Osmosis Updates from the Lab, January 25, 2023: Concentrated Liquidity, Cross-Chain Swaps, Carbon Market

Osmosis Updates from the Lab (UftL) occurs on alternating Wednesdays at 1 PM EST (5 PM UTC) on the Osmosis Zone Twitter Space. Replays are available on the Osmosis YouTube channel or the podcast. These expanded recaps are available on the Community Updates blog and the Osmosis Labs blog.

Welcome back to the lab!

We start with a special thanks from Secret Network moderator Marty to the Osmosis Support Lab. He has walked many of his users through Osmosis interactions with their help. Thanks to the OSL for continuing to provide such friendly, competent help in the bear market.

Quick Updates

• Axelar now supports the bridging of native, non-wrapped assets. This means that, for example, plain ETH can be sent from Ethereum to Osmosis without the user having to convert it to WETH first — saving time, hassle, and fees. The user still receives a wrapped asset on Osmosis, but the conversion is handled invisibly. This works for other assets as well, e.g. BNB for WBNB.
• AVAX has been added to the front-end, where it has been incentivized by the DAO and added to the MAJOR asset category. This is yet another major ecosystem now connected to Osmosis!

Concentrated Liquidity

Concentrated Liquidity (CL) is the upcoming AMM upgrade that will radically improve the capital efficiency of Osmosis liquidity pools by allowing users to provide liquidity in the ranges of their choice. For more background, see the last UftL recap.

The back-end work for CL is on track for the end of February, while the front-end integration may take a little longer. A launch in mid-to-late March therefore seems likely, barring any surprises. To track the progress in real time, see the ever-evolving mechanism architecture docs.

A Better User Experience: While Osmosis CL largely takes its cues from the Uniswap v3 design, the UX of liquidity provision will be much improved.

• Better ticks: a novel geometric tick spacing mechanism will allow LP providers to set their liquidity at intuitive, whole-cent intervals (without any rounding on the front-end)
• Limited full-range incentives: governance is expected to approve a small number of incentives for this passive (potentially IL-averse) liquidity. (Incentivizing full-range liquidity is good not only for UX, but for providing an extra buffer against TWAP manipulation.)
• Built-in Strategy Vaults: Osmosis will have actively managed on-chain strategy vaults built by a number of teams, such as Quasar and Astroport. To read more about Quasar, see their recent Osmosis Ecosystem Spotlight. Astroport (built by Delphi Labs, the developer of Mars Protocol) is developing a Curve v2-style strategy that auto-rebalances the target concentrated liquidity range around the pool’s TWAP.
• Pre-set Ranges: Novice users will be able to use these vaults to make CL LPing simple, or they can select easy-to-understand pre-set ranges from the Osmosis front-end.
• Tools for Advanced Traders: Advanced users will be able to set their own ranges just as they can on other CL AMMs. And tools like Hummingbot will be integrated for professional market-makers and other trading bot enjoyoors.

CL Incentives
Reduction: CL will allow the Osmosis DAO to radically reduce LP incentives. (This reduction process has already been ongoing for quite a long time with respect to the unconcentrated Balancer-style pools — see Governance Corner below for the latest.)

CL pools need fewer incentives for two basic reasons. First, they can deliver low price-impact trading with far less liquidity than non-CL pools. This means that CL pools can target a much lower liquidity depth, which means they need fewer incentives. Second, LP providers earn far more in fees in CL pools, though it takes more skill than passive liquidity provision, and requires careful planning to navigate the magnified impermanent loss.

No More LP Bonding: LP bonding does not work with CL because the restricted liquidity ranges makes LP positions non-fungible. However, the DAO should still find a way to incentivize loyal liquidity over mercenary, just-in-time (JIT) liquidity.

The best way to do this is likely by only awarding fees (or only awarding full fees) to liquidity that has been on the DEX for a certain minimum amount of time. This will prevent the sort of sophisticated, MEV-like frontrunning of liquidity provision illustrated in the tweet below.

While disincentivizing JIT liquidity might have the first-order effect of making execution worse for traders, the second-order promotion of sticky liquidity should lead to stabler DEX pricing over time, a more consistent UX for both LP providers and traders, and ultimately, better execution.

CL Limit Orders: CL will also enable on-chain limit orders. These can be constructed by providing liquidity in user-specified ranges: as the price shifts through a CL position, the better-performing asset is sold to buy the worse performing asset. This enables users to set