In-depth exploration of the liquidity engine Aerodrome on the Base chain

Original Title: "Aerodrome: The Onchain Liquidity Engine"

Authors: Bryan Tan & Arthur Cheong

Compiled by: Felix, PANews

Before discussing Aerodrome, let's understand some background knowledge about DEXs.

Breaking the Stalemate of DEXs: Why Traditional Models Fall Short

The development of DEXs has been accompanied by a fundamental struggle: balancing the interests of multiple stakeholders while maintaining sustainable growth. Two key challenges have plagued traditional DEX models:

1. Balancing Interests:

DEXs must serve three different groups simultaneously: traders seeking efficient markets, liquidity providers (LPs) pursuing yields, and token holders demanding appreciation.

Uniswap, as a typical representative, directs 100% of the fees to LPs, leaving UNI holders without direct protocol revenue. Meanwhile, Curve adopts a neutral stance, splitting CRV between LPs and veCRV holders. However, as the release volume decreases, this model faces sustainability issues.

The result is a continuous tug-of-war, leading to suboptimal returns for all parties involved.

2. Issuance Dilemma:

The summer of DeFi in 2020/21 exposed the flaws of strict issuance plans, with countless Uniswap v2 forks attracting liquidity through token inflation, resulting in fierce competition.

Curve's innovative veCRV system introduced bribery as a mechanism to guide liquidity, but it produced unintended consequences: voters maximized personal interests through bribery rather than supporting pools that generated sustainable protocol revenue.

Even Andre Cronje's Solidly, which attempted to address these issues, fell victim to its design flaws—early issuance and token whitelisting ultimately undermined its effectiveness.

Every iteration of DEX design has attempted to tackle these fundamental challenges, but none have fully resolved them to date.

Aerodrome: The MetaDEX Revolution

Aerodrome combines the best features of previous DEXs—tokenomics inspired by Curve/Convex for improved governance and emissions, centralized automated market makers (clAMM) inspired by Uni v3 for capital-efficient exchanges, and enhancements to the Solidly codebase.

These features provide a solution to align incentives across parties and position it as the preferred venue for user trading.

veAERO holders can earn 100% of the fees and bribes from the pools they vote on as compensation. This incentivizes them to direct emissions and fees toward the pools with the highest returns, benefiting the protocol.

LPs will receive 100% of AERO emission incentives and will fund the pools with the highest yields.

Traders benefit from the high liquidity of the DEX, allowing for better execution compared to other exchanges.

Notably, since the launch of Aerodrome Slipstream (Uni v3-style clAMM) in April this year, Aerodrome's market share in the Base DEX market has surged to 63%, effectively replacing Uniswap.

Source: DeFiLlama, as of November 3

Compared to Uniswap V3 on Base, Aerodrome Slipstream has achieved absolute growth in numbers while overall achieving higher capital efficiency. This dominance becomes even more apparent considering the numerous scam tokens present on Uniswap.

Source: DeFiLlama, as of November 3

Moreover, Aerodrome is also the highest fee-generating application among all dApps on Base.

Source: DeFiLlama, as of November 3

The Rapid Rise of Aerodrome

In the past year, Aerodrome's TVL has skyrocketed 12 times to $1.3 billion, accounting for nearly 50% of Base's TVL. Notably, from March to September, Aerodrome's TVL continued to grow amidst a turbulent market, demonstrating resilience.

Source: DeFiLlama, as of November 8

At the same time, Aerodrome's monthly trading volume surged 111 times, reaching $16.5 billion by the end of October. Additionally, Aerodrome's share of total DEX trading volume has risen to 8.5%. In recent months, despite an overall decline in DEX trading volume, Aerodrome's trading volume has continued to grow.

The Coinbase Effect

Base plays a key role in Coinbase's strategy to promote crypto utility and reduce on-chain transaction complexity. They have pioneered several ecosystem initiatives, such as integrating Base into the Coinbase smart wallet, hosting hackathons, and partnering with institutions like Stripe for fiat-to-crypto conversions on Base. As a result, Base is currently the largest rollup by TVL, with approximately $2.7 billion.

Source: DeFiLlama, as of November 3

As the largest dApp on Base, Aerodrome is benefiting from Base's rapid expansion. Base's DAU and daily trading volume have steadily increased over the year, contributing to the usage of Aerodrome.

Source: Artemis

Protocols on Base hold nearly 10% of veAERO, aiming to enhance the liquidity of their governance tokens by locking AERO and voting to direct issued tokens to their own pools. With the growth of users and economic activity on Base, it is expected that future protocols launched on Base will follow suit, stimulating demand for the $AERO token.

With Coinbase's decision to launch cbBTC to challenge WBTC, economic activity on Base is also increasing. Since its launch on September 12, cbBTC's TVL has grown to $839 million.

