design

• How the token design benefits the protocol

• Meta-governance protocols and their need

• The negative aspects of the ‘ve’ token design

If you are not familiar with the Curve vote escrow token design please read this excellent primer to get a more comprehensive understanding prior to reading this series.

What is Vote Escrow?

Introduced by Curve Finance, token holders lock up their governance tokens (e.g. CRV) for a predetermined amount of time and receive vote escrowed tokens in return (e.g. veCRV). Lockers can choose a lock duration from 1 week up to 4 years. The longer you lock your tokens for, the more voting power is issued to you as a reward for your loyalty. During this lock period the locked tokens are illiquid and unable to be unstaked or sold. The locked tokens decay linearly over the duration of the lock until 0 vote escrowed tokens remain at the end of the locking period. Users may periodically relock the decayed tokens to indefinitely extend their lock period and earn the max rewards and governance rights.

In addition to locking your tokens and voting on proposals veToken holders are given additional perks, in Curve’s case they are:

1. Select a pool you would like boosted CRV emissions on (up to 2.5x).

2. A share of protocol fees paid in 3crv (in proportion to your % of all veCRV).

3. Vote weekly on where the CRV emissions are directed (resulting in bribe revenue).

4. Vote on governance proposals.

In basic terms, stakers lock their tokens for up to 4 years and in return they receive proportionate voting weight, protocol fees and other benefits.

How does this benefit the protocol?

For protocols the benefits are that the actors who lock their tokens for the longest period of time are generally the most loyal supporters of the protocol and have a long term view of where they would like the protocol to go. These lockers are willing to turn their capital into an illiquid position to receive governance power over the protocol thus improving governance (in theory), making them more willing to make informed and time conscious decisions.

The reduction in circulating supply also makes the ‘ve’ token design a self fulfilling superior token design prophecy. When a protocol pivots to the ‘ve’ token design and starts to distribute protocol rewards or accepts incentivised voting, this generally generates excitement and causes price appreciation of the tokens which are being removed from the supply and locked. Thus thinning liquidity and in turn making price appreciation more aggressive (in theory). The increase in token price plus more attention on the protocol is beneficial to building a community and standing out from competitors.

“As times get tough and we head into the other not so glorious part of the cycle, lockers just want a way out.”

Weaknesses with the ‘ve’ token model:

There are certainly advantages to the vote escrow model, which aims to reward long term holders with the majority of the governance power and passive income from protocol rewards. Locking of tokens also reduces selling pressure of the protocol’s token and creates an army of loyal supporters. While the ‘ve’ token design is a step in the right direction, the influx of liquid wrapped derivatives and meta-governance protocols building on top of it is disconcerting. A significant risk is that over time, voting power becomes more centralised and the passive income is extracted away from those loyal actors that are locked for an extended period of time.

We need ‘ve’_v2.

-‘ve’ & the Meta-governance Monster

The below will primarily focus on the Curve ecosystem, although the same weaknesses of the vote escrow design, along with the “meta-governance monster”, are theoretically applicable to all ‘ve’ tokens.

The vote escrow model is integral to the Curve ecosystem due to the highly inflationary nature of the CRV token design. Directing the CRV emissions to specific gauges to promote deep liquidity to those pools is a genius concept, resulting in protocols incentivising (bribing) veCRV holders to vote for their gauge.

Meta-governance protocols such as Convex build on top of the underlying ‘ve’ protocol, to capture as many of the governance tokens as possible and permanently lock them. This takes the governance token out of supply and reduces sell pressure, but results in the majority of governance power of the base ‘ve’ DAO being held by a meta-governance protocol. As in the case of Convex which has a much shorter locking period on its own protocol governance token, vlCVX. This means that the long term incentive has disappeared as the vlCVX holders with all the governance power now only have a 16 week time horizon.

Figure 1: Percentage of veCRV owned by Convex vs. all other DAOs (as of 17/10/22).

Figure 2: cvxCRV locked daily update  in the Convex Discord (as of 17/10/22).

Figure 1 shows, since Convex’s inception, the amount of CRV that has been accumulated and permanently locked is reaching 50% of all veCRV that has been locked and rising fast. According to the cvxCRV locked bot in the Convex Discord, an average of 86.71%% of new daily CRV emissions have been locked into the Convex protocol since its inception.

