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What Are the Curve Wars? (The Secret of Attrition)

By Todd Mei PhD | Crypto U Education | 11 Jan 2023


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Wars of any kind are never pleasant. Even in the crypto space, or I should say especially in the crypto space, things can get quite hot with the amount money and degree of egoism involved.

The Curve protocol (apologies in advance for the Tolkien analogy!) became the equivalent of the Lonely Mountain, where the five armies of goblins, orcs, humans, dwarves, and elves fought. A lot of posturing and strategizing until one winner broke through by the hand of attrition.

at·tri·tion
noun
the action or process of gradually reducing the strength or effectiveness of someone or something through sustained attack or pressure.

Before launching into a basic explainer about the Curve protocol, you might want to brush up on another decentralized finance platform in Uniswap. This is because part of Curve’s innovation involves making improvements to what Uniswap offers with respect to making passive income when providing liquidity to pools. To recall, liquidity providers make their money by claiming a portion of the transaction fees for borrowing, buying, etc. which is based on the percentage of liquidity they provide to the pool.

Pitching the Curve

One of the most signficant problems with trying to make money when providing liquidity to decentralized finance pools is impermanent loss. It’s a huge topic. You can read more about it here. But for our immediate purposes, all you need to know is that one way to eliminate the risk of impermanent loss is to reduce volatility. If the assets deposited in a liquidity pool can remain stable with respect to value, then liqudity providers do not have to worry about whether or not they would have been better off not depositing their money at all.

Enter Curve.

Whereas Uniswap allows traders to swap any ERC-20 token, Curve is specifically for trading stablecoins on Ethereum. Yield farming with stablecoins is inherently less volatile and less vulnerable to impermanent loss since the value of stablecoins is less likely to fluctuate significantly.

Curve also changed the formula according to which its pools operate. Instead of the XYK constant product formula, Curve introduced a more complex formula:

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In short, Curve’s “stable swap” formula flattens the price curve which, in turn, minimizes slippage in prices.

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But there’s more. Yes, an updated version . . .

Yet Another Curve

Curve V2 is an update to the Curve lending protocol that occurred in June 2021, and was aimed at taking over the Decentralized Finance space. Its main innovation was to allow users to trade non-pegged and non-correlated assets, whereas prior to V2 the Curve pools involved only stablecoins and/or value correlated assets. So, for example, V1 involved trading assets of equal, pegged value–such as, ETH and stETH. V2 allows users to trade coins like ETH and USDT.

In addition, like Uniswap V3, Curve V2 uses concentrated liquidity to optimize return on deposits to a pool. Per Curve:

“Crypto pools use liquidity more effectively by concentrating it at current prices. As trades happen, the pool readjusts its internal price to the highest liquidity region without creating losses for the pool. Crypto pools also have variable fees which can range between 0.04% and 0.40%.”

As you can imagine, with the kind of trading activity involved in liquidity pools, the coins that are bought and sold can benefit the protocols who create those coins. If there are two pools — one of which trades ETH and USDT, the other of which trades ETH and USDC — then whichever has more activity will have knock-on effects for the attractiveness of that coin. Trading volume matters:

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This is one of the factors in understanding how the Curve Wars emerged. We can see things heating up according to the action that took place in Curve’s 3Pool.

Curve’s 3Pool

The 3Pool or tripool is a liquidity pool offering three stablecoins to trade–i.e. USDC, USDT, and DAI. The main benefit of a third liquidity asset is to make trading more efficient. Instead of being limited to two coins, a third coin adds much more trading dynamic and efficiency. It therefore provides extremely deep liquidity for trading.

3Pool is specific to the stablecoin triplet named above, but you can find other pools on Curve that trade in triplets, e.g. Tricrypto2.

The way depositing works in the 3Pool is different from your typical liquidity pools where you have to provide equal value amounts of the two coins that are paired. With 3Pool, you can deposit any one of the stablecoins, which will then subsequently be portioned out by the pool according to the three stablecoins. The 3Pool site will show you the amounts of the stablecoin in the pool. Providers can gain a small bonus when depositing the coin that is substantially lower than others.

Withdrawing works similarly in that providers can withdraw their deposits in any one of the three stablecoins.

One of the risks of pools with more than two coins is that if providers don’t like one of the coins and feel it is a risk, then there might be an imbalance of withdrawal proportions. So, for example, if for some reason there was a problem with USDT that was market-wide, providers would see the 3Pool as a potential problem. They are most likely going to withdraw their percentage of the pool, and do so in one of the other coins (i.e. not in USDT). If there are enough providers doing the same, then the pool balance would weigh heavily in USDT.

So now we are set to understand how the Curve Wars arose. The setting is the trading activity in Curve’s liquidity pool. But what was the prize and incentive?

More plunder, of course.

The Curve Wars

The Curve Wars are essentially the battle of various platforms to gain as much of Curve’s governance token (veCRV) as possible. Think of it akin to a basic fantasy or political series in which various kingdoms vy for the control of a central territory. Instead of gaining power through brute force (orcs, elves, dragons, or whatever), the Curve Wars involve gaining power through the accumulation of the token, veCRV. The more veCRV, the more voting power one has.

