The current market environment presents a challenging backdrop for an asset like Ethereum ($ETH), which despite a recent spot ETF launch, has not managed to come out on top of a so-called “identity crisis”. Such sentiment setback has been caused by Ethereum L2s, which contrary to expectations that they would be the unlock for Ethereum scalability, have been perceived by the market as “parasitic to the L1”. The argument behind that claim is that L2s have decreased mainnet activity and caused $ETH to no longer be a deflationary asset.

Source: TradingView – $ETH and Ethereum L2 tokens have notably underperformed $BTC since the start of the year.

Many investors already hold $ETH, resulting in limited rotation into the asset at current levels. Since the market doesn’t perceive the asset as “cheap”, the current large market cap is acting as a gravitational force against which it is very challenging to experience a “hated rally”.

Source: Kaito.ai – We saw yearly all-time-lows for $ETH sentiment just a couple of days before the US elections and anticipated rates cuts, all while memecoins and AI tokens showed remarkable strength and managed to outperform the market, with most deployments being concentrated in the Solana ecosystem.

Simultaneously, while Layer-2 solutions (L2s) continue to gain traction in the form of TVL and active users, their respective tokens continue to underperform. Sequencer revenue is not being shared with token holders and, as a result of not being cash-flow generating assets, L2 tokens have underperformed due to frequent and sizable token unlocks.

Source: DefiLlama – Despite the success of their ecosystems, token unlocks have created a big divergence in L2 tokens that don’t share revenue with token holders ($ARB in the image above, down 75% since the start of  the year).

Even if one wanted to get exposure to Ethereum L2s, the fact that the technology has now been commoditized makes it even more complicated to pick winners. Everyone wants to have their own chain nowadays, and the advent of Rollup as a Service (RaaS) currently makes it very easy to spin up a new L2 in just a few clicks. This oversupply and lack of differentiation makes picking a standout winner difficult.

Source: Conduit.xyz – Today, the barrier to entry for launching a dedicated rollup is very low. There are multiple RaaS providers that can handle the infrastructure and tooling required.

Amid this complexity, Coinbase’s Base has emerged as a standout within the L2 space. Built on the OP Stack, and lacking a native token, it has ignited refreshed network effects for the OP Stack, acting as a magnet for an increasing number of L2s to start joining the Optimism Superchain. Leading protocols on Base, such as Moonwell (lending) with the $WELL token, and Aerodrome (DEX) with $AERO, have become popular entry points as a proxy for Base exposure in a portfolio.

Source: TradingView – The base ecosystem has outperformed, as people looked for ways to get on-chain exposure to Base via leading tokens such as $AERO and $WELL being the leading DEX and money market respectively.

The Superchain vision, powered by the OP Stack, seems to overcome one of the major challenges in the Ethereum ecosystem: cross-chain L2 interoperability as a solution for liquidity fragmentation. This vision is designed to enable a seamless, interconnected network of chains—including Coinbase’s Base, Kraken’s Ink, and other DeFi and RWA-focused chains.

Source: OP Blog – Optimism has evolved from a single L2 chain to the foundation of the Superchain, a network of interoperable blockchains built on a shared codebase and governance model.

However, the $OP token itself faces drawbacks as an investment, given its use for frequent grants, diluting its appeal as a stable asset. In this context, Velodrome has distinguished itself by evolving from a simple DEX on top of Optimism to becoming the liquidity hub for the Superchain. We think $VELO is currently the most promising proxy for the broader Superchain’s growth, extending beyond Base’s Aerodrome by targeting cross-chain liquidity and competing on par with industry leaders like Uniswap.

Source: Hyperlane Blog – Collaborating with Hyperlane, a rising player in interoperability, Velodrome has introduced Superlane, a dual-layer for cross-chain functionality.

With the OP Superchain likely becoming the main on-ramp to Ethereum’s ecosystem, Velodrome’s $VELO holds strategic positioning as a vehicle for direct exposure to this vision. The potential for a merger with $AERO is also a possibility that is not completely off the table, and that would accelerate the $VELO repricing while consolidating Velodrome’s dominance not only on Base but across the entire Superchain.

