Understanding the Liquidity Incentive Process at Osmosis
Hi all! Today we will talk with you about an equally important topic, how liquidity mining works, token blocking mechanisms, distribution among all participants in the Osmosis protocol.
There are many ways that pools on Osmosis can encourage liquidity mining. One way is through (internal) Osmosis liquidity mining; Osmosis allocates 45% of its inflation to incentivize users to put their liquidity into Osmosis. In addition, Osmosis allows the creation of (external) Liquidity Mining Gauges without permission, allowing projects to add their own rewards to further incentivize users to provide liquidity to the pool.
External incentives are an effective way to encourage users to provide liquidity, and also a great way to consider including a pool in the set of pools receiving Osmosis Liquidity Mining (internal) incentives. Creating an incentive scale does not require permissions, so anyone can contribute tokens to the distribution scale as rewards. This feature allows third parties to extend Osmosis’ own liquidity reward program.
You can add promotions to any combination of 1-day, 7-day and 14-day sensors. Incentives allocated for the one-day scale will be divided among all three scales. Incentives allocated for the 7-day scale will only be split between the 7-day and 14-day scales, not for the 1-day scale. Incentives intended for the 14-day scale will only apply to the 14-day scale.
Osmosis not only allows the community to add stimuli to sensors. Anyone can contribute tokens to the sensor for distribution. This feature allows third parties to extend Osmosis’ own liquidity reward program.
For example, there could be an ATOM<>FOOCOIN pool that has a one-day scale incentivized by OSMO management rewards. However, the Foo Foundation may also add additional incentives to the one-day scale, or even add incentives to a new scale (such as the weekly scale).
These external incentive providers can also create long-term incentive programs that distribute rewards over an extended period of time. For example, the Foo Foundation can contribute 30,000 Foocoins to be distributed through a monthly liquidity program. The program will automatically allocate 1000 Foocoins per day to the scale.
Bonded Liquidity Gauges are mechanisms for distributing liquidity rewards to LP tokens that have been bonded for a minimum period of time. 45% of OSMO’s daily issuance goes towards these liquidity incentives.
For example, Pool 1 LP share, 1-week scale, will distribute rewards to users who have pegged Pool 1 LP tokens for one week or longer. The amount each user receives is proportional to the number of their tied tokens.
An associated LP position may be eligible for multiple Gauges. The Gauges qualification assumes a minimum connection time.
Users are free to disable their LP tokens at their convenience. However, there is a 2 week shutdown period. At this stage, users can submit another request to withdraw their tokens. Users are rewarded with OSMO tokens that do not need to go through the unbinding process.
Not all pools have promotional Gauges. At Osmosis, OSMO stakeholders choose which pools to incentivize through on-chain governance offerings. To incentivize the pool, management may assign “allocation points” to certain Gauges. At the end of each daily epoch, 45% of the newly issued OSMOs (Liquidity Incentive Portions) are distributed in proportion to the distribution points each Gauges has. The percentage of OSMO Liquidity Reward that each Gauges receives is calculated as the number of points divided by the total number of distribution points.
In addition to liquidity mining, Osmosis provides three sources of income: transaction fees, swap fees, and exit fees.
1. Transaction fee
A transaction fee is paid by any user for posting a transaction on the chain. The amount of the commission is determined by the costs of calculating and storing the transaction. The minimum gas costs are determined by the author of the block in which the transaction is included. This transaction fee is shared among the OSMO stakers on the network. Validators can choose which assets to accept for fees in the blocks they offer. This capability is unique to Osmosis.
2. Swap fee
The swap fee is the fee charged for the exchange in the LP pool. The commission is paid by the trader in the form of an input asset. Pool creators specify the swap fee when creating the pool. The total commission for a particular trade is calculated as a percentage of the swap size. Fees are added to the pool, which effectively results in a pro-rata distribution between LPs in proportion to their share of the total pool.
3. Exit fees
Osmosis LP pay a small fee when withdrawing funds from the pool. As with the swap fee, the pool exit fee is set by the pool creator. The exit fee is paid in LP tokens. Users withdraw their tokens minus a percentage of the withdrawal fee. These shares of LP are burned, resulting in a proportional distribution of the remaining LP.
Osmosis Superfluid Staking can further incentivize users to provide liquidity to the pool as they will be able to stake their LP tokens for additional rewards. Super Fluid Staking rewards come from OSMO in the staking pool, so only OSMO Pools can qualify for Super Fluid Staking.
There are currently no strict criteria by which pools can include Superfluid staking. This feature is enabled for certain pools through on-chain management. The reason why Osmosis simply did not allow all OSMO pools to enable Superfluid staking is that any sudden excessive loss of value of an asset paired with OSMO would result in a significant reduction in the OSMO side of the pool, and this poses a security risk to the chain. A super-fluid staking OSMO is designed to be securely staked and immune for at least 14 days (the length of the disengagement period) like all staking OSMOs, but if the number of OSMOs in the pool is suddenly reduced, then this essentially has the effect of releasing the staked OSMO before it expires. 14 days. That’s why management needs to evaluate if the pool seems to be stable,
So far, there hasn’t been a proven way to speed up the inclusion of Superfluid staking for a pool, although one can always try to gain community support and then suggest down the chain to enable this feature for a pool.