What then is at stake with voting power?

Instead of controlling a kingdom, the spoils of the Curve War have to do with how liquidity in the Curve ecosystem is allocated. The more voting power, the more one can direct the spoils of liquidity to one’s own pool.

That’s the gist of the Curve Wars, but as one can imagine the actual storyline is much more complex and interesting.

First, let’s provide some context that is somewhat counterintuitive.

The Story of an “Enchanted” Tokenomics

There is nothing unique to Curve’s tokenomics. Like many protocols, it offers two tokens–one that is fungible and can be bought (CRV); another that cannot be bought and is for governance (veCRV).

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In order to obtain the governance token (veCRV) one has to use CRV. In other words, to get more voting power, one has to acquire more CRV. The mechanism by which this occurs is a locking or staking commitment. One has to lock CRV for four years to earn veCRV.

Locking mechanisms do at least two things for an ecosystem:

  • it makes the token to be locked more valuable; and
  • it prevents that token from being dumped as its value rises.

In short, the locking token has value only because it has a utility function in being able to gain voting power.

Why Curve’s ordinary tokenomics became an “enchanted story” had to do with the way in which a simultaneous relation emerged.

CRV became valuable in price AND it also became valuable for governance.

To reiterate, governance is important because it is through governance that those with the most voting power can control the emissions of the CRV token–in particular which liquidity pool gets the most. By Nov 2021, the CRV token had increased in value by 70%, to just under $6.

So the incentive is to get more CRV in order to control the means by which you can get more CRV with little capital sacrifice.

But there is at least one more incentive. By controlling the CRV token emissions and allocating more CRV rewards to one’s own liquidity pool, you attract more liquidity providers and traders to your pool and therefore to use your pool’s tokens.

Attrition: Why Convex Is Winning the Curve Wars

Convex is a DeFi platform built on top of the Curve protocol. It therefore provides a liquidity pool in which CRV can be staked and earned. It is perhaps the real innovator in this story since it took the power of earning veCRV to new heights. Here are three reasons informing its attrition of accumulation:

  1. It improved the locking mechanism of CRV by allowing CRV to be locked and, in effect, usable while locked.
  2. It made getting involved in investing more accessible for smaller investors by allowing them to benefit from aggregated deposits.
  3. It mimicked Curve’s tokenomic incentives for governance.

Locking CRV
Locking CRV for four years to earn veCRV is quite a commitment. With Convex, the stakes (no pun intended!) seem higher. When depositing CRV at Convex, it is locked forever.

However, there is an advantage to this assuming Convex itself does not collapse or lose a great deal in value. When locking CRV, that CRV turns into veCRV, just as in the normal locking process. Yet with Convex, depositors receive a tokenized version of veCRV in return. And that token is cvxCRV (or Convex Curve), which is returned at a 1:1 ratio to veCRV.

What can users do with cvxCRV?

As a listed token, they can trade it.

They can also stake it on Convex, which entitles them to receive “the normal Curve admin fees one would get for staking their veCRV on Curve.fi.” Admin fees are listed on the Curve homepage:

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Staking also allows depositors to receive “CRV from Convex’s performance fee, as well as the platform native token CVX.” This occurs through airdrops.

Aggregation
When CRV is locked forever at Convex, it provides the platform with an aggregated amount of CRV. Essentially, all depositors at Convex reap the benefit of pooling their assets together. This makes it easier for small investors to take advantage of the size of the deposit pool.

Governance
CVX is the governance token for Convex. As a holder, you can stake it for rewards or lock it to vote on allocation of veCRV, just as you can lock veCRV on Curve to decide how CRV is allocated.

As Brady Dale of the DeFiant puts it:

“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, 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.”

Succeed it did.

And while things can change in terms of winners, there is one clear loser.

No One (named Do Kwon) Wins in War

The 4Pool was UST Terra’s attempt to enter and win the Curve Wars. It began in April 2022. Its ploy is obvious, increase liquidity by adding four coins–i.e. UST, FRAX, USDT, and USDC. By leaving out DAI, one of the stablecoins in the 3Pool, Terra was aiming to disrupt Maker’s (DAI’s native protocol) prominence in the market.

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The 4Pool has the same inherent balancing risk as the 3Pool. And well, as we all know, UST became unbalanced to say the least with Terra’s collapse in May 2022. And so ended Terra and the 4Pool.


This article was originally published on Medium and is a part of the Crypto Industry Essentials educational program presented by The Art of the Bubble.

Though this article is credited to me, it contains some written material by Sebastian Purcell, PhD from his The Art of the Bubble education series on cryptocurrencies.

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Todd Mei PhD
Todd Mei PhD

Todd is a former Associate Professor of Philosophy with over 16 years of research experience in the philosophy of work and economics. He is currently the lead researcher and writer for the Web3 consultancy group, 1.2 Labs.


Crypto U Education
Crypto U Education

Cypto U is a series of blogs providing educational content for crypto enthusiasts. Content and lessons have been taken from The Art of the Bubble and 1.2 Labs.

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