With no VC funding and the team locking their allocation, Velodrome has proven its capacity for innovation beyond the misconception of being a simple Solidly fork. This has been demonstrated in production with features like Slipstream, concentrated liquidity, and Superlane (a cross-chain xVELO ERC20 model with emissions and voting capabilities across the Superchain), making it more than just a basic DEX. Positioned as a direct competitor to Uniswap and its most recent Unichain, Velodrome’s strategic vision is supported by a skilled team that has been collaborating with L2s building on the Superchain for over a year.

Key Takeaways

• Investment Thesis: Velodrome is evolving from a ve(3, 3) DEX to becoming the cross-chain liquidity backbone of the Optimism Superchain, expanding the current incentives layer across the Superchain’s expanding L2 ecosystem.

• Positioning and Exposure: Given $ETH’s underperformance and the absence of value drivers for L2 tokens such as $OP, we find in $VELO an opportunity to capitalize on a rerating as it becomes one of the most critical and direct proxies to the Superchain thesis.

• Ecosystem Synergies and Network Effects: Partnering with Hyperlane for cross-chain capabilities can give Velodrome a competitive advantage over incumbents like Uniswap’s Unichain, enhancing interoperability with RWA, DeFi, and a broad variety of chains joining the OP Stack ecosystem.

• Expansion and Growth Opportunities: A potential VELO-AERO merger, if realized, could consolidate market leadership in L2 liquidity. As the Superchain grows, the de-facto DEX would capture network effects and accelerate adoption finding synergies through token incentives in the form of bribes and veVELO locking.

• Risks and Invalidations: As a ve(3, 3) DEX, the sustainability of token emissions remains uncertain and requires close monitoring. Additionally, DEX tokens and DeFi interest generally are experiencing limited buy-in.

• Abrupt Competition: With AERO’s success tied to Base, VELO’s reliance on the broader Superchain thesis makes it vulnerable to Base-specific competitors if the Superchain narrative doesn’t drive sustained adoption.

• Conviction and Relative Value: As AERO mirrors Base, VELO may see a repricing if the Superchain gains traction; With a market cap below $100M and FDV just around $150M, Velodrome would offer Superchain exposure with limited downside given its organic growth without VC backing and max-locked team incentives.

Overview

Born out of the original idea presented by Andre Cronje introducing the ve(3, 3) Solidly DEX, Velodrome operates as a MetaDEX—that is, a DEX that merges the functions of an Automated Market Maker (AMM) for both volatile and stable pairs with an incentives layer designed to coordinate token emissions and align interests across participants. By combining key elements from Curve’s veModel, Convex’s boosts and optimizations on top of veTokens, UniV2, UniV3, and Automated Liquidity Managers in collaboration with Mellow Protocol, Velodrome provides a comprehensive platform where traders benefit from lower slippage, liquidity providers (LPs) earn fees from higher volumes, and token holders capture protocol fees while LPs gain additional token emissions.

Source: Velodrome on X – In a ve(3, 3) DEX token holders can lock their tokens to gain voting power and earn protocol fees from the pools they vote for. In return, liquidity providers earn token emissions, incentivizing them to add more capital to attract higher trading volume and, therefore, increasing amounts of fees for token lockers.

At the heart of this ecosystem is $VELO, the ERC20 utility token that is locked and removed from circulation, with positions tokenized as veNFTs. Ownership of veVELO NFTs confers voting power to influence the allocation of liquidity incentives. Since lockers earn fees from the pools they vote for, they have an incentive to vote for those pools driving the most volume.

Source: Velodrome Medium – Supporting these locked positions, Velodrome Relay automates position management, enabling protocols to direct emissions, maximize voting efficiency, and manage rewards, making it seamless for both liquidity-seeking protocols and users optimizing their returns.

Velodrome’s veVELO holders wield significant influence within the ecosystem, directing $VELO rewards to specific liquidity pools and earning 100% of the fees from pools they support, in addition to voter incentives (also called “bribes”) from each epoch. This mechanism enables fee-generating pools to reach self-sustainability, reducing the need for partner protocols to continuously supply incentives, thus lowering operational costs and promoting a more efficient liquidity provision model. In return, Liquidity Providers (LPs) in Velodrome benefit from steady, time-based farming rewards, allowing for consistent returns independent of market volatility—a marked improvement over other concentrated liquidity AMM (clAMM) implementations that solely rely on swap fees.