By allowing CRV to be permanently deposited into Convex, in exchange for cvxCRV (a liquid wrapped alternative), this allows cvxCRV to be staked in order to receive similar rewards to those who have locked CRV directly with Curve for 4 years. Allowing someone to speculate on the price, receive the same rewards (excluding bribe rewards) and have a liquid position with the only risk being the cvxCRV/CRV peg seems to be an easy decision for the 281M CRV deposited by those who are willing to forfeit their governance rights to vlCVX holders in exchange for a liquid position.

This results in the majority of the governance power being taken away from individual veCRV lockers who have locked for up to 4-years and placed into the hands of vote locked CVX (vlCVX) holders who are locked for a maximum of 16 weeks. This results in the opposite outcome of what was initially hoped for the vote escrow model.

Figure 3: DAO controlled veCRV distribution (as of 17/10/22)

As hungry DAOs like Convex accumulate all the CRV, their voting weight increases with it; this in turn can make it more economically viable for protocols to purchase CVX rather than CRV if the ratio of veCRV controlled by 1 vlCVX grants the purchaser more governance power than purchasing that CRV and locking it.  This ratio of governance power also flows down to those DAOs that are currently bribing veCRV and vlCVX holders for their votes. The poor ever diluted ‘ve’ holder is now missing out on bribe revenue as their voting power is diminishing every time someone locks another CRV into Convex.

Although they hold an increasing amount of the veCRV governance power, vlCVX holders aren’t overly concerned about where the CRV emissions are directed. As shown in Figure 4, 55.0% have delegated to Votium, which is a protocol built on top of Convex and is designed to maximise voting incentives by distributing them in a way to earn the maximum revenue, rather than directing to a specific pool of their choice.

Figure 4: Percentage of vlCVX votes allocated to Votium (as of 17/10/22)

To further complicate things, we now have liquid wrappers of meta-governance tokens such as vlCVX (e.g. Pirex – which has amassed almost 1.5 million CVX since June, shown in Figure 5), making it clear a 16 week lock is too long for those who want the passive income plus a liquid position.

Figure 5: Amount of CVX deposited into Pirex + TVL of Pirex (as of 17/10/22)

The end result is, ‘ve’ ends up aligning less with long term holders and more for protocols building on top, extracting the value for shorter lock times. This results in those most committed to the project at the beginning getting their voting power diluted at an ever increasing rate (unless they continue to lock the same amount of emissions as their original % of the tokens owned) by people who can exit their position every 16 weeks, or hold liquid wrapped derivative positions. When price increases this allows the liquid meta-governance token holders to sell and drive the price down on the committed community members who are locked and cannot exit their positions. As price falls and trading volume dries up, rewards distributed also deteriorate, which may lead to less attractive reward returns for certain lockers, however they can’t as they still have to wait another 3 years to escape.

“This results in those that were the most dedicated getting impacted the hardest, not a great result for the community, governance decisions and the protocol.”

No one knows if a protocol will be around in 4 years time, let alone a dominant piece of infrastructure. Requiring a lock for 4 years to receive the maximum benefits of their purchase makes ‘ve’ tokens extremely unattractive to buy. As shown below in Figure 6, the daily number of locks has been drastically reduced since the middle of 2021, which coincides with when Convex launched.

Figure 6: Daily CRV locked and daily number of  wallet locks (as of 17/10/22)

As times get tough and we head into the other not-so-glorious part of the cycle, lockers just want a way out. Their voting power is decaying and they aren’t interested in re-locking as they are just trying to salvage as much capital as they can. New investors aren’t interested in buying and locking because they can see what’s happened to those before them. This results in low governance participation during times when leadership and community is needed the most.

The need for meta-governance:

The goal of the vote escrow token design was to incentivise long term lockers the most and build a loyal community to help govern the protocol over the next few years. As we have seen above, allowing them to lock and not allowing them to leave may not be as great as first thought. All this does is incentivise protocols to build on top, extract the governance power away from early base protocol lockers and put it in the hands of people prioritising rewards over long term governance. Protocols like Convex don’t add any infrastructural changes to the way protocols like Curve operate, their whole business model is to accumulate the governance power for themselves and rent that out to the highest bidder. If the base level protocols token design was sufficient, there would be no need for these meta-governance protocols to exist and the base level protocol could achieve more decentralisation, more community participation and reward its lockers in a fairer way…sounds like the original goal right?

