Original title: Aerodrome: The Onchain Liquidity Engine
Original author: Bryan Tan & Arthur Cheong
Original translation: zhouzhou, BlockBeats

Editor's note: This article mainly discusses Aerodrome's role as a liquidity engine on the Base chain and its growth potential. By solving problems such as token issuance and stakeholder incentives, Aerodrome has successfully attracted a large amount of trading volume and established a solid liquidity foundation. The article also pointed out that Coinbase's support and the expansion of the Base chain will drive Aerodrome's further growth, with an expected TVL of $4 billion and a monthly trading volume of $50 billion. Overall, Aerodrome is expected to become a key infrastructure in the DeFi ecosystem.

The following is the original content (the original content has been reorganized for easier reading and understanding):

Before introducing Aerodrome, let’s first understand the background of DEX

Breaking the DEX deadlock: Why the traditional model is difficult to work

DEX faces a core problem in its development: how to achieve a balance between multiple stakeholders while maintaining sustainable growth. The traditional DEX model has always been plagued by two major challenges:

1. The balance problem of stakeholders:

DEX needs to serve three different groups at the same time: traders who want to obtain an efficient market, LPs pursuing returns, and token holders who require value appreciation. Uniswap is a typical example of this balance problem. The platform allocates 100% of the fees to LPs, resulting in UNI holders not being able to directly benefit from the protocol revenue. At the same time, Curve tried a compromise approach, with the issuance of CRV being 50% each between LP and veCRV holders, but this model also faces sustainability issues brought about by reduced issuance.

What is the result? The constant tug of war between the interests of all parties often leads to unsatisfactory results for all parties.

2. Token emission dilemma:

The DeFi boom in 2020/21 exposed the drawbacks of fixed issuance plans. Many forked projects of Uniswap v2 competed for liquidity to attract users through inflation, resulting in unsustainable competition. Curve's innovative veCRV system introduced a bribery mechanism to guide liquidity, but it also brought unexpected consequences: voters began to hunt for personal interests through bribery rather than supporting a pool of funds that could bring sustainable income to the protocol.

Even though Andre Cronje’s Solidly attempted to address these issues, its design flaws made it less effective: large upfront issuance and abuse of token whitelisting ultimately undermined Solidly’s effectiveness.

Each generation of DEX design has attempted to address these fundamental issues, but none have been able to fully crack them — until now.

Aerodrome: The MetaDEX Revolution

Aerodrome combines the best features of previous DEXs: it uses a token economics model inspired by Curve and Convex to optimize governance and token issuance, and a Uni v3-style centralized automated market maker for efficient capital exchange, while improving on Solidly’s code.

These features provide a solution to align the incentives of various stakeholders, making Aerodrome the preferred trading venue for users.

·veAERO holders:Receive 100% of the fees and bribes from the pools they vote for. This mechanism incentivizes them to direct token issuance to high-volume, high-fee pools, which is beneficial to the protocol as a whole.

·Liquidity providers:Receive 100% of AERO issuance rewards, incentivizing them to invest capital in the highest-yielding pools.

·Traders:Enjoy deep liquidity on DEXs, allowing for superior execution compared to other venues.

Notably, since the launch of Aerodrome Slipstream (Uni v3-style clAMM) in April 2024, Aerodrome’s DEX market share on the Base chain has surged to 63%, successfully replacing Uniswap’s position.

Image source: DeFiLlama as of 3rd Nov 2024

Aerodrome Slipstream has achieved growth in total trading volume while being more capital efficient overall on the Base chain than Uniswap V3. This dominance is even more pronounced when considering the scam token pools on Uniswap.

Source: DeFiLlama as of 3rd Nov 2024

In addition, Aerodrome also generates the highest fee income among all dApps on the Base chain.

