Original Title: LayerZero Part 3 - Zero Token: Utilities and Future Prospect
Original Source: Animoca Brands Research
Original Translation: Scof, Chaincatcher
Overview
· The $ZRO token will be launched in June 2024, with planned use cases including protocol governance, transaction fee payments, and staking for DVN security. These three functions significantly impact the value of $ZRO.
· We expect that in the next three years, the circulating supply of $ZRO will rapidly increase, along with the growth in usage within the protocol and its popularity as a common currency for cross-chain transactions.
· We propose a valuation framework for $ZRO utilizing the Market Capitalization to Transaction Volume Ratio (MCTx), combined with projected trading volume scenarios. This framework aims to provide readers with insights into the relationship between protocol growth and token value.
Introduction
In the first and second parts of our analysis on LayerZero, we introduced the mechanisms of the LayerZero protocol, its business model, and the dynamics of the entire cross-chain space. In this third part of the article, we will focus on the protocol token $ZRO.
Token Uses
The $ZRO token of LayerZero will be launched on June 20, 2024, and listed on major exchanges such as Binance, OKX, Bybit, and Gate.io. Initially, $ZRO will be distributed through airdrops to reward early contributors and community members. Over the past five months, the project team has steadily introduced various token applications, further expanding its role within the LayerZero ecosystem.
$ZRO token applications can be summarized into three typical categories, which are common in infrastructure tokens, and we will interpret them one by one:
1. Protocol Governance: $ZRO holders can vote on key protocol decisions that influence the direction and evolution of LayerZero.
2. Protocol Transaction Fees: $ZRO can be used to pay protocol fees, and it can also be used for transaction fee payments within the LayerZero network, in addition to on-chain native tokens.
3. DVN Security Staking: $ZRO is an accepted staking asset used to help secure the distributed validation network (DVN) of LayerZero Labs, supporting the network's security and stability.
Protocol Governance
$ZRO's first announced use is for governance over potential protocol fee switches, as mentioned in the initial $ZRO token introduction.
· The LayerZero protocol may charge fees equal to the total costs of cross-chain message validation and execution. If the DVN 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 voting every six months, allowing $ZRO holders to vote on whether to activate or deactivate the protocol fee switch.
LayerZero currently charges a fee for each transaction to cover the costs incurred by the DVN and executors in performing their roles. If protocol fees are implemented, there will be an additional fee layer on top of these operational costs. According to the project team, this additional fee could be as high as 100% of existing transaction fees. Although the semi-annual voting contract has not yet been released, support for this protocol fee is already embedded in LayerZero's V2 codebase, with a function named '_payTreasury' capable of collecting this additional fee.
Token Price During Fee Switch Proposal
Looking at the potential fee switch governance mechanism of the $ZRO token, we can find a similar case in Uniswap's $UNI token, which also has a similar protocol fee governance function.
When $UNI was launched in 2020, it included an option allowing the community to vote on whether to activate the fee switch. If the switch were activated, a portion of the decentralized exchange (DEX) transaction fees would be transferred to the protocol, potentially benefiting $UNI holders. Since mid-2022, several fee switch proposals have been made, with each announcement triggering significant price increases for $UNI. 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. The proposal in May 2024 also experienced a similar price fluctuation pattern.
However, so far, all fee switch proposals have been voted down or withdrawn. Although introducing fees may align with investor interests by creating value for the protocol and $UNI holders, it faces two main objections:
1. Competitive Impact: Increasing protocol fees may reduce Uniswap's competitiveness, as it essentially taxes transactions, which could increase costs for liquidity providers or users.
2. Regulatory Risks: Allocating the generated value to token holders or stakers may raise regulatory concerns, especially if such practices are viewed as income distribution, which could touch upon securities law issues.
It is currently unclear whether $ZRO will face the same voting challenges as Uniswap's $UNI; the key lies in the specific design of the fee voting mechanism, which has not yet 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 competitiveness in transaction costs will be key for LayerZero to promote sustainable long-term growth while also considering the interests of investors.