Source: Blockbeats – The ve(3, 3) flywheel is a game theoretical attempt to align incentives between token holders, liquidity providers, and traders by encouraging long-term participation and protocol sustainability.

Expanding beyond a traditional DEX, Velodrome is now evolving to become a chain-level incentives layer. What started as a dedicated AMM on Optimism is progressing toward a comprehensive MetaDEX model serving interconnected L2 chains in the OP Superchain.

Source: Blockworks Research Superchain Dashboard – Currently, nine Superchain L2s have locked veVELO and collectively committed over $4 million in incentives to boost liquidity on their chains, a trend set to continue as more L2s adopt and lock $VELO.

From a growth perspective, it is worth noting that the Superchain itself now encompasses more than 50 chains, with Velodrome intending to provide seamless liquidity infrastructure across this network, ensuring deep on-chain liquidity for essential assets like $ETH, $WBTC, $OP, $USDC, LSTs and LRTs, and more. Through invisible cross-chain interoperability, Velodrome’s infrastructure supports swapping, voting, and incentives across all Superchain networks, accessible in a streamlined experience via Velodrome’s front end. Importantly, all of this occurs by tapping into LPs across the Superchain without vamping the TVL of the respective chain—this will be achieved with an upcoming feature called “Superswaps”.

Source: Hyperlane Blog – On October 16th, 2024 Velodrome and Hyperlane announced SuperLane. Available to all rollups in November 2024, it is an interoperability solution for shared liquidity and interchain applications on the OP Superchain.

The actual evolution from Velodrome being a simple ve(3, 3) DEX to an interchain liquidity layer cannot be easily replicated, as we are talking about a grassroots project with no VC backing with an already consolidated brand and long track record. Unlike typical projects that raise funds by selling tokens to VCs—who then expect rapid token price appreciation to realize returns—Velodrome sidesteps all sorts of short-term pressures. Without VC-imposed benchmarks or investor exit pressures, Velodrome can focus on strengthening its value proposition partnering with ecosystem projects and boosting its credibility. The team’s token lock-up also underscores their commitment, fostering trust among users who recognize the team’s vested interest in the protocol’s longevity rather than immediate liquidity from unlocked token sales.

Source: Velodrome on X – Through Velodrome’s integrated dashboard, users can easily track deposits, rewards, and positions without the need to switch between chains, providing an improved user experience by consolidating liquidity rewards and positions. Tokens across all Superchain L2s are searchable within this unified interface.

The Superchain’s network effects are the most powerful competitive advantage and tailwind for Velodrome at the moment, offering broad exposure to diverse Layer-2 chains, including OP Mainnet as the governance hub, Zora for NFTs, Lisk for Real World Assets (RWAs), Worldchain for Proof of Humanity (PoH), DeFi-focused chains like Mode and Fraxtal, and more market verticals that will eventually arise, such as DePIN or social, or even more large entities following Sony’s playbook with Soneium. This interconnected network—backed by a combined total value locked (TVL) in the billions—continues to grow as more chains join, positioning Velodrome at the forefront.

From a competitive standpoint, Curve and Uniswap are the two most prominent DEXs, and they also have the ability to enable cross-chain functionality, with the former launching their own chain, and the latter via friendly forks with revenue-sharing agreements. However, both face enduring challenges in sustainably incentivizing user participation and aligning contributors. For instance, the lack of revenue distribution to $UNI holders places the onus on Uniswap Labs to seek alternative monetization avenues, such as frontend fees, which disproportionately benefit the company rather than users. As $UNI tokenholders don’t participate in protocol earnings, they also lack a financial incentive to engage with governance. Similarly, Curve’s community is dispersed across derivative protocols with their own incentive structures.

Source: Coingecko – Market Cap and FDV of $UNI, $CRV, $VELO and $AERO

A token economy is fundamental for the success of a DEX, and failing to share value with token holders leads to a setup that fails to incentivize LPs to stay, making it easy for them to migrate to platforms offering more comprehensive value-sharing mechanisms. That’s the opportunity that $VELO must tackle to slowly take market share out of Uniswap and narrow down the large capitalization gap that exists between $UNI (above $4 billion in market cap) and $VELO (under $100 million in market cap). Unlike traditional businesses that benefit from passive investors, decentralized systems gain resilience and adaptability from active token holders. Tokens that both distribute and manage value encourage participants to act in the protocol’s long-term interest, driving growth beyond the promise of future distributions or “governance value”.

