OlympusDAO: Stability analysis during its expansion phase

✍️ Author: Jimbobkos

Disclosure — The OlympusDAO core development team has not solicited this investment analysis regarding the OHM token. It has been published for informational purposes only and is not investment advice, thus should not be solely relied upon to make investment decisions.
Members of 0x Ventures have invested in OHM.
This statement is intended to disclose any conflict of interest and is not a recommendation to purchase the OHM token.

Purpose

The purpose of this analysis is not to describe or critique the mechanics of the protocol but use a range of metrics to highlight OHM’s characteristics as a stable asset during the ‘expansion phase’ by comparing its stability to traditional stablecoins (e.g. USDT, USDC, UST, DAI, sUSD) as well as Bitcoin and Ethereum. There is NOT an expectation that OHM’s price will be stable during this phase, however this analysis provides an indicator of the current behaviour of its return profile to date. This analysis will be repeated again during the protocol’s ‘mature phase’ where its effectiveness as a stable asset will be much more heavily critiqued.

Key takeaways

1. OHM’s 30d rolling beta and correlation with Bitcoin and Ethereum indicates that the price of OHM is becoming less influenced by the price movements of Bitcoin and Ethereum.
2. The daily volatility (over rolling 30d periods) is greater than Bitcoin and Ethereum and magnitudes larger than stablecoin incumbents, implying weak price stability based on this metric.
3. When comparing the price of OHM to stablecoin incumbents, it has incurred a higher quantity of large declines (e.g. -5%, -10% etc.) and has much larger drawdowns when Bitcoin experiences a negative return. Both metrics imply that OHM is less effective in preserving capital when compared to traditional stablecoins.
4. Under a pragmatic view, OHM (in its current form) is not exhibiting consistent characteristics to conclude it to be a reliably stable asset.

Enter OlympusDAO

In Greek mythology, located on the highest peak of the largest mountain in Greece was Olympus. Housing the twelve ancient gods, including the almighty Zeus, it was said to be the gateway between Heaven and Earth.

The significance of the twelve ancient gods within the timeline of Greek mythology fortifies the importance of Olympus being the foundation for such glory to be built upon it.

“Olympus — The gateway between Heaven and Earth”

Much like the significance of Olympus laying the foundations to which Greek mythology could be built upon, OlympusDAO intends to do the same for the cryptocurrency industry.

Similar to other algorithmic-based stablecoins, its purpose is for the purest form of decentralisation. By providing a solution to remove the reliance of “pegged” assets which rely on the centralised entities that the stablecoin is pegged to (e.g. the Federal Reserve in the case of assets pegged to the USD).

OlympusDAO attempts to achieve this by creating a stablecoin which is “backed” by a pool of assets owned by the protocol, rather than “pegged”. Broadly, the lifecycle of the protocol includes two phases:

1. Expansion phase: Where the protocol focuses on increasing the issuance/supply of OHM to bootstrap the network, whilst incurring price volatility; and
2. Mature phase: Where the protocol focuses on managing the supply/issuance of OHM to stabilise the price.

From the outset, given the protocol is still in an ‘expansion phase’ there is NOT an expectation that the price of OHM exhibits stability. Reiterating the purpose of this exercise, it is simply to analyse the behaviour of OHM return profile to gauge for any price stability (in its current form), using a range of metrics including:

• Bitcoin & Ethereum beta
• OHM correlation with Bitcoin and Ethereum
• Daily volatility
• Drawdown analysis — Over time
• Drawdown analysis — Point in time

A couple of high level comments:

• Daily data has been used, the number of observations of OHM’s price is a lot smaller than Bitcoin and Ethereum. Applying the analysis with data points more frequent than ‘daily’ could lead to different takeaways.
• All analysis includes data to 31 August 2021.
• Calculations and data supporting the below analysis can be accessed here.
• Analysis between the trade-offs of centralised and decentralised stablecoins is not addressed here (although may be in a future analysis), however the below outputs do provide some interesting insights into their relative effectiveness to each other as a stable asset solution.

Bitcoin & Ethereum beta

Metric purpose: This metric determines the sensitivity of price return of one asset (dependent) against price return of another asset (independent). Commonly used in traditional finance when assessing the influence that an equity index (e.g. S&P 500, Nasdaq, etc.) can have on an individual stock (dependent). A result greater than 1 implies the asset is more sensitive to the index move, thus exhibiting somewhat of a leveraged-market play (e.g. Emerging market stocks). A result less than 1 implies the asset is less sensitive to the index move, thus exhibiting diversification benefit with the asset class (i.e. gold stocks).