The original ‘ve’ model is outdated:

Despite this thought piece having focused primarily on the Curve and Convex ecosystems, it is even more important for protocols that do not share Curve’s emissions schedule, gauge voting and superior product to think whether the current version of the vote escrow design is right for them. Implementing vote escrow tokenomics on a protocol that is trying to pivot away from former token design mistakes in the past may be an even larger risk.

The long-term incentive alignment that vote escrow was supposed to attract works well when we see a growth period like we did from 2020 – 2021. However, when goblin town arrives it’s every locker for themselves. As liquidity dries up so does volume and protocol revenue, resulting in lockers receiving substantially less rewards than they did when times were good. The loss in principle and rewards results in those most dedicated to governing the project losing faith and thus governance participation will suffer in the times it is needed most.

If Curve could have their time again, they would hopefully look to change their token design to remove the need for a protocol like Convex to step in and extract all the value away from their own holders. Unfortunately Convex holds far too much governance power for Curve to pivot. For projects launching or pivoting to ‘ve’ now, some serious consideration must be given to the current weaknesses in the model and ways to correct them, especially when the protocol does not have the same gauge voting, emissions and product that complements the current ‘ve’.

Look out for a follow up article soon on what mechanisms can be used to improve the vote-escrow token design, reward the loyal supporters, achieve more decentralisation and increase governance participation.

When thinking about the price of an asset, it is important to remember that current price is not what the market believes an asset is worth now, it is the imperfect manifestation of projected future value.

Having established this, we can dive into the various components that guide this manifestation.

Qualitative Components

Unlike investors in traditional companies, a large percentage of the Web3 demographic is made up of ‘millennial’ or ‘gen z’ investors, who build narratives and communities around the companies they invest in. This is done via memes, on crypto twitter (CT) and community engagement exercises on Discord and Telegram channels. This alternative way of marketing may seem unusual for Web2 companies dipping their toes into Web3 for the first time, however it is a necessity to understand and use it to your advantage. While extremely important, a vibrant community, marketing and social media following are not the only aspects that give a token and its company perceived value.

Narrative

The Web3 space is cyclical in nature, starting from the Bitcoin 4 year halving cycle narrative that drives the whole market or transient market narratives, understanding and knowing how to use these narratives to your advantage is important. By using positive sentiment on a particular sector or application to your advantage, whether this is through partnerships, product announcements or assigning a link between the narrative and your own product can be very valuable at driving users to your product.

Due to the importance of narratives in the Web3 space, it is important to have a constant finger on the pulse of the sector you operate in and capitalise on any narratives that may form to drive value to your token.

Community

Building a community is one of the most important aspects of driving qualitative value to your token. Due to the decentralised nature of Web3, where token stakers may have a governance vote over some decisions of the protocol, they are more likely to show interest in the day to day actions of the company. A large, quality community will work as your marketing agency. A good community will champion your project on social media, write marketing material and will spread the word about what you are building.

Some of the key areas of focus are:

• Internal community tools (Discord, Telegram, WhatsApp):

  • Keep things fun with competitions, activity in the channels and constant engagement with the community you are building. This can be done with community calls, drop ins from the team or developers to disclose some ‘alpha’ or insights into the future of the product.

• Brand representation/marketing platforms (Twitter, LinkedIn, Reddit, Instagram, Facebook, YouTube, TikTok, Twitch):

  • These outlets are essential for growing your community and increasing your social footprint. By releasing threads, video content or regular posts you are likely to get more eyes on what you are building.

• Brand publication platforms (Medium, Substack, Quora):

  • For longer form content it is essential to release project updates or milestones on these publications. Usually the big Web3 media agencies cover the big protocols, so as a start-up trying to build and find PMF in the space, writing your own updates and posting on these publishing platforms is essential to getting your news out to your community.

Utilising a tool like Lunar Crush will allow investors to see the total number of social mentions and total social engagements over the past 3 months. it is essential to implement marketing campaigns to ensure that this engagement is continuously improving.

Unique Token Holders

Web3 gives projects a unique advantage and allows them to see how their token is dispersed amongst their community. Decentralisation is a core value of Web3, and building on a diverse and distributed community, monitoring on-chain data such as unique token holders is a great way to track how diverse your community is. Ideally, the more unique holders, the better. This should help to grow governance participation, as there are more token holders who want to have a say in the future of your product. It also means that more people find your token valuable enough to hold and will champion your company as it’s in their best interest that the token and company does well over the long term.

