Even fairly sophisticated DeFi watchers might be baffled why so many are so obsessed with Curve, the automated market maker known for trading stablecoins.
What’s so exciting about stablecoins after all?
But the market gets it. Curve‘s token is up 50% over the last month. And Curve has become, crucially for what’s to follow, inextricably linked to another product built to work atop it: Convex Finance.
Convex’s CVX token is up roughly as much. Convex exists to help Curve liquidity providers maximize their returns, so the two products have always been symbiotic. But now they’ve grown so interdependent that the pair are poised to effectively merge, and to do so in such a way that no other team could ever disrupt Convex again.
“Our view with Convex and Curve, whoever controls this stuff essentially controls the liquidity of stablecoins,” said Sam Kazemian, founder of the algorithmic stablecoin protocol Frax Finance.
Curve is the largest DeFi project of them all, at the moment, according to DefiLlama, with $19.8B in total value locked (TVL) across seven different blockchains and sidechains. It’s also the largest automated market maker (AMM) on Ethereum right now, with more than twice the TVL of Uniswap.
Providing liquidity to Curve has always been a good way to earn yield, but Curve is complicated. Convex made it simple for rank-and-file yield seekers to get the most lucrative returns.
It would not be surprising if over time these two tokens move increasingly in sync. Convex would be nothing without Curve and, before long, Curve might do nothing without Convex. In other words, Curve may do nothing without Convex’s permission. Convex was built for people to use to maximize their yield investing in Curve. The yield is driven by distribution of Curve’s governance token, CRV, which means Convex also dominates Curve governance.
Governance tokens have been the go-to way for DeFi projects to spread authority over their applications (that is, to decentralize). In the most basic form, they distribute a token to users, and each token is worth one vote when a decision needs to be made.
Fresh CRV is emitted every day, and it’s distributed to depositors in Curve’s many liquidity pools. How much CRV each pool gets is the main job of Curve governance. As Curve becomes more crucial to DeFi’s many investors, Convex’s dominant place puts it in an extremely powerful position, but that is largely due to an unusual rule in Curve governance.
On Curve, smart contracts can’t participate in governance unless they have been voted onto a whitelist. Only three smart contracts have been permitted: Yearn, StakeDAO and Convex.
Right now there’s a proposal in a Curve governance discussion forum to change that. A user named WormholeOracle has written a proposal that would make it easier for other DeFi projects to chip away at Convex’s increasing hold on Curve. Convex has worked very well, but its power is raising concerns about whether or not others could innovate atop Curve as Convex has done. Other smart contracts are shut out now.
A Very Contentious Proposal
The proposal summary reads:
“The SmartWalletWhitelist contract requires any contract wishing to interact with Curve DAO to first pass a vote of approval by the DAO. This proposal is to retire the whitelist contract and make access to Curve DAO universally permissionless.”
Convex is on that whitelist, and it has made outstanding use of that spot.
The proposal is only at the discussion phase right now, but it’s received many more views in Curve governance than most proposals do. “This is a very contentious proposal, and I honestly don’t know whether it will proceed to a DAO vote,” WormholeOracle told The Defiant via email. “My prediction is that, if it does succeed, it will be by a slim margin.”
If the proposal moves forward, the whole question for supporters and opponents will be the impact that it might have on their ability to take part in emissions of CRV. Those emissions are a powerful source of yield in these early days of DeFi, yield experts told The Defiant.
CRV is going to come out for a very very long time, but the lion’s share is getting emitted in the next few years. On Curve, liquidity mining is more complicated than it is on other protocols, which tend to equally distribute daily governance token emissions based on depositors’ share in pools. On Curve, the largest deposits get a disproportionate amount of CRV. It’s impossible for individuals to become an extra large depositor on Curve now, but Convex did an end run so that everyone could be part of a very large pool. Convex came along and said: Use us and we’ll just make one big bag.