Application to crypto: Given the size of Bitcoins market cap. compared to the broader market (~40%), it still has a large influence on price movements of non-Bitcoin tokens. As such, Bitcoin is viewed as the market/independent asset in this exercise. Ethereum has also been used as a market proxy given its large size (albeit much smaller relative to Bitcoin) as well as it being the blockchain that OlympusDAO resides on.

Expectation: Given the purpose of the protocol is to create a stablecoin that is not impacted by external forces, the expectation would be that OHM’s ‘Bitcoin beta’ and ‘Ethereum beta’ would be close to zero.

Takeaways:

• Per Chart 1, OHM’s Bitcoin and Ethereum beta are both trending towards zero, which would imply that OHM’s price is beginning to be less influenced by the price movements of Bitcoin and Ethereum.

OHM correlation with Bitcoin and Ethereum

Metric purpose: A somewhat similar metric to beta, identifying the correlation between the price return of two assets assesses — as the name suggests — how co-related they are to each other. A result of 1 means that the two assets are perfectly correlated (e.g. Amazon within Nasdaq Index) and a result of -1 being perfectly negatively related (e.g. Gold, although this is more likely to be somewhere between 0 and -1).

Application to crypto: Again, similar to beta and Bitcoin/Ethereum’s categorisation as representing the ‘market’, we can use these assets to test OHM’s price return correlation.

Expectation: A correlation of 0 between Bitcoin/Ethereum and OHM

Takeaways:

• Similar to the beta analysis, Chart 2 highlights the correlation of OHM’s price with Bitcoin and Ethereum is trending towards zero which supports a reducing influence by these large-cap tokens.

Daily volatility

Metric purpose: To determine the daily variability/fluctuation of an asset’s price around its mean/average, over a set time period. On a relative basis, results that are larger in size are considered more volatility and less optimal for a stablecoin.

Application to crypto: The crypto market provides a number of ‘stablecoin’ solutions, each exhibiting their own risks (e.g. levels of centralisation, smart contract risk, etc.). Comparing OHM’s daily price volatility against the existing incumbents (e.g. USDT, USDC, UST, DAI, sUSD) serves as an intuitive benchmark to determine its effectiveness as a stable/low-volatility asset. Comparison with Bitcoin and Ethereum have also been used for further reference.

Expectation: OHM’s daily price volatility to be negligible (+/- 0.5%), similar to incumbent stablecoin solutions.

Takeaways:

• Chart 3 highlights the daily volatility (over rolling 30d periods) of OHM, Bitcoin and Ethereum. It implies that OHM’s daily price is much more volatile (less stable) relative to Bitcoin and Ethereum. Although, there is a modest declining trend in OHM’s daily volatility.

• Unsurprisingly, OHM’s daily volatility dwarfs that of the prominent stablecoin solutions, per Chart 4.

• By zooming in on the daily volatility of these stablecoins, Chart 5 highlights the daily volatility that OHM should be aiming for, being approximately +/- 0.5% around its mean (average).

Drawdown analysis — Over time

Metric purpose: This metric visually demonstrates the quantity and magnitude of historical asset drawdowns, more importantly though, it highlights whether there is a trend of these drawdowns. For example, assets with a small quantity and magnitude of drawdowns will preserve its value more relative to an asset with large quantities/magnitudes of drawdowns. However, should the drawdowns become less frequent and of smaller magnitude over time, one could conclude that the asset is becoming more stable.

Application to crypto: Whilst it is easy to conclude the limited ability for Bitcoin and Ethereum to preserve value (in their current form), stablecoins are looked at as (relatively) the most stable crypto asset. Given the nascency of these solutions, it is unavoidable in experiencing frequent drawdowns, however at this stage of maturity it is more important that the magnitude of these drawdowns are quite small.

Expectation: An asset price with drawdowns being of a small magnitude

Takeaways:

• Given the relatively small magnitude of drawdowns by stablecoins (albeit quite frequent) per Chart 6, it’s fair to conclude that OHM’s price is not (yet) stable enough to compete with stablecoin incumbents, based on this metric. Ideally, when it comes to the ‘mature phase’, the protocol should be aiming to keep the drawdowns to ~0.5%, similar to USDT and USDC

Drawdown analysis — Point in time (At 31 Aug 2021)

Analysis purpose: Consists of a number of metrics designed to demonstrate a more pragmatic/less statistical approach to analysing stability. Completed by categorising the daily returns and calculating the quantity and magnitude of the asset price drawdown/decline (since asset inception), this can assist in evaluating asset price stability.

Application to crypto: This analysis has been applied to the incumbent stablecoins (e.g. USDT, USDC, UST, DAI, sUSD) as well as Bitcoin and Ethereum.