Product & Token

As established above, a token’s value is the market’s imperfect manifestation of future value. Due to this market dynamic, future utility is taken into account when an investor is evaluating the potential value of a token. Building, iterating and progressing your company is what every company does, especially start-ups which may have drastic pivots away from their original vision. Relaying this future utility and potential product improvements is essential, even if it is a little snippet, to keeping the community engaged and interested in what you are building.

A token will generally derive its value by leveraging different value capture mechanisms. Ideally it will have utility within the product, such as ways to improve the user experience (UX) and govern over the protocol. Along with utility, the token should ideally capture value via revenue share, buybacks, discounts and extra benefits that will create demand to buy and hold the token.

Ideally a token’s perceived value will scale with the product, as the product finds more PMF and higher usage, the token should be capturing this value and becoming more valuable itself. Some tokens may have weaker value capture mechanisms than others, this can be for a multitude of reasons, whether caused by regulatory constraints in different jurisdictions or how the token can be utilised within the product.

The first iteration of application specific tokens were limited with their token utility within the product. However as shown by Uniswap and the UNI token, even a ‘weak’ value capture mechanism of governance has proven to be a strong driver of token value due to the quality of the product that token is governing. In Uniswaps specific case, governance over the Uniswap protocol has shown to be very valuable to token holders, thus driving value to the UNI token.

Putting it all together

Putting all these components together revolves around one thing: community and the narrative they can champion for your project. Your community and brand is your biggest qualitative strength and is something we see Web2 companies struggle with when moving into Web3. Your community will become your biggest fans and critics, and understanding which metrics to track how the community is maturing is one of the biggest value drivers to your token that is not easily assessed with traditional valuation metrics. By increasing your social presence, along with the diversity of your token holders, your reach as a project will be much larger than those who don’t focus on these areas.

It is also important to remember that your token should not be the product and it should be utilised to complement your product, capture value and increase the user experience. If you aren’t sure whether you need a token or not, please read this Outlier Ventures article “Does your product need a token”. In addition to this, it is important to ensure the product and user experience is solving a pain point for the user. If all of these aspects line up, your token has the best chance of capturing value through the qualitative component stack of token value.

For a look into some of the quantitative components that make up token value, please read the next piece in this series: “Token Value – Quantitative Components”.

There are multiple components that make up the perceived value of capital assets. The previous article looked at the qualitative components, which cover the ‘intangible’ aspects of token value. This includes aspects of community , narrative and token utility.

This thought piece will look at which quantitative components contribute to perceived value of capital assets. Combining a mixture of qualitative and quantitative components will help explain why a token or protocol is potentially valued the way it is. Both aspects are equally important and deserve the same attention by founders looking to build a successful Web3 business.

Quantitative Components

Data driven asset valuation has become a standard valuation method in the traditional finance system. Whether this is achieved through a comparison of similar companies’ price to earnings ratio (P/E), conducting discounted cash flow analysis (DCF), earnings per share (EPS) or any of the popular alternative methods of quantitative analysis.

In the Web3 space, this sort of analysis is not as common. Prior to the technological advancements in smart contracts that allowed DeFi, NFTs, and thousands of other applications to be built on-chain, the quantitative data points were limited to network usage via token transfers and fees paid to miners or stakers. Now, as the market has progressed and there are real businesses generating real revenue, the data to conduct quantitative analysis is available and this component of token value will become a greater focus for investors.

The following quantitative components of token value can be used as some of the building blocks when researching what gives a token value;

Total Value Locked (TVL)

Total value locked is currently one of the standard metrics for determining the value of a protocol. Predominantly applicable to the DeFi space, this metric takes into account the total value of all the crypto assets locked into a platform. This could be assets lent into a lending pool on Aave or deposited into a liquidity pool on Uniswap.

TVL is generally an indication of Product Market Fit (PMF), where the protocols with the largest total volume locked in them are the most trusted in terms of a security standpoint, and the most used. This is due to the fact that liquidity flows to where it is utilised most, as this is what generates liquidity providers fees.

A useful resource for researching the current TVL of protocols is DeFi Llama.

Amount of users

The amount of users of a particular product or protocol can be used to derive adoption rates and PMF of that protocol. This data can be utilised within a greater thesis, along with other metrics to determine whether the product has found increased adoption in comparison to its competitors. The amount of users a protocol has can be found on Token Terminal.