In a recent presentation, LayerZero CEO Bryan Pellegrino announced during the Q&A session that the first public voting is scheduled for December 19, 2024, which is exactly six months after the token's release. The presentation video was released on November 19, 2024, and since then, the price of $ZRO has been on the rise.
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 so far, we have not seen projects actively switch to $ZRO for fee payments.
Accepting $ZRO as a protocol fee can significantly expand the token's uses and demand. Projects that integrate will need to maintain reserves of $ZRO to cover ongoing protocol usage, creating sustained demand. As the LayerZero ecosystem develops, demand for $ZRO will grow accordingly, necessitating larger reserves to support increasing cross-chain operations.
This expansion of $ZRO's demand across chains will also create a compound effect: as LayerZero's links expand, $ZRO will cover multiple ecosystems, becoming one of the most widely used tokens in the cross-chain space. Its widespread 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 sufficient preparation and incentives, such as:
1. $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.
2. Project Incentives: Currently, the application scope of on-chain native tokens is broader than that of $ZRO, so sufficient incentives need to be provided to encourage projects to choose $ZRO. Possible incentives include fee discounts when using $ZRO or establishing a single $ZRO reserve to cover fees across all LayerZero-supported chains, making it more attractive to developers.
3. Operational Implementation: For the 50,000 contracts already deployed, the _payInLzToken flag needs to be manually enabled for each contract. To simplify this process, a unified switch at the protocol level may be required, or a one-time incentive may be provided to encourage project teams to adjust their contract settings.
Given the importance of $ZRO as the 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: Distributed Validation Network (DVN) Framework in Cryptocurrency Economics
In October 2024, LayerZero and EigenLayer announced a collaboration to develop an open-source economic framework for Distributed Validation Networks (DVNs). This framework aims to enhance the security of DVNs by introducing economic incentives that allow users and decentralized applications (dApps) to consider factors beyond just technical stability when selecting DVNs.
The framework introduces an arbitration process that runs on a specified chain (e.g., Ethereum), allowing the DVN to stake assets and verify when the validity of cross-chain messages is questioned. The specific process is as follows:
· Staking: Stakers lock assets into the DVN through EigenLayer's AVS; these assets may be slashed if DVN is found to be behaving improperly or validating incorrectly.
· Verification: If a user or dApp questions the validity of a message, the framework will trigger a round-trip message requesting other DVNs to verify the accuracy of the original message.
· Rejection: If mismatches are found, the rejection contract will escalate the decision and call for a token holder vote to decide whether to reduce DVN's staking.
· Slashing: If voting confirms malicious or erroneous behavior, the staked assets will be slashed.
As an open-source framework, any DVN can adopt it and freely choose staking assets. LayerZero Labs' DVN will be the first to implement this framework on Ethereum, accepting $ZRO, $EIGEN, and $ETH as staking assets. Since LayerZero Labs' DVN is still responsible for most of the protocol's validation work, the newly added staking pool may become an important driving force for $ZRO staking.
Specific incentives for $ZRO holders to participate in this staking pool have not yet been announced, making it difficult to predict the total amount of $ZRO that may be staked at this time. Overall, staking helps regulate the supply of tokens in circulation, potentially similar to the role of a 'central bank' in balancing demand and supply.
$ZRO Token Economics
$ZRO's distribution and unlocking plan has been clearly defined in the initial announcement. The total amount is 1 billion $ZRO tokens, allocated to four categories:
· 38.3% for the community: Including operational funds for the LayerZero Foundation.
· 32.2% for strategic partners: Such as investors and advisors.
· 25.5% for core contributors: Allocated to current and future team members.
· 4% allocated for tokens repurchased by LayerZero Labs: For future community activities.
At the token generation event (TGE), 25% of $ZRO tokens were already unlocked, all from the community category. The remaining locked tokens will unlock linearly in the second and third years, with all 1 billion tokens fully unlocked by the end of the third year.
Of the 25% of tokens unlocked:
· 8.5% allocated for rewarding early contributors, distributed through airdrops to the community.