Aerodrome is the biggest beneficiary of this initiative, as it accounts for about 80% of the trading volume for cbBTC trading pairs. This is not surprising, as cbBTC on-chain is redeemable for BTC on Coinbase CEX, driving CEX/DEX arbitrage activities. As Aerodrome is the largest and most liquid venue for cbBTC on-chain, it naturally facilitates most of the traffic.

Source: Dune Analytics

Additionally, Coinbase has ample reason to support the development of Aerodrome. Coinbase Ventures has accumulated a significant position in AERO (approximately $20 million). They have acquired it through the open market like other market participants and locked a large portion as veAERO. Coinbase Ventures is an active participant in Aerodrome governance, voting to release AERO into the cbBTC pool, further strengthening Aerodrome's market dominance.

DeFi Renaissance on Base

We are currently witnessing a new wave of liquidity entering DeFi, driven by new innovations. Given Base's positioning as a leading L2 platform and its direct distribution channel into Coinbase, Aerodrome is poised to be a blue-chip project in the thriving DeFi landscape. It is conceivable that Base will become the primary on-chain venue for retail trading, arbitrage, and stablecoin forex liquidity. As Aerodrome is the hub of liquidity on Base, it will benefit from this in the future.

With cbETH and cbBTC trading pairs already launched, it is expected that Coinbase will expand its coverage of wrapped assets and introduce them to Base. Having high-volume trading pairs like cbSOL, cbDOGE, and cbPEPE will incentivize more DEX/CEX arbitrage flows to migrate to Base/Coinbase. Furthermore, this will greatly enhance the user experience on Base, as trading native tokens from other chains on Base without bridging will make trading on Aerodrome a CEX-like experience.

Data as of November 3

We are already seeing the prospects of wrapped assets protected by universal asset protocols. Aerodrome traders can now trade popular assets like SOL and DOGE without leaving the chain.

The trading volume of stablecoins is also a promising growth area that could drive economic activity on Base. After acquiring Circle in 2023, Coinbase has the ability to promote greater adoption of stablecoins by Circle on Base. In addition to USDC and EURC, other high-volume global currencies like the Japanese Yen and British Pound may also be launched in the future. Aerodrome has already begun to tap into this massive market, which contributes $7 trillion in trading volume daily, with liquidity pools supporting USDC and EURC.

Source: A16z

Another favorable situation is the active participation of AI agents in DeFi protocols. In the past week, a robot trained on internet knowledge, Terminal Truth, semi-autonomously interacted with Crypto Twitter and publicly supported the memecoin $GOAT on Solana. The AI agent Luna, created by Virtuals Protocol, is based on the Base chain. Luna has complete autonomy over its tweets and on-chain transactions, capable of token swaps, and has already distributed $LUNA token rewards to its followers.

The interest in $LUNA and other AI agent tokens created by Virtuals has increased Aerodrome's trading volume, making Aerodrome's Virtuals/cbBTC pool one of the largest in TVL and trading volume.

Moreover, Coinbase seems to be broadly promoting consumer AI applications focused on AI agents. They recently launched Based Agents, a platform for developers to create autonomous on-chain agents capable of conducting financial transactions, unlocking unique use cases that were previously impossible. For example, performing complex DeFi operations could become as simple as a conversation.

Transforming Issuance into a Growth Engine

A significant reason for investors' hesitation regarding AERO is the perception that the token unlocks a large amount, with approximately 40% of tokens set to unlock after Epoch 67 (early December 2024). However, this inflation situation is much better compared to venture-backed projects. In venture-backed projects, large allocations to teams and investors are ultimately sold off.

In the case of Aerodrome, the issuance mechanism has been largely effective and has significantly contributed to establishing a solid liquidity foundation. This has opened a virtuous cycle where Aerodrome attracts trading volume, which in turn generates fees for veAERO, ultimately making AERO's issuance valuable, thereby solidifying Aerodrome's liquidity advantage.

Additionally, the team's AERO allocation is capped at 4 years of veAERO. This creates an incentive mechanism where their only way to receive substantial compensation is to act in the long-term interest of the protocol. These incentives effectively mitigate concerns about inflation.

Conclusion

Aerodrome has proven its ability to grow rapidly as the liquidity engine on the Base chain, showing no signs of slowing down. Given that Aerodrome has successfully addressed key incentive issues by aligning its primary stakeholders (traders, LPs, token holders), this growth trend is expected to continue. Aerodrome will continue to benefit from its partnership with Coinbase/Base and the ongoing growth of DeFi on the blockchain.

However, Aerodrome has not yet fully realized its potential, and it is expected that TVL will double from its current level to $4 billion within a year, while monthly trading volume will reach $50 billion. This will be driven by a loosening of liquidity conditions in TradFi and the continued growth of Base. Aerodrome is one of the fastest-growing DeFi protocols, and more significant growth is anticipated in the future.