Revenues

Revenues are defined by Token Terminal as “Fees generated to the token holders”. This revenue is derived from the fees generated via the usage of the platform and then captured by the company. The revenue associated with a particular company is the remainder of the revenues that the company (or token) captures as profits. This revenue is not to be confused with the fees (sales) that we will look at below in the P/S ratio. Revenues are the remaining profits that accrue to the company after the fees that may be paid to different stakeholders have been deducted. For example, the revenues that are captured by an AMM after the liquidity providers have been given their portion of the trading fees.

By monitoring company revenues, this allows you to determine if that company is a profitable revenue generating business and whether the token captures value from the operations of that business. These profits may, or may not be captured by the token, depending on the token value capture mechanisms utilised in its design. Due to the complexity of value accrual mechanisms for each company, it is imperative to understand how the token aims to capture the value generated by the company as there is no standard approach to token value capture.

Market Cap/Total Value Locked (MC/TVL)

Assessing like companies by dividing their fully diluted market capitalization by the total value locked on the platform allows an assessment to be made on the ratio of those two metrics. This ratio, when compared to competitors in a similar industry can be used to determine the value of the companies in comparison to their competitors.

Price/Sales (P/S)

The price to sales ratio is a metric derived on Token Terminal from their company data. This ratio is calculated by dividing the fully diluted market cap with the annualised revenues. This

ratio shows how a project is valued in relation to its revenues generated, which can then be compared to other web3 companies.

Price/Fees (P/F)

Similarly to the P/S ratio, the price to fees ratio or P/F is calculated by dividing the fully diluted market cap by the annualised fees generated by that company. These fees may be used to pay stakeholders of that company that allow it to function, like liquidity providers on an AMM. This ratio shows how a project is valued in relation to the fees generated, which can be compared to companies in the same industry.

Discounted Cash Flow (DCF)

DCF is a method of evaluating an investment based on its future cash flows and attempts to predict how much an investment is worth today based on the return in the future. There has been little evidence of this common equity valuation analysis being used on cryptocurrencies due to their lack of historical data, volatile nature and extreme risk associated with this new technology.

The traditional formula for DCF is:

DCF = CF11+r1+CF21+r2+CF31+r3+ … +CFn1+rn

Where:

CF**1= The cash flow for year one

CF**2 = The cash flow for year two

*CF3 *= The cash flow for year three

CF**n = The cash flow for additional years

r* *= The discount rate

​

Discounted cash flow uses a discount rate *r *to determine whether the future cash flows of an investment are worth investing in or whether a project is worth pursuing. Historically, when completing DCF on an immature and early stage company one must discount that future cash flow to be in line with the risks associated with investing in early stage start-ups which is achieved by discounting the future cash flows by anywhere from 25% to 50%.

Companies in the Web3 space, and particularly tokens, have many nuances in their monetary policies, the traditional formula is not a perfect fit for conducting a DCF on crypto tokens. Now that data sources such as Token Terminal make the data readily available, we will begin to see more traditional methods be adapted and modified to better analyse the web3 space.

What this means for founders

Quantitative data points, when analysed in isolation, only have limited use, but they become more powerful as you blend them together. However, the art is to weigh each of the factors the right way for the corresponding market conditions, along with integrating the qualitative components mentioned in the previous article.

As with most cases of assigning value to something, much of the value is down to personal perspective and personal bias. Some investors may value revenue distributing companies, while others value governance over industry bluechips. There is no right or wrong answer to this question and all of the tools listed in this article are just that; tools that may be used by investors to assess and value a company or token.

As a founder, this information is necessary to understand as it shapes the story you tell to investors and your community. By combining qualitative and quantitative data, you can show investors why your company and products are valuable, run your marketing initiatives around this data, and create a compelling narrative.

After speaking to @robert_lauko I am eagerly awaiting to see how v2 could potentially solve the ever elusive stablecoin trilemma.

A quick primer on the stablecoin trilemma:

Stablecoins consist of 3 major traits:

• Scalable

• Decentralised

• Stable peg

Its common for stablecoins to be strong in 1 or 2 of these traits, however we are yet to see a stablecoin achieve all 3 traits to build the ideal stablecoin

Liquity will be attempting to solve the stablecoin trilemma by innovating on the decentralized reserve backed delta-neutral hedged style of decentralised stablecoin that has previously been attempted by protocols such as Angle or UXD.