Governance tokens have been the go-to way for DeFi projects to spread authority over their applications…
Convex does what might be called meta-liquidity mining. It’s a project that exists exclusively to maximize profit on the liquidity mining of another project. Convex doesn’t touch Curve’s fundamental use case: making markets. Convex is solely devoted to maximizing the collection of CRV and other forms of yield.
There is no equivalent of Convex for other projects that offer liquidity mining incentives. There’s no Convex for Compound or Balancer or Aave.
“Convex is a boosting service, not a yield aggregator. Convex only exists on Curve as the mechanics of Curve allow for boosting,” Convex’s Winthorpe told The Defiant in an email. “No other protocol has this yet and thus why we aren’t on any other protocols yet.”
Lots of Pools
Convex has established itself as the best way to maximize yield for Curve LP deposits, and that’s why it controls the most CRV now.
The Curve team did not respond to a request for comment from The Defiant.
Curve is known as a protocol that’s always ready to trade one stable coin for another stablecoin. But the truth is it has lots of pools that allow trades between assets that are priced basically the same (between dollar coins, between synthetic bitcoins, etc), with a design that allows for very low slippage even on large trades.
AMMs are robots on the internet that always have a buy and sell price for every asset they list. The more assets they have in their pools, the better AMMs work and the more liquidity those assets have, making users more confident that the price of those assets will be steady.
For stablecoins, deep liquidity is a very powerful signal that allows them to gain marketshare. So Curve is an important source of growth for stablecoins, especially new ones.
“The reason Curve is such a hot topic is because it’s the backbone of the yield in DeFi,” Chris Spadafora of BadgerDAO, the DeFi-for-Bitcoin project, told The Defiant in an interview. “The goal is not to lose funds, the goal is to make funds.”
The chief way to lose funds in AMMs is via impermanent loss. AMMs are good because depositors get trading fees, but they can be dicey because most require depositing two assets and then when the market moves the wrong way, a user can end up with less in dollar terms than they started with. Curve allows AMM fees with just one asset, and because Curve specializes in pools of like-priced assets, there’s nearly no impermanent loss risk, at least not outside of black swans.
But Curve actually ends up going two steps further. First, it offers its governance token, CRV, in rewards for the people who supply it with liquidity in order to make those trades. CRV is attractive because people believe in Curve and because CRV can earn a revenue share. Second, Curve started allowing other projects to offer rewards to LPs. So in some pools, LPs earn some completely non-Curve token for depositing, and those opportunities are all readily apparent right on the Curve user interface.
Put all this together, Curve allows steady yield with low risk in a way that’s hard to find elsewhere in DeFi, and that’s why it’s so crucial in various yield strategies. The heart of it all though is really CRV rewards for token pools, and CRV is finite — probably. So, again, this won’t last forever — probably.
Let’s step way, way back, for the DeFi curious: When these new protocols give away governance tokens to people who entrust them with money, it’s as if the banks that came to later form Bank of America or Citibank had been giving equity to depositors back in the early days.
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If you think about it like that, the outsized yield in DeFi these days makes a lot more sense (provided you believe DeFi is here to stay).
Curve’s CRV is like the hypothetical equity in those early banks. The CRV token was launched during DeFi summer. Some random user paid 20 ETH to launch Curve’s liquidity mining code slightly early, without changing a thing. So the team just rolled with it and CRV emissions went live. Curve also innovated on how it distributes rewards.
The money market Compound kicked off the liquidity mining boom by paying its COMP governance token to everyone using it, which invited “predatory mining.” Curve only shares revenue and voting power with folks who have locked their CRV for some length of time, creating vote escrowed CRV or veCRV. “It had this amazing quality of taking a short term oriented profit seeker and [converting] them into a long term protocol stakeholder,” WormholeOracle wrote.
Important Yield Engine
But there’s an upshot: the distribution of equity-like-tokens will not last forever, and that’s why those who have gone down the rabbit hole feel like they’ve found a secret that no one is trying to keep secret.
These are lucrative early days, and they are numbered in Ethereum blocks.