Source: DeFiLlama as of 3rd Nov 2024

The rise of decentralized exchange giants: The rapid rise of Aerodrome

In the past year, Aerodrome’s total locked value has soared 12 times to US$1.3 billion, accounting for about 50% of the total TVL of the Base chain. Notably, Aerodrome’s TVL continued to grow from March to September despite market volatility, demonstrating strong resilience.

Image source: DeFiLlama as of 3rd Nov 2024

Meanwhile, Aerodrome’s monthly trading volume surged 111 times, reaching $16.5 billion in October. In addition, Aerodrome’s share of overall DEX trading volume has risen to 8.5%. Even more impressive is that Aerodrome has maintained its trading volume growth despite a decline in overall DEX trading volume over the past few months.

The Coinbase Effect

Base L2 plays a key role in Coinbase’s strategy to drive utility for cryptocurrencies and simplify the complexity of on-chain transactions. Coinbase has led multiple ecosystem initiatives, such as integrating Base into the Coinbase Smart Wallet, hosting hackathons, and partnering with Stripe and others to support fiat-to-crypto conversions on Base. As a result of these initiatives, Base is now the largest Rollup with $2.7 billion in locked value, and these funds are being effectively utilized on-chain.

Source: DeFiLlama as of 3rd Nov 2024

As the largest dApp on the Base chain, Aerodrome is benefiting from Base's rapid expansion. Base's daily active users and daily transaction volume have steadily increased throughout the year, further driving the use of Aerodrome.

Source: Artemis

Almost 10% of veAERO is held by protocols on the Base chain, which increase the liquidity of their governance tokens by locking up AERO and voting to direct token issuance to their own funding pools. As the number of users and economic activity on Base expands, it is expected that future protocols launched on Base will also adopt similar strategies, driving market demand for AERO tokens.

Economic activity on the Base chain has also increased further due to Coinbase's decision to launch cbBTC to challenge WBTC, and cbBTC's TVL has grown to $839 million since its launch on September 12.

Aerodrome is the biggest beneficiary of this development as it consistently accounts for about 80% of the volume of the cbBTC trading pair. This is not surprising as cbBTC is fungible on-chain with BTC on Coinbase CEX, which will drive arbitrage flows between CEX and DEX. As the largest and most liquid trading venue on the cbBTC chain, Aerodrome will naturally become the carrier platform for most arbitrage flows.

Image source: @seoulon Dune Analytics

In addition, we believe Coinbase has a strong case for supporting Aerodrome's growth. Coinbase Ventures has accumulated a large AERO position (~$20 million), which we believe is Coinbase Ventures' largest single investment ever. They purchased these AERO tokens through the open market and locked up a portion of them to obtain veAERO.

Coinbase Ventures is an active participant in Aerodrome's governance, voting in favor of directing AERO token issuance to the cbBTC funding pool, further consolidating Aerodrome's market dominance. This also once again proves the close connection between Aerodrome and Base and Coinbase, which will make the protocol a cornerstone financial infrastructure of Base L2.

The DeFi Renaissance on Base

As we outlined in our DeFi Renaissance Theory, we believe DeFi is experiencing a new wave of liquidity driven by new innovations. Given Base’s strong competitive advantage as a leading L2 and its direct connection to the Coinbase distribution channel, we believe Base will be an ideal candidate for DeFi to thrive.

We envision a future where Base will become the primary on-chain venue for retail trading, arbitrage volumes, and stablecoin foreign exchange flows. As the lifeblood of Base’s liquidity, Aerodrome will benefit greatly from the realization of this future.

Given that cbETH and cbBTC trading pairs are already live, we would not be surprised if Coinbase expands its coverage of wrapped assets and brings them to Base. Having large, high-volume trading pairs like cbSOL, cbDOGE, cbPEPE will incentivize more DEX/CEX arbitrage flows to migrate to Base and Coinbase. In addition, this will greatly enhance the user experience of Base users, as they can trade native tokens of other chains on Base without going through a cumbersome bridging process, making the trading experience on Aerodrome similar to that of a CEX exchange.