· 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 amount of tokens is expected to stabilize at about 11% of the total supply. This stability is anticipated as no further unlocking occurs 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. With the acceleration of the unlocking speed, most tokens have been allocated to strategic partners (32.2%) and the team (25.5%), which may quickly enter circulation after unlocking.
Rapid unlocking of tokens for investors and teams may put pressure on the LayerZero team to quickly enhance the overall value of the project. We expect that by the end of the three-year unlocking period, approximately 65% of the $ZRO tokens will enter circulation (using Chainlink as a benchmark). This means that the circulating supply will increase fivefold compared to current levels. Such rapid supply growth will require a corresponding increase in the project's market capitalization to maintain price stability.
$ZRO Value Framework
To help readers build a clear mental model for evaluating the value of $ZRO, we propose a structured framework based on trends in the cross-chain space and LayerZero's strategic positioning within it. This framework is designed to assist users in assessing the $ZRO token by considering various factors, although specific parameters will vary based on individual views of industry and project growth.
Our goal is not to provide a definitive parameter combination but to offer a flexible framework that readers can adjust based on their analysis. It should be noted that this framework is neither exhaustive nor a final conclusion.
Methodology
One way to assess the $ZRO token is to apply the Market Capitalization to Transaction Volume Ratio (MCTx), combined with LayerZero's projected three-year trading volume scenarios. The reason for selecting the MCTx ratio is that trading volume is a primary driver of protocol success, and trading 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, while the cross-chain space is likely to sustain high growth momentum. Additionally, we will conduct cross-validation by comparing with Layer 1 protocols like Ethereum and Solana.
Market Capitalization to Transaction Volume Ratio (MCTx)
First, we establish a reference Market Capitalization to Transaction Volume Ratio (MCTx) using Wormhole, Axelar, and ZetaChain as benchmarks, comparing them with LayerZero. These four protocols focus on cross-chain messaging and have launched tokens in the past 12 months. We use third-quarter 2024 data as an observation window to track their average daily trading volumes and market capitalizations, as this period is far from any short-term trading volume peaks.
Market Capitalization to Cross-Chain Trading Volume Ratio
Comparable projects have MCTx ratios ranging from 50 to 100, while LayerZero's current ratio is lower. One reason could be the relatively low circulating supply of $ZRO, which is associated with its later TGE issuance and first-year unlocking plan. Another factor may be that, compared to other projects, $ZRO's utility is relatively limited. For example, AXL and ZETA tokens facilitate not only cross-chain transactions but also support the operations of their respective blockchains.
We expect that as the industry develops, MCTx ratios will converge among leading projects, with trading volume becoming the dominant driver of protocol value. In the following example, we use an MCTx ratio of 50 for illustration.
The next step is to create scenarios for LayerZero's future trading volumes. In the second part of our coverage of LayerZero, we estimate that the current cross-chain trading/message volume is approximately 3.5 million per month (about 120,000 daily), with LayerZero capturing 25% to 30% of the market share. We also anticipate that due to expanding on-chain liquidity and increasing chain numbers, the annual trading volume growth for the entire industry will reach around 100%.
Based on these parameters, readers can formulate transaction volume assumption scenarios for LayerZero over the next three years based on different industry growth rates and LayerZero market share combinations. In this process, readers may need to estimate daily trading volumes under different scenarios and apply MCTx ratios to derive an estimated range for the market capitalization of ZRO at specific points in time.
LayerZero's Projected Trading Volume for the Next Three Years
By applying an MCTx ratio of 50, we can convert each daily trading volume scenario into market capitalization estimates. This leads to a forecast for the market capitalization of the $ZRO token over the next three years, with a conservative scenario of $2 billion and an optimistic scenario of $47 billion.
Estimated Market Capitalization of LayerZero Over the Next Three Years
To derive the present value of $ZRO, we introduce additional assumptions: that the circulating supply of $ZRO tokens is 65%, and apply a 35% discount rate to adjust for future value. Based on these parameters, we calculate the estimated current value of $ZRO tokens for each scenario.