Convex seems to have found the best way to capitalize on Curve’s early days. Its method worked so well that there was a short-lived Curve war this year, where three different projects were struggling to be the biggest holders of CRV: StakerDAO, Yearn Finance and Convex.
Convex won it quickly and decisively, and its lead grows every day. But in a space as big and complex as DeFi, one might be wondering: Why just three in the race?
WormholeOracle’s proposal is intended to allow more combatants to enter the fray and fight for control of this very important yield engine.
As the proposal author put it in an email to The Defiant, “Some ambitious dev team smarter than I am should be able to launch their experimental app tomorrow, and then see if they can build a community and attract attention from the market. Innovation should be market driven, not decided by a collection of DAO voters who may be motivated by other concerns.”
Not everyone agrees. The main objections, per GoodGirlGoneCrypto, appear to be stopping spammers, and, per Mask, scammers. Which apparently means flash in the pan projects looking for a quick money grab. The Convex team declined to comment on the proposal to The Defiant. The Curve team did not reply to a request for comment.
Because Curve is particularly important for stablecoins, one might think stablecoin projects would want to accumulate a lot of veCRV, but the stablecoin projects themselves can’t hold and vote CRV directly.
The point was for yield-bearing CRV to not be tradeable, and veCRV can’t leave the wallet that creates it. CRV is only allowed to be voted by wallets, not by smart contracts. This is because, as the Curve documentation explains, smart contracts could tokenize staked CRV, and Curve’s team did not want that early on.
But Curve has approved those aforementioned three smart contracts to hold CRV, and they have all made tradable derivatives of veCRV anyway. So that protection hasn’t worked. And only those three have succeeded in getting whitelisted, and they all get to vote on whether or not to let in new entrants.
In DeFi, smart contracts can create flywheels that allow them to swiftly compound specific gains in a token. If more smart contracts were whitelisted, it’s unlikely to disrupt Convex, but several could chip away at its relative weight. It’s an oversimplification, but to no small degree, much of the business of crypto is making the public confident about a token.
Liquidity — that is, a lot of people willing to buy and sell a thing, in volume — inspires confidence. Curve is always willing to buy and sell, but it can’t sell more than it has. So Curve is on some level an easy way to amp up liquidity on a token, if its promoters can persuade holders to entrust it in Curve.
Free money is a great incentive. That’s why token projects fight for LPs for their tokens’ pools to get free money in the form of CRV. Magic Internet Money cares about its stablecoin MIM. Frax Finance cares about its stablecoin FRAX. BadgerDAO basically cares about all the tokenized versions of Bitcoin.
They are three of the largest entities now working to have as much influence as they can within Convex, each using its own distinct strategy. They are doing this because they are shut out of doing the same on Curve directly.
“It’s about having an influence around where CRV emissions go,” Spadafora said. It’s really the amount of CRV emissions that defines the yield on a pool and yield drives liquidity.
Monopoly Over Governance
Kazemian was more frank. “By being able to control where those rewards go, you are basically able to decide where the liquidity of stablecoins on ETH, and elsewhere as Curve expands.” As someone running an algorithmic stablecoin, he can basically see a path to where his algorithmic coin has more ready liquidity than the leading algorithmic coin, TerraUSD (UST).
That’s why Frax has made growing its power within Convex a priority. “Convex has adroitly positioned itself as the arms dealer of this ongoing “war”. And it has become the greatest beneficiary of all the action,” Wormholeoracle said. “It’s on track to have a monopoly over Curve governance.”
There is a total circulating supply of 413.5M CRV. Of that, 133.8M are controlled by Convex right now. But it’s not like Convex itself has a dog in the fight about whether the, say, Fei metapool or the Aave tokens pool has the sweetest rewards.
Even if Convex completely took over Curve governance, you can make the case that it would just be a new venue. “Convex still has a voting system of its own and all Curve proposals get passed through,” Winthorpe said. “The system would still be decentralized.”
