What Is Aerodrome Finance? The Ultimate Guide to Base's Principal DEX

What Is Aerodrome Finance?

Aerodrome Finance is the principal DEX on Base, serving as the liquidity hub for the Base ecosystem. 

Key Takeaways

• Aerodrome combines multiple liquidity structures from various DEXs and has a ve(3,3) incentive layer, making it a next-generation 'meta' DEX.

• It redirects 100% of trading fees to users who lock their AERO tokens, receiving veAERO tokens in return.

• It hosts the top on-chain pools for ETH, BTC, and FX trading, often surpassing trading volumes on Coinbase Exchange.

Aerodrome Finance is a decentralized exchange (DEX)  that serves as the principal trading platform on Base and the liquidity hub for the Base ecosystem. Unlike traditional DEXs where liquidity providers earn trading fees, Aerodrome redirects 100% of the fees to users who lock their AERO tokens for a period.

Why Is Aerodrome Finance Unique?

Termed as a next-generation 'meta' decentralized exchange (DEX), Aerodrome combines multiple liquidity structures into one optimized DEX without fee-extracting middle layers. These liquidity structures include:

• Uniswap V2’s standard automated market maker ( x*y=k model)

• Curve’s StableSwap to facilitate the trading of stablecoins and other stable assets

• Uniswap V3’s concentrated liquidity for improved capital efficiency

• Convex’s performance mining incentives.

Aerodrome Finance also utilizes a special token model for rewards and voting, often called ‘ve(3,3)’ which denotes vote-escrowed tokens, but we’ll explore that in greater detail under veAERO later.

The team behind Velodrome on Optimism re-engineered Solidly, a DEX created by Andre Cronje – a co-founder of Sonic (formerly Fantom), improving upon its deficiencies. They then shifted their focus to the Base network, launching Aerodrome. 

Another unique aspect of Aerodrome is that Base does not have a token, and likely will not have a token in the future. Base uses ETH for gas, the OP token for chain governance, and Aerodrome’s AERO token as the ecosystem incentive token. AERO is closely tied to the Base ecosystem, as Coinbase One members can lock AERO for additional rewards, and the Base ecosystem fund has acquired AERO to distribute as incentives.

Alignment With Coinbase

As the main DEX on Base, Aerodrome is backed by and aligned with Coinbase, the company behind Base. 

• Base Ecosystem Fund Investment: As mentioned above, the Base Ecosystem Fund, which is led by Coinbase Ventures, acquired a position in AERO, Aerodrome Finance's native token. Even though Coinbase Ventures did not get any liquid token allocations or special treatment, this investment by the fund associated with Coinbase signifies a direct backing.

• Leading DEX on Base: Aerodrome is considered the one of the largest liquidity protocols and decentralized exchanges on the Base blockchain, an Ethereum Layer 2 network developed by Coinbase. This positions Aerodrome as a critical component of the Coinbase-initiated Base ecosystem.

• Coinbase Ventures' Participation: Coinbase Ventures not only invested but also holds and locks a substantial amount of AERO tokens (as veAERO) to participate in Aerodrome's governance. They actively vote to direct AERO token emissions, for example, towards cbBTC (Coinbase's wrapped Bitcoin) pools, thereby strengthening Aerodrome's market position as well as their own ecosystem. 

What Is Aerodrome Finance Used For?

Aerodrome hosts the top on-chain pools for ETH trading, BTC trading, and FX trading (USD <> EUR).

Token Swaps

At its core, Aerodrome enables users to swap tokens in a decentralized way. It does this aiming to be as fast (2s) as possible, while minimizing trading disruptions, such as slippage, and maintains low transaction fees.

Providing Liquidity

A key feature of DEXs is the liquidity pool, where liquidity providers deposit a pair of tokens into the pool. When traders want to swap one for the other, the pool has tokens available, ensuring smooth trading, and liquidity providers are rewarded for keeping the pool full.

On Aerodrome, liquidity providers are rewarded with AERO tokens that can be staked or locked to participate in protocol governance. These incentives are important for liquidity providers, as the value of deposited tokens can change relative to each other, where a provider might have been better off holding them separately.

Learn more about impermanent loss. 

Governance Participation

By locking AERO tokens, users receive veAERO NFTs, which confer voting rights within the platform. This decentralized governance mechanism allows token holders to influence crucial protocol decisions, such as the distribution of AERO emissions among liquidity pools and other essential upgrades.

Yield Farming

Aerodrome presents various yield farming opportunities that allow users to maximize their returns by moving assets strategically across different pools. These opportunities come without lock-up periods. Aerodrome caters to a diverse range of risk appetites and strategies by offering various types of pools, including stable, volatile, incentivized, and low TVL pools.

Base Appchains

As the next generation of builders deploy on Base, and when protocols want to bootstrap liquidity for their token pairs, they deploy rewards incentives to Aerodrome pools.

For example, when CBBTC (Coinbase's Bitcoin coin wrapper) launched, Coinbase Ventures shifted a significant amount of their voting power towards the CBBTC pools, and it took just one week for CBBTC volumes on Aerodrome to flip WBTC (wrapped Bitcoin) volumes on Ethereum mainnet.

AERO Token Explained

The AERO token is primarily used as a reward for liquidity providers on Aerodrome Finance. Users who deposit their tokens into the platform's liquidity pools receive AERO tokens as incentives. 

The Aerodrome Foundation has all of their tokens locked. There is no liquid vesting token for any contributor or team member.

The tokens being locked means the Aerodrome Foundation is a participant in the system just like any everyday user who farmed some AERO and locked it.