Thesis

Our thesis is that $VELO offers a good risk-reward opportunity at the present price levels to bet on Velodrome becoming the Superchain’s Hub. It is currently being valued as a DEX token and we don’t think the interoperability component is being priced in. Outpacing rivals like the Polygon CDK, the ZK Stack, and Arbitrum Orbit chains, the Superchain is rapidly building momentum, with Velodrome as its key cross-chain liquidity layer poised to disrupt incumbents like Uniswap.

Source: Kaito.ai – Unlike $AERO, $VELO has been moving sideways in both price and mindshare.  Despite being the parent protocol, $VELO’s market cap is currently 8x lower than $AERO’s

Uniswap’s recent moves further validate this idea and reinforce the thesis. Importantly, Velodrome has been closely collaborating with Superchain L2s to build according to their needs. Furthermore, the reason why Velodrome can afford to do so is because they are an incentives layer in addition to a DEX, further facilitating partnership and integrations via strategic $VELO locking for voting power and incentives alignment. Contrast this with Uniswap, where the $UNI token has been only useful for governance purposes so far. Even though $UNI will have extra utility with Unichain, the token is already in the top 25 by market capitalization with $4.6 billion in market cap and a $7.7 billion fully diluted valuation.

While Uniswap is prioritizing vertical integration and new revenue sources for the main development company via frontend fees, the Uniswap wallet, etc, Velodrome is prioritizing a synergistic model where veVELO holders (now predominantly L2s in addition to DeFi protocols) and additional voter incentives attract liquidity and strengthen ecosystem growth, creating a self-sustaining liquidity engine where value accrues to the $VELO token itself. As more partners lock tokens, $VELO experiences a natural supply sink, reducing the circulating supply.

Source: Kaito.ai – Contrary to the quick repricing and sentiment spike in $UNI in Q1 when a proposal to turn on the fee switch was posted on the forum, the announcement of Unichain barely moved the needle in terms of price action despite a sudden mindshare increase.

Notably, the team has locked their allocation for the maximum duration and, without reliance on VC allocations and their subsequent unlocks, they have an incentive to grow Velodrome and capitalize via cash flow and protocol revenue, instead of hoping to sell their token allocation at higher prices. Unlike most DeFi protocols, which raise VC money and where insiders hold a large share of tokens, Velodrome overcomes the principal-agent problem by locking all team tokens and tying the team’s financial outcomes with those of long-term token holders and users.

Source: Coingecko – There is an asymmetric opportunity and big upside in $VELO if the thesis plays out.

Invalidations

Despite Velodrome’s compelling growth story, there are also several risks that could undermine the long-term viability of the thesis. Even though there has been more optimism around the “DeFi Renaissance” narrative, DEX tokens and DeFi assets, in general, have faced waning investor interest, limiting the appeal of $VELO in an environment dominated by AI. Additionally, the market’s attention on VELO could be diluted by its proximity to $AERO, as $AERO’s success may be more a reflection of Base’s popularity rather than underlying demand for cross-chain liquidity solutions.

Conclusion

We believe that at the current capitalization levels, $VELO offers exposure to both growth and cash flow opportunities that capitalize on the network effects and upcoming catalysts for the OP Superchain. Especially as Ethereum struggles to find a narrative on its own, we believe that positioning by core tokens for the Superchain can give more upside opportunities that directly outperform $ETH and $OP respectively.

With veVELO incentives and coordination with partner chains, Superlane interoperability, and future Superswaps, our view is that Velodrome is differentiated enough to directly compete face-to-face versus competitors like Uniswap. The latter has been facing setbacks in both mindshare and economic strategy, while $VELO is now exposed to a large (and growing) number of tailwinds while the $VELO market cap is more than 60 times lower.

Disclosures

Revelo Intel has never had a commercial relationship with Velodrome and this report was not paid for or commissioned in any way.

Members of the Revelo Intel team, including those directly involved in the analysis above, may have positions in the tokens discussed.

This content is provided for educational purposes only and does not constitute financial or investment advice. You should do your own research and only invest what you can afford to lose. Revelo Intel is a research platform and not an investment or financial advisor.