Reserve backed stablecoins are a promising design for stablecoins as they are inherently more scalable than other types, such as over-collateralized stablecoins with decentralised collateral (LUSD for example). However, there are challenges with keeping the peg tight and the system collateralised as the price of the reserve backing asset begins to fall during market downturns.

When a user wants to mint a decentralised reserve stablecoin, they must deposit some of the reserve asset to mint the stablecoin. Lets run through an example to make this clear:

Alice holds 1E which is worth $2000 at current prices. She then decides that she wants to sell this ETH to realise her profits but does not want to sell to a centralised fiat-backed stablecoin and take on the counterparty risk that is associated with those.

Alice can then come to Liquity v2 and deposit her 1E ($2000) for 2000 v2USD. This now means that Alice is essentially short ETH and Liquity hold 1E and a $2000 liability owed to Alice.

If the market price of ETH is increasing, everything is great as the 2000 v2USD Alice holds are now backed by >$2000 worth of ETH.

When the market is trending down, this is when the issues with decentralised reserve stablecoins arise. If ETH falls below $2000, the v2USD Alice holds will be unbacked and wont be worth $1 each. This can lead to a death spiral which has been the result of past efforts at this design.

Past efforts have attempted to counteract this problem via inflationary token incentives (bad for token price) or by trying to hedge the reserve collateral long position held by the protocol. This has usually been attempted via in-built perpetual futures or via centralised exchange futures contracts.

Neither of these attempts have proven successful, primarily due to the reliance on funding rates and the reduced appetite for leverage during times of high market volatility or downturn.

So when the protocol needs actors to hedge the collateral the most, they are not willing to do it.

Liquity are looking to innovate on the previous attempted delta-neutral hedging style of reserve backed stablecoins by focusing on the demand for leverage when the market is volatile.

This is achieved by leveraging two novel mechanisms:

Innovation 1:

Users: Demand for leverage reduces as the market is more volatile or trending down. This is a logical reaction by market participants as capital preservation becomes priority & risk taking reduces during market downturns.

Liquity have thought about how you can increase the demand for leveraged long positions as the market is falling and claim they have discovered a way to create principal protected leveraged positions.

Principal protected (PP) positions are enabled via a dynamic premium that is paid by a user who opens one of these positions. Depending on the collateralization ratio of the reserve and user demand, the system automatically adjusts the premium to make PPs more or less attractive to new participants looking to open a position.

Leverage is enabled as price of the collateral increases, the reserves that have been deposited by v2USD minters also increases in value, these extra reserves that are no longer needed to back the stablecoin and can be used to pay out the hedgers leveraged positions.

If the price of the collateral falls, the premium also reduces, making these positions more desirable and should increase the demand for these positions (which adds to the backing of v2USD).

These premiums are then collected by the protocol to finance the principal protection.

By offering principal protected leverage positions, Liquity believe they will be able to tap into the proven demand of crypto participants ‘buying the dip’ on leverage, however now these users can do this with only their premium on the line as they know their principal will be protected.

*This also means that the lower the price goes towards the v2USD backing, the lower the premium and in-turn the higher the leverage for people who are longing the collateral. This enables stakeholder alignment and should mean that the demand for leverage increases as price falls….which is exactly what is required for delta-neutral reserved back stablecoins to function correctly.

Innovation 2:

Liquity will be building a specialised secondary market that a principal protected position holder can try to sell their position p2p on a secondary market - ideally for a premium above the principal protected amount.

If a position is not being bought by other market participants off the secondary market, Liquity will subsidise this position to increase its attractiveness until it is purchased. This results in the protocol only having to subsidise those positions which need it most until they are sold to another actor. These subsidies then remain within the protocol until the position is redeemed.

In the last few months, we have seen a plethora of new stablecoin projects launch, most of them are Liquity v1 forks with different collateral types (usually stETH). These projects are leveraging the current LSDfi narrative, however they do not innovate or attempt to solve the stablecoin trilemma.

After watching Roberts presentation at ETHCC and wrapping my brain around the game theory dynamics of Liquity v2 I am excited to read the white paper and see the details of v2. Liquity have built the most decentralized and robust stablecoin on the market, LUSD, I believe this is the team that could finally solve the stablecoin trilemma with Liquity v2:

Scalability - Reserve backed stablecoin

Censorship resistant - ETH or some form of staked ETH as collateral

Stable peg - Principal protected leverage to hedge the reserve backing and a secondary market for these principal protected positions to be sold p2p rather than redeemed.