We are already seeing the beginnings of this scenario, thanks to wrapped assets powered by the Universal Asset protocol. Aerodrome traders can now trade popular assets like SOL and DOGE without leaving the Base chain.

Stablecoin volume is also a promising growth area that could significantly boost economic activity on Base. Following its acquisition of a stake in Circle in 2023, Coinbase also has a vested interest and ability to drive wider adoption of Circle stablecoins on Base.

In addition to USDC and EURC, we believe that other major high-volume global currencies, such as the Japanese Yen and the British Pound, may also be listed on Base in the future. Aerodrome has already begun to enter this large market, supporting liquidity pools for USDC and EURC, which currently have a daily trading volume of $7 trillion.

Another development front that is beneficial to Aerodrome is the rise of AI agents as active participants in DeFi protocols. We have already seen the initial manifestations of this trend, especially in the past week, when the AI agent Terminal of Truth semi-autonomously interacted with crypto Twitter and publicly supported Memecoin GOAT on Solana, which now has a market cap of $600 million and listed perpetual contracts on Binance.

The Base chain is also home to Luna, another popular AI influencer created by Virtuals Protocol, who tweets and conducts on-chain transactions completely autonomously. She has the ability to execute token swaps and has already issued LUNA token rewards to her followers. Interest in LUNA, and other AI agent tokens created by Virtuals, has driven growth in trading volume on Aerodrome, making the Virtuals/cbBTC pool one of the largest pools by TVL and trading volume on Aerodrome.

Following closely, Coinbase appears to be making a big push into consumer-facing AI applications, with a focus on agent-based AI. They recently launched Based Agents, a framework for developers that allows them to create autonomous on-chain agents capable of conducting financial transactions.

This opens the door to unique use cases that were previously unattainable, for example, conducting complex DeFi operations could become as simple as a conversation. Imagine that you only need to type "exchange some ETH for the best yield opportunity" and then the AI agent comes into play through various DeFi dApps to complete the task.

Turning Token Issuance into a Growth Engine

One of the main concerns investors have about AERO is its perceived high token issuance, which is expected to reach about 40% by the 67th issue (early December 2024). We believe this inflationary scenario is far better than VC-backed projects where a large portion of tokens allocated to the team and investors are ultimately sold off. In fact, some VC-backed tokens have more dramatic unlocking schedules where the circulating supply can grow more than 3x in a year.

For Aerodrome, the token issuance has been primarily productive and has contributed greatly to building a solid liquidity foundation. This kicks off a virtuous cycle where Aerodrome attracts trading volume, which in turn generates fees for veAERO, ultimately making the issuance of AERO valuable, thus solidifying Aerodrome's liquidity advantage. For example, 13% of voting income is automatically compounded into AERO each week through Relay and Flight School and is locked up to a maximum of veAERO.

In addition, the team's AERO allocation will be locked up as veAERO for 4 years, creating an incentive mechanism where they will only be rewarded handsomely if they drive the interests of the protocol over the long term. We believe that productive use of token issuance and aligned incentives for the team have mitigated inflation concerns.

Concluding Thoughts

We are bullish on Aerodrome’s prospects of becoming the liquidity engine on the Base chain. The protocol has demonstrated its ability to grow rapidly and shows no signs of slowing down. We believe this trend will continue given that Aerodrome has successfully addressed key incentive issues by uniting key stakeholders (traders, liquidity providers, token holders). Aerodrome will continue to benefit from its partnership with Coinbase and Base, as well as the continued growth of DeFi on the Base chain.

We believe Aerodrome has yet to reach its full potential and expect its TVL to triple from current levels to $4 billion within a year, while monthly trading volume will reach $50 billion. This growth will be driven by the easing of liquidity conditions in traditional financial markets and the continued development of Base. Aerodrome represents one of the fastest growing DeFi protocols and we expect more growth in the future.

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