Original title: LayerZero Part 3—Zero token: Utilities and Future Prospect
Author: Animoca Brands Research
Compiled by: Scof, Chaincatcher
Overview
$ZRO token was launched in June 2024, with planned use cases including protocol governance, transaction fee payments, and staking for DVN security. These three functions have significant implications for the value of $ZRO.
We expect that over the next three years, the circulating supply of $ZRO will increase rapidly, along with the growth in usage within the protocol and its adoption as a commonly used currency for cross-chain transactions.
We have proposed a valuation framework for $ZRO, utilizing the market cap to transaction volume ratio (MCTx) combined with projected transaction volume scenarios. This framework aims to provide readers with a perspective on the relationship between protocol growth and token value.
Introduction
In the first and second parts covering LayerZero, we introduced the mechanisms, business model, and dynamics of the entire cross-chain space for the LayerZero protocol. In this third part, we will focus on the protocol token $ZRO.
Utility of the token
LayerZero's $ZRO token was launched on June 20, 2024, and listed on major exchanges such as Binance, OKX, Bybit, and Gate.io. Initially, $ZRO was distributed through airdrops to reward early contributors and community members. Over the past five months, the project team has steadily rolled out various token applications, further expanding its role within the LayerZero ecosystem.
$ZRO token applications can be categorized into three typical categories, which are more common among infrastructure tokens, and we will interpret each one:
Protocol governance: $ZRO holders can vote on key protocol decisions that influence the direction and evolution of LayerZero.
Protocol transaction fees: $ZRO can be used to pay protocol fees, as well as for transaction fees within the LayerZero network, in addition to the on-chain native tokens.
DVN security staking: $ZRO is an accepted staking asset used to help secure the Decentralized Verification Network (DVN) of LayerZero Labs, supporting the network's security and stability.
Protocol governance
$ZRO's first announced utility is governance over potential protocol fee switches, which was mentioned in the initial introduction of the $ZRO token.
The LayerZero protocol may charge fees equal to the total costs of cross-chain message verification and execution. If DVNs and executors charge $0.01 for transactions between Arbitrum and Optimism, LayerZero may also charge $0.01.
There will be 'immutable voting contracts', with public on-chain votes held every six months, allowing $ZRO holders to vote on whether to activate or deactivate the protocol fee switch.
LayerZero currently charges fees for each transaction to cover the costs incurred by DVNs and executors performing their roles. If protocol fees are implemented, an additional layer of fees will be added on top of these operational costs. According to the project team, this additional fee could be as high as 100% of the existing transaction fees. Although the semi-annual voting contract has not yet been released, support for this protocol fee has already been built into LayerZero's V2 codebase, with a function named '_payTreasury' capable of collecting this additional fee.
UNI token price during fee switch proposal
Looking ahead to the potential fee switch governance mechanism for the $ZRO token, we can find a similar case in Uniswap's $UNI token, which also has similar protocol fee governance capabilities.
When $UNI launched in 2020, it included an option that allowed the community to vote on whether to activate the fee switch. If this switch were activated, a portion of the decentralized exchange (DEX) transaction fees would be redirected to the protocol, which could benefit $UNI holders. Since mid-2022, several fee switch proposals have been made, with each announcement resulting in significant increases in $UNI's price. For example, when a new proposal was released in March 2024, $UNI's price surged by 65%, but fell back after the voting results were announced. A similar price fluctuation pattern was observed in the proposal from May 2024.
However, so far, all fee switch proposals have been voted down or withdrawn. Although introducing fees may align investor interests by creating value for the protocol and $UNI holders, it faces two main counterarguments:
Competitive impact: Increasing protocol fees may reduce the competitiveness of Uniswap as it effectively taxes transactions, potentially increasing costs for liquidity providers or users.
Regulatory risk: Allocating generated value to token holders or stakers may raise regulatory scrutiny, especially if this practice is seen as revenue distribution, which could touch upon securities law issues.
It remains unclear whether $ZRO will face the same voting challenges as Uniswap's $UNI, as the key lies in the specific design of the fee voting mechanism, which has not been fully disclosed. Given the rapid growth and fierce competition in the cross-chain protocol space, LayerZero's current priority may be to focus on expanding market share rather than pursuing short-term value accumulation for $ZRO. Finding a balance between enhancing protocol value and maintaining competitive transaction costs will be key to LayerZero promoting sustainable long-term growth while also considering investor interests.
In a recent speech, LayerZero's CEO Bryan Pellegrino announced during the Q&A session that the first voting referendum is scheduled for December 19, 2024, exactly six months after the token's launch. The video of the speech was released on November 19, 2024, and since then, the price of $ZRO has been rising.