Expectation: Whilst it is close to unrealistic for an asset (when comparing to Fiat) to exhibit no drawdowns, the key expectations here would be to have a) a high % of observations where price return was zero; and b) small drawdowns when Bitcoin incurs a drawdown (both generally and when certain drawdown thresholds are applied (e.g. greater than 5%, 10% and 15%)

Takeaways:

With reference to Table 1 (calculations linked here):

• Row 3–8: The aim here is to highlight the number of ‘zero’ returns. This infers a stable price of an asset. USDT is the benchmark given its high proportion of zero returns (Cell D8–33.2% of all observations). OHM has recorded a much smaller number of ‘zero’ return observations (Cell C8–1.3%). However, this metric should be discounted because it doesn’t identify when those ‘zero’ returns were achieved. For example, an asset that is not frequently priced in its early days (e.g. Ethereum) can still show a high number of ‘zero’ returns;
• Row 9–11: Demonstrates the portion of the total daily return observations that exceeded a set of drawdown thresholds. Approximately a quarter of OHM’s daily returns (Cell C9) have been worse than -5%, which in absolute terms does not support a level of price stability in addition to a relative basis, this frequency being nearly double that of the next asset (Cell B9 — Ethereum);
• Row 12–14: Provides a measure to determine the average asset return when a particular magnitude of drawdown occurs with Bitcoin. For stablecoins, their average return profile is strong (as expected), with centralised stablecoins having a marginal positive return (Cell D12:E14) and decentralised stablecoins having a marginal positive/negative returns (Cell F12:H14*). *Noting an outlier/idiosyncratic case in sUSD in Cell H14. OHM’s price will on average have a material negative return typically when Bitcoin incurs a drawdown over the set thresholds (Cell C12:C14), demonstrating weak stability; and
• Row 15–23: Categorises the number and proportion of positive, negative and ‘zero’ returns (over the life of an asset) when Bitcoin’s daily return is negative. Whilst the frequency of observations in each category is interesting, the importance is the average return (magnitude) during a negative Bitcoin return. The portion of OHM’s return observation between negative (Cell C17) and positive (Cell C20) are broadly the same, implying that their is effectively no relationship of return when Bitcoin incurs a negative return, based on this metric. Whilst this is broadly similar for the stablecoins (Cell D17 — H17 and D20 — H20), it is OHM’s much larger magnitude of average returns (Row 18 and 21) in each circumstance which differs, which would imply weak stability relative to stablecoins. The ideal asset would be one which has a much greater portion of returns in the ‘zero’ return category (Row 23), however noting the limitations this can attract as mentioned in the first dot point.

Conclusions

Digesting the key takeaways from the above analysis, the below conclusions can be made:

1. By applying a more statistical approach to OHM’s daily return series, the rolling 30d beta and correlations imply that OHM’s price is trending towards exhibiting minimal influence by the price movements of Bitcoin and Ethereum, which is a key attribute for a ‘stable’ asset;
2. For an asset to be stable, a holder of the asset must have confidence that the asset’s price will remain relatively stable during its holding period as well as at the time they choose to use that asset (i.e. for transaction purposes, redeployment into risk-assets etc.). An asset with a low daily volatility serves to meet this objective. Based on this metric, stablecoin incumbents are a more superior solution relative to OHM given they have a much lower daily volatility; and
3. Similar to a stable asset exhibiting low daily volatility, its ability to preserve its value is just as important so an investor can be confident that it will hold its value until such time that they wish to use that asset and maximise its full value. For example, Table 2 provides a simple hypothetical of the impact on redeploying stable assets when value is preserved. If Bitcoin were to incur a market drawdown (e.g. -40%) and also drags down an inferior stable asset (e.g. Stable asset 2, -15%), whilst there would be some preservation of value to the order of 25% (being -15% minus -40%), it is not as strong as if the stable asset had completely preserved its value (e.g. Stable asset 1). Therefore, by holding a superior stable asset in this example, an investor would have maximised the redeployment of this value and captured an extra 0.3 Bitcoin.

Overall, it is open to interpretation on how much weight one places on each metric used to evaluate stability of an asset. My preference is more pragmatic, such that I want confidence in an asset that it will have a stable price at the time when I wish to use it and the value is preserved to ensure this value is maximised when used. On this basis, I would conclude that in its current form, OHM is not representing stability. However, as previously mentioned this is NOT the expectation during the ‘expansion phase’ of the protocol. Brief versions of this exercise will be repeated in future to assess whether investor behaviour or market forces begin to demonstrate trends which highlight stability. A more detailed analysis like the above will be completed when the protocol transitions to its ‘mature phase’, which we very much look forward to.

Long live Olympus