Aerodrome employs a dual-token system and a ve(3,3) model consisting of:

AERO

This is an ERC-20 token used to reward liquidity providers and for staking purposes. AERO tokens are emitted to LPs as rewards. You can do anything with these tokens – swap them, trade them, LP with them. But the primary utility of the token is to be locked.

veAERO

By locking AERO tokens for veAERO (up to four years), with longer locks resulting in more veAERO, users become eligible to earn from various sources within the ecosystem. These include trading fees, incentives (formerly known as bribes), and rebases. 

The veAERO is a transferable NFT and can be sold on NFT marketplaces, so while it's not as liquid as the circulating token, there is a way to transact locked positions.

What Is the ve(3,3) Model?

When you lock AERO  tokens, you get to vote on which pools receive emissions on a weekly basis (known as an epoch). Your vote essentially chooses which pools get rewarded and which LPs are going to grow.

100% of the fees generated by the pools that you vote for flow back to you proportional to your vote weight. So if you have 10% of the voting power and you put it all in one pool, you get 10% of the fees from that pool.

When a pool generates significant fees, such as $1.5 million in a week, it attracts more voters to allocate their votes to that pool. This is a beneficial mechanism because it ensures that the pools contributing the most to the protocol's success receive a larger share of the liquidity rewards. 

Revenue Streams

Aerodrome distributes 100% of its protocol revenue to veAERO lockers based on their voted pools. This revenue is derived from:

• 100% of Trading Fees: All trading fees collected are distributed to veAERO holders.

• 100% of Incentives: These are incentives provided by other protocols to encourage votes towards their liquidity pools.

There are no off-chain diversions of revenue. The power of having the token model plus the LP model is that you can bootstrap any of the pools. Because of the predictability and the stream of rewards, this offers a better experience for liquidity providers than the volatility of these fee-based models.

Where to Buy and Trade AERO

As AERO is the token of the decentralized exchange Aerodrome, it can be swapped on its native DEX. It is also listed on some centralized exchanges (CEXes) worldwide. Users can buy and trade AERO on major exchanges such as Coinbase and Bybit.

Considerations When Using Aerodrome Finance

Despite undergoing multiple security audits and being considered relatively secure, Aerodrome Finance, like any DeFi protocol, isn't entirely free from risks.

Protocol Security Details

Funds can be stolen if a contract receives a malicious code upgrade. Upgrades must be approved by both the BaseMultisig1 and the OpFoundationOperationsSafe, and there is no delay on upgrades. Users should stay updated on any security announcements and patches.

Other remaining permissions related to the rewards system and periphery contracts are controlled by several multisigs, including an undeclared multisig with specific permissions:

1. Control over a whitelist of special voters who can change the rewards distributed to Liquidity Providers.

2. Ability to approve or reject factory contracts that create pools in the protocol.

3. Power to kill and revive gauges, which affects the distribution of rewards to LPs and voters, but does not impact already distributed rewards.

Aerodrome and its sister platform, Velodrome, have faced issues with front-end hacks, including DNS compromises. Always ensure you are using official URLs and interfaces to avoid falling victim to phishing attacks.

The protocol provides multiple access points for users, including both centralized and decentralized interfaces. Centralized interfaces include aerodrome.finance and alt.aerodrome.finance, while decentralized interfaces on IPFS include aero.drome.eth, aero.drome.eth.limo, and aero.drome.eth.link. Nothing outside of Aerodrome can change the expected protocol performance. (Data taken from https://x.com/defiscan_info/status/1917911786315018668)

Dependency on Base

The success of Aerodrome Finance is closely tied to the wider adoption and development of the Base blockchain. A lack of growth or user migration away from the Base platform could adversely affect liquidity, trading volume, and demand for AERO.

Lockup Duration of AERO

Participating in governance by locking AERO tokens to receive veAERO involves a commitment of up to four years. Users should carefully consider the potential opportunity costs and their long-term willingness to lock tokens.

Latest Updates and Roadmap

In Q1, Aerodrome secured a 650K OP grant to strategically grow TVL on Base. This introduced OP incentives on Aerodrome for the first time. The results were incentivized pools seeing a 275% increase in TVL, growing from 8M to 22M.

Also in Epoch 87, Aerodrome marked its 5th straight epoch where $AERO token locks exceeded AERO emissions. This effectively reduced the circulating supply of AERO by over 7 million tokens in the last 5 epochs.

Aerodrome processed a massive $2.84 billion in trading volume during the epoch. This represents approximately 57% of all DEX volume on the Base network. Around $2.3 million worth of tokens were distributed to Aerodrome users as voting rewards.

Another update comes with Flashblocks that will make Base 10x faster by reducing effective block times from 2 seconds to just 200 milliseconds. This speed improvement is currently live on the Base Sepolia testnet  and will be coming to Base mainnet in Q2.

Users will enjoy better prices and quicker confirmations, similar to the experience on centralized exchanges. Liquidity providers will also have more flexibility in managing their positions as these faster trades can translate to higher returns for LPs.

It will also mitigate the latency arbitrage (LVR) that occurs when prices differ between centralized and decentralized exchanges due to block times. Arbitrageurs will need to trade more frequently to maintain their profits, driving up overall trading volumes on Aerodrome. 

Conclusion

Aerodrome has established itself as the dominant DEX on Base, capturing over 60% of DEX volumes and generating substantial revenue. By distributing 100% of its revenue to veAERO holders as incentives and implementing a balanced token emission and buyback strategy, Aerodrome has created a robust and sustainable ecosystem. The absence of VC or team token unlocks further reinforces the protocol's commitment to aligning the interests of all stakeholders.

Aerodrome Finance: Redefining AMMs on Base with Alexander Cutler