Protocol transaction fees
In addition to the announced uses, the protocol's codebase also supports using $ZRO as an alternative currency for transaction fees. When the 'payInLzToken' flag is set to TRUE, protocol transaction fees will be paid in $ZRO instead of the native token of the chain. However, the native token remains the default payment method for the protocol, and we have not yet seen projects actively switch to $ZRO to pay fees.
Accepting $ZRO as protocol fees can significantly expand the utility and demand for the token. Projects coming on board will need to maintain $ZRO reserves to cover ongoing protocol usage, creating sustained demand. As the LayerZero ecosystem develops, the demand for $ZRO will correspondingly grow, necessitating larger reserves to support the increasing cross-chain operations.
This demand expansion for $ZRO across chains will also have a compounding effect: as LayerZero links expand, $ZRO will cover multiple ecosystems, becoming one of the most widely used tokens in the cross-chain space. Its broad availability has the potential to make $ZRO the preferred currency for cross-chain transactions, similar to the role of ETH in the EVM ecosystem.
Despite the many benefits, converting the default native token to $ZRO still requires adequate preparation and incentives, such as:
$ZRO Deployment: Currently, $ZRO has been deployed on 8 chains, while LayerZero covers 90 networks. Expanding the application of $ZRO to more chains is crucial for its widespread adoption as the default fee token.
Project incentives: Currently, the application scope of on-chain native tokens is broader than that of $ZRO, so sufficient incentives are needed to encourage projects to choose $ZRO. Possible incentives include fee discounts when using $ZRO or establishing a single $ZRO reserve covering fees across all chains supported by LayerZero, making it more attractive to developers.
Operational implementation: For the 50,000 contracts already deployed, the _payInLzToken flag needs to be manually enabled for each individual contract. To simplify this process, a unified switch at the protocol level may be required, or a one-time incentive may be offered to encourage project teams to adjust their contract settings.
Given the importance of $ZRO as a protocol fee currency, it is essential to closely monitor LayerZero's plans and developments in promoting $ZRO as a fee token.
LayerZero's fee flow
Staking: Cryptoeconomic framework for Decentralized Verification Networks (DVN)
In October 2024, LayerZero and EigenLayer announced a partnership to develop an open-source cryptoeconomic framework for Decentralized Verification Networks (DVNs). This framework aims to enhance the security of DVNs by introducing economic incentives, allowing users and decentralized applications (dApps) to consider not only the technical stability of DVNs but also other factors when choosing them.
The framework introduces an arbitration process that runs on a designated chain (e.g., Ethereum), allowing DVN staked assets to be validated when the validity of cross-chain messages is contested. The specific process is as follows:
Staking: Stakers lock assets into the DVN through EigenLayer's AVS, and these assets may be slashed if the DVN is found to be acting improperly or validating incorrectly.
Validation: If a user or dApp questions the validity of a message, the framework triggers a round-trip message to request other DVNs to verify the accuracy of the original message.
Veto: If discrepancies are found, the veto contract escalates the decision, calling on token holders to vote on whether to slash the DVN's stake.
Slash: If the vote confirms malicious or erroneous behavior, the staked assets will be slashed.
As an open-source framework, any DVN can adopt it and freely choose its staking assets. The DVN of LayerZero Labs will be the first to implement this framework on Ethereum, accepting $ZRO, $EIGEN, and $ETH as staking assets. As LayerZero Labs' DVN is still responsible for most of the protocol's validation work, the new staking pool may become an important driving force for $ZRO staking.
The specific incentives for $ZRO holders to participate in this staking pool have not been disclosed, making it difficult to predict the potential total amount of $ZRO that may be staked. Overall, staking helps regulate the supply of tokens in circulation, potentially similar to how a 'central bank' balances demand and supply.
$ZRO Token Economics
The allocation and unlocking plan for $ZRO has been clearly outlined in the initial announcement. The total supply is 1 billion $ZRO tokens, allocated across four categories:
38.3% to the community: including operational funds for the LayerZero Foundation.
32.2% to strategic partners: such as investors and advisors.
25.5% to core contributors: allocated to current and future team members.
4% for tokens repurchased by LayerZero Labs: to be used for future community activities.
At the token generation event (TGE), 25% of the $ZRO tokens have already been unlocked, all from the community category. The remaining unlocked tokens will be released linearly in the second and third years, with all 1 billion tokens fully unlocked by the end of the third year.
In the unlocked 25% of tokens:
8.5% allocated for rewarding early contributors, distributed to the community through airdrops.