Yields in CRV to Curve’s pools get revisited every 10 days. It’s a straight vote by CRV holders who have staked. There’s a certain amount of CRV that comes out every block and they vote on which pools get more CRV and which gets less. A healthy distribution of CRV is the key to strong yields for a pool on Curve, and a strong yield pool is a useful thing for all the yield aggregators (like Yearn) and all the advanced yield farmers out there to build a strategy on.
But how Convex weighs in on CRV reward changes isn’t decided by Convex staff, but by CVX holders. In fact, Curve LPs can boost yields further by staking the CVX they earn and getting bribed to vote for good CRV yields on certain pools. Many times, a new project will offer some of its own governance token for a favorable vote, which makes for yet another way Convex enables a yield boost.
Bribes might feel a little weird to some out there still enamored with the bright future of transparency that crypto — particularly Ethereum — has promised.
One could argue: The more things change, the more they stay the same.
This next little bit is going to rattle off a lot of token names. It can’t be helped. This is the mental tax everyone pays for doing DeFi. At this time, Convex controls the largest bloc of voting weight on Curve. And here’s the thing about Convex: If you hold one Convex token, CVX, your voting power in Curve grows, but if you use CRV directly to weigh in (as veCRV) , it shrinks.
See, veCRV is always decaying in power. Every day your vote is just a little less (unless you spend gas to relock), but CVX grows in power, because Convex earns all kinds of CRV and it locks some of that CRV up forever in its smart contracts. It’s CVX that actually votes on Curve rewards, and each CVX is voting a growing pool or veCRV.
Even if everyone pulled all their LP tokens and CRV out of Convex at once, CVX holders would still be incredibly influential within Curve for a long time. As long as Curve is important to DeFi, Convex will be at least fairly important to Curve.
And that’s a nice position to be in. The power of CVX can actually be seen in its price. CVX is trading very close to parity with CRV itself, whereas Yearn’s veCRV derivative, yvBOOST, trades at a big discount to CRV, now. It’s price started to fall pretty fast after May, when Convex launched.
This approach could be called DeFi 2.1, the sweat strategy. Whereas DeFi 2.0 is all about buying liquidity rather than renting it, DeFi 2.1 is about earning it by leveraging a protocol’s market power to lock in holdings that belong to the protocol, not its individual depositors.
For example, Frax maintains its stablecoin’s peg by expanding and contracting its supply as needed. When it expands, it now buys certain assets it finds useful and holds them. One of these assets it buys is CVX. In other words, it’s able to use the basic mechanics of its protocol to earn more CVX. It’s like protocol sweat. Frax has managed to become a major force within Convex this way, which indirectly makes it a force within Curve.
If it weren’t for the whitelist, though, Frax could do the same thing and buy CRV, becoming a force within the Curve DAO directly.
Spadafora doesn’t believe Curve needs the protection of the whitelist any longer. “I believe Curve has reached that point of inflection that it’s really not going anywhere,” he said. And with Curve 2.0 and its dynamic peg coming, Curve will begin making markets for volatile tokens as well as like-priced tokens. All of those volatile tokens want deep liquidity just as much as the new stablecoins do.
“Imagine how many fat DAO treasuries are going to be spending as much money as possible to have huge influence on that,” Spadafora said. “That’s really going to be a massive explosion that’s going to be happening soon.”
But he doesn’t think those entities should have to look for ways to do that indirectly, as BadgerDAO has had to. They should be able to belly up straight to the Curve DAO, as the three OGs can.
There’s still almost 3B CRV that have yet to be minted. That’s a lot of yield driving potential left to go, for new projects that wish to place their bet on Curve as a way to build confidence in whatever their new idea is.
Either lots of projects can take part in leveraging all that forthcoming yield by wiring straight into Curve, or Convex can grow its current lead into becoming the one venue for picking winners and losers. Which outcome sounds more true to the decentralized spirit of this industry?
“DeFi is poised to take over the world, and Curve is poised to be the backbone of DeFi,” Gerrit, author of the Curve Market Cap newsletter told The Defiant.
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