Weekly Gauge #57: Multichain Liquidity Migration

Impact on voting incentives dynamics

As Ethereum grapples with soaring gas prices, scalability concerns back in front of the scene. The focus has inevitably shifted to Layer 2 solutions, gaining significant traction over the past year. In this exploration, we zone in on the Balancer ecosystem to scrutinize the pervasive adoption of L2 solutions, not just among liquidity providers, but within governance frameworks.

Our primary query: What intricate connections unfold between Balancer's liquidity providers and governance token holders, and how do these dynamics are impacted by the development of Layer 2 solutions?

1. how much TVL growth L1 vs L2

Let’s start with analyzing the evolution of liquidity depth on Balancer by network; while we can observe a strong dominance of Polygon and a clear correlation with ethereum cash flows during 2022 and early 2023, a shift has happened during last summer characterized by the strong growth of alternative L2s led by Arbitrum. 

The decline of Polygon liquidity was balanced by other layers’ growth, and Ethereum TVL experienced volatility between $500M to $1B. This evolution reflects the trends of voting incentives for the DEX’s gauges.

2. how much incentives growth L1 vs L2

It is possible to observe a divergence between mainnet and L2 growth or decline in voting incentives, considering that the total value distributed tends to stay flat we’d be naturally tempted to explain the divergence by a simple migration of liquidity, directed solely by gas efficiency.

Nevertheless, as we saw in the first part of this article, Mainnet TVL is experiencing as much if not more liquidity inflow than L2s, meaning changes in vote incentive creators’ behavior is driven by another catalyst.

The data sample used to build the chart above indicates on which network type (Mainnet or L2) the voting incentives are created, however a brief history point is necessary to understand the impact of layer 2 growth over governance markets at a structural level. 

Tetu pioneered the ecosystem’s higher stack expansion with the creation of a veBAL locker on polygon facilitating its governance on the side chain. Although it managed to attract over 6% of the veBAL supply it wasn’t enough to sustain the liquidity inflow toward the network, as we saw in the first part of this article the TVL on Polygon reduced significantly following the early 2023 bootstrap.

3. L2 Foundations Grants as catalysts 

To fulfill the vision and guidelines of layer 2 foundations, generally oriented toward the growth in TVL and diversity of the DeFi stack built on top of the network, grants programs are issued systematically stirring up drama and controversy on the crypto twittering scene. 

While the heat is often deserved on proposals posted by mercenary or inactive projects; a number of initiatives harnessing governance markets as strategic incentive distribution channels to drive growth have proven to be very efficient. Let’s name a few:

Optimism: 

Velodrome, 1st Grant from July 2022 distributing 3M OP tokens, among primary objectives boosting ecosystem efficiency with vote incentives matching. Over one year the project contributed to onboard over 30 new protocols to Optimism through governance markets, generating over $1B volume on subsequent new pools.

All details at: https://gov.optimism.io/t/velodrome-grant-performance-update/5998 

Arbitrum:

Balancer, $1.2 million ARB dedicated to incentivize Arbitrum pools, with primary focus to foster the 8020 governance paradigm and assist ecosystem projects with onboarding. Supported by the joint deployment of Aura on Optimism, Gnosis, Polygon, Base, and Arbitrum, we observed in the first part of this article the significant growth of all these layers’ TVL. 

All details at: https://medium.com/balancer-protocol/the-balancer-report-why-l2-grants-are-important-eb62f45d2f36 

Overall, grants programs from layer 2 foundations found a very synergistic and efficient approach to bootstrap liquidity by leveraging gauge systems, enabling the complete automation of incentives distribution. Furthermore this encouraged vote lending marketplaces and other projects of the DeFi stack to expand and deploy directly on L2, although it was already possible to incentivise L2 based gauges directly from mainnet. 

4. Transition of voting incentives from L1 to L2

Driven by the incentive matching mechanisms, during the past 20 weeks, the number of pools incentivised on L2 for Balancer / Aura emissions increased from 10 to 30 which represents a change from 30% to more than 50% of the incentivised pools.

In conclusion, the Balancer ecosystem undergoes a transformative journey from Mainnet and Polygon dominance to the rise of other alternative layers, particularly Arbitrum. The migration narrative extends beyond mere gas efficiency, uncovering a nuanced interplay between liquidity providers and governance token holders. While L2 grants programs catalyze liquidity influx, questions linger. The catalyst for the migration of liquidity from the mainnet to L2s hinges on more than gas efficiency; it reflects a strategic alignment with governance incentives. 

The correlation between vote incentives and cash flows on L2s emerges as a focal point, unveiling the intricate dynamics of veDEXs. Furthermore, as the depth of L2 pools trails mainnet, the exploration of whether the attracted liquidity carries the same cost per dollar raises pertinent considerations. This prompts a future exploration into the intrinsic value of liquidity from a governance perspective, delving into sustainability and efficiency.