Possible Token Prices for LayerZero
Please remember that the methods described above are just one of the many possible ways to assess $ZRO. The estimated value of $ZRO is highly sensitive to multiple factors, including the future growth rate of the cross-chain industry and LayerZero's market share within it. The future trajectory of the industry will largely depend on the broader cryptocurrency market environment, which itself is highly volatile. Meanwhile, 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 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 to MCTx fee ratios and compare them with leading infrastructure projects like Ethereum and Solana. In the first part of our LayerZero analysis, we estimated that LayerZero's average transaction fee is approximately $0.70. Based on this data, an MCTx ratio of 50 (i.e., $1,000 daily) results in an MCTx fee ratio of 196.
This makes LayerZero's three-year MCTx fee ratio comparable to the current ratios of Ethereum and Solana, which are 250 and 226 respectively. This similarity also means that $ZRO needs to become a core part of the LayerZero ecosystem, supporting its multiplicative rationale, just as $ETH and $SOL do within their respective networks. Whether $ZRO can achieve this remains a contentious topic with both sides having their arguments.
Supportive arguments may include:
· Cross-chain protocols and Layer 1 projects generate protocol revenue by charging transaction fees and paying fees to validating nodes.
· With the recent introduction of the EigenLayer partnership, the $ZRO token may play a significant role in LayerZero's DVN operations, similar to the applications of $ETH and $SOL in their respective networks.
Market Capitalization Compared to Transaction Fees
Counterarguments:
Possible objections include:
· $ZRO has not yet become the default token for transaction fee payments: Currently, $ZRO is not the default fee token for all transactions, so its widespread adoption remains limited.
· Fee switching introduces uncertainty: The ability to switch transaction fees brings uncertainty to users and developers, which may affect their decisions, especially if the fee structure changes frequently.
· $ZRO is currently not used as a 'transaction currency': $ZRO is currently only used as a payment tool for protocol fees and has not expanded into a widely used transaction currency. Therefore, its primary function 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 available for DVN staking, which limits its exclusivity in certain contexts.
Different views on these factors may affect market participants' assessments of MCTx fee ratios and MCTx trading volume ratios, subsequently adjusting based on differing assumptions about the future role of $ZRO.
Other Risks to Consider
Robustness of LayerZero V2 Architecture
LayerZero V2 will be launched in December 2023, and no security vulnerabilities have been reported so far. The protocol's confidence in its design is reflected in its $15 million bug bounty, which is one of the highest in the industry.
One of the cores of LayerZero's security model is that there is no collusion between the DVN (Decentralized Validation Network) and executors. So far, this design has been running well, partly because the executors are entirely operated by LayerZero, while the DVN remains decentralized. However, as LayerZero allows external parties to build executors, the possibility of collusion has increased.
Furthermore, as more projects adopt LayerZero as the primary cross-chain asset transfer and governance infrastructure, the motivation for malicious actors to attack the network will gradually increase. If security vulnerabilities occur, they could significantly damage LayerZero's growth momentum, slow future development, and negatively impact the value of the $ZRO token.
$ZRO Utility Deployment
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 use cases, such as:
· Semi-annual fee switch voting: By introducing a fee switch voting mechanism, expectations for value accumulation among token holders can be increased.
· Default adoption of $ZRO as the fee currency: Increasing the holdings of $ZRO in decentralized applications (dApps) and enhancing the speed of capital circulation.
· Adoption of $ZRO as a universal transaction currency: Expanding the use cases of $ZRO to ensure 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 in 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 planned to become a core part of the LayerZero ecosystem, providing key utility for governance, protocol fees, and DVN staking. Additionally, as the protocol evolves, $ZRO's role is expected to further expand, potentially becoming a widely used cross-chain transaction currency. We anticipate that in the next three years, the utility of LayerZero and $ZRO will experience a rapid growth phase.
Although $ZRO currently lacks direct utility, we have outlined a potential evaluation model that helps readers provide context for future protocol development and assists in assessing $ZRO's role in that future by predicting MCTx ratios and future trading volumes.
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