5% allocated to the treasury of the LayerZero Foundation, including liquidity pools.
11.5% reserved for future activities.
Token unlocking plan
By the second half of 2024, the circulating token volume is expected to stabilize at around 11% of the total supply. This stability is anticipated because there will be no further unlocking in the first year. Starting in the second year, the supply will increase, with the remaining 75% of tokens fully unlocked by the end of the third year. As the unlocking pace accelerates, most tokens have been allocated to strategic partners (32.2%) and the team (25.5%), and these tokens may quickly enter circulation after unlocking.
Rapid unlocking for investors and the team may put time pressure on the LayerZero team to quickly enhance the overall value of the project. We anticipate that by the end of the three-year unlocking period, approximately 65% of $ZRO tokens will enter circulation (using Chainlink as a benchmark). This means that the circulating supply would increase fivefold compared to current levels. Such rapid supply growth will need to be matched by a corresponding increase in project market capitalization to maintain price stability.
$ZRO Value Framework
To help readers develop a clear mental model for assessing the value of $ZRO, we propose a structured framework based on trends in the cross-chain space and LayerZero's strategic positioning in that space. This framework aims to assist users in evaluating the $ZRO token by considering various factors, although specific parameters will vary based on individual perceptions of industry and project growth.
Our goal is not to provide a definitive set of parameter combinations but to offer a flexible framework that readers can adjust based on their analyses. It should be noted that this framework is not exhaustive or a final conclusion.
Method
One way to evaluate the $ZRO token is to apply the market cap to transaction volume ratio (MCTx) in conjunction with LayerZero's projected three-year transaction volume scenarios. The reason for choosing the MCTx ratio is that transaction volume is the primary driver of protocol success, and transaction volume data is widely available among major projects, allowing us to assess a reasonable range. The three-year time span aligns with the unlocking period of the $ZRO token, and the cross-chain space is likely to maintain high growth momentum. Additionally, we will cross-verify by comparing with Layer 1 protocols like Ethereum and Solana.
Market cap to transaction volume ratio (MCTx)
First, we establish a reference market cap to transaction volume ratio (MCTx) comparing LayerZero with Wormhole, Axelar, and ZetaChain as benchmarks. All four protocols focus on cross-chain messaging and have launched tokens within the past 12 months. We use Q3 2024 data as an observation window to track their average daily transaction volumes and market caps, as this period is far from any short-term transaction volume peaks.
Market cap to cross-chain transaction volume ratio
Comparable projects have MCTx ratios ranging from 50 to 100, while LayerZero's current ratio is lower. One reason may be that the circulating supply of $ZRO is relatively low, associated with its later TGE issuance and unlocking plan in the first year. Another factor may be that $ZRO's utility is more limited compared to other projects. For instance, AXL and ZETA tokens not only facilitate cross-chain transactions but also support the operations of their respective blockchains.
We expect that as the industry develops, the MCTx ratio will tend to converge among leading projects, and transaction volume will become the dominant driver of protocol value. In the following examples, we use an MCTx ratio of 50 for illustration.
The next step is to create scenarios for LayerZero's future transaction volumes. In our coverage of the second part of LayerZero, we estimate the current cross-chain transaction/message volume to be approximately 3.5 million per month (or about 120,000 daily), with LayerZero capturing 25% to 30% of the market share. We also anticipate that due to increased on-chain liquidity and the number of chains, the annual transaction growth for the entire industry will reach approximately 100%.
Based on these parameters, readers can create scenarios for LayerZero's future three-year transaction volume assumptions based on different industry growth rates and LayerZero's market share combinations. In this process, readers may need to estimate daily transaction volumes for various scenarios and apply the MCTx ratio to derive an estimated range for the ZRO market cap at specific points in time.
LayerZero's projected transaction volume over the next three years
By applying an MCTx ratio of 50, we can convert each daily transaction volume scenario into market cap estimates. This leads to market cap predictions for the $ZRO token over the next three years, estimating $2 billion in the most conservative scenario and $47 billion in the most optimistic scenario.
LayerZero's market cap estimates for the next three years
To derive the present value of $ZRO, we introduce additional assumptions: the circulating supply of $ZRO token is 65%, and a 35% discount rate is applied to adjust future value. Based on these parameters, we calculate the current estimated value of the $ZRO token for each scenario.
Possible token prices for LayerZero
Please remember that the methods described above are just one of many possible ways to assess $ZRO. The estimated value of $ZRO is highly sensitive to several factors, including the future growth rate of the cross-chain industry and LayerZero's market share within it. The future trajectory of this industry will largely depend on the broader cryptocurrency market environment, which is itself highly volatile. At the same time, LayerZero's market share will be influenced by its ability to provide robust technology that retains users and effectively seize emerging business opportunities.
Triangulation of the MCTx ratio
As an additional reference, the MCTx ratio used in the previous section can be triangulated. One method is to convert the MCTx ratio into an MCTx fee ratio and compare it with leading infrastructure projects such as Ethereum and Solana. In the first part of our LayerZero analysis, we estimated LayerZero's average transaction fee to be approximately $0.70. Based on this data, with an MCTx ratio of 50 (i.e., $1,000 per day), the MCTx fee ratio would be 196.
This brings LayerZero's three-year MCTx fee ratio close to the current ratios of Ethereum and Solana, which are 250 and 226, respectively. This similarity also implies that $ZRO needs to become a core part of the LayerZero ecosystem, akin to the roles of $ETH and $SOL in their respective networks, to support its multiple rationales. Whether $ZRO can achieve this remains a contentious topic, with arguments on both sides.
Supporting arguments may include:
Cross-chain protocols and Layer 1 projects generate protocol revenue by charging transaction fees and paying fees to validation nodes.
With the recent introduction of the EigenLayer partnership, the $ZRO token may play an important role in LayerZero's DVN operations, similar to how $ETH and $SOL are utilized in their respective networks.
Market cap to transaction fee comparison
Counterarguments:
Possible counterarguments include:
$ZRO has not yet become the default transaction fee payment token: Currently, $ZRO is not the default fee token for all transactions, so its widespread adoption remains limited.
Fee switch introduces uncertainty: The fee switch functionality brings uncertainty to users and developers, potentially affecting their decisions, especially if the fee structure changes frequently.
$ZRO is currently not functioning as a 'transaction currency': $ZRO currently serves only as a tool for paying protocol fees and has not expanded into a widely used transaction currency. Therefore, its primary role as a token for cross-chain transactions has not yet been fully realized.
$ZRO is not the only token used for DVN staking: While $ZRO plays an important role in the LayerZero ecosystem, it is not the only token that can be used for DVN staking, which limits its exclusivity in certain contexts.
Different perspectives on these factors may affect market participants' assessments of the MCTx fee ratio and MCTx transaction volume ratio, leading to adjustments based on differing assumptions about the future role of $ZRO.
Other risks to consider
Robustness of the LayerZero V2 architecture
LayerZero V2 was launched in December 2023, and no security vulnerabilities have been reported to date. The protocol's confidence in its design is reflected in its $15 million bug bounty, which is among the highest in the industry.
One of the core aspects of LayerZero's security model is that there is no collusion between DVNs (Decentralized Verification Networks) and executors. So far, this design has been successful, partly because the executors are entirely operated by LayerZero, while the DVN remains decentralized. However, as LayerZero allows external parties to build executors, the potential for collusion has increased.
Moreover, as more projects make LayerZero the main cross-chain asset transfer and governance infrastructure, the motivation for malicious actors to attempt to attack the network will gradually increase. If a security breach occurs, it could severely damage LayerZero's growth momentum, slow future developments, and negatively impact the value of the $ZRO token.
Deployment of $ZRO utility
By the end of 2024, the utility of $ZRO has not yet been fully realized. The high expectations for $ZRO need to be supported by actual usage, such as:
Half-year fee switch voting: By introducing a fee switch voting mechanism, the value accumulation expectations of token holders can be increased.
Defaulting $ZRO as a fee currency: Increasing holdings of $ZRO in decentralized applications (dApps) and enhancing capital circulation speed.
Adoption of $ZRO as a universal transaction currency: Expanding the use cases of $ZRO so that it is not only used within LayerZero but also becomes a widely accepted cross-chain token.
If these utility goals are achieved, it will significantly enhance the role of the $ZRO token within the LayerZero network. However, as technology advances, LayerZero will face not only development challenges but also the need for strategic efforts in user engagement, partnerships, and ecosystem incentives to fully integrate these utilities.
Summary
$ZRO token is set to become the core of the LayerZero ecosystem, providing key utility for governance, protocol fees, and DVN staking. Additionally, as the protocol develops, the role of $ZRO is expected to further expand, potentially becoming a widely used cross-chain trading currency. We anticipate that in the next three years, both LayerZero and the utility of $ZRO will experience a rapid growth phase.
Despite the current lack of direct utility for $ZRO, we have outlined a potential assessment model that helps readers contextualize future protocol developments through MCTx ratios and projected future transaction volumes, thereby assisting in evaluating the role of $ZRO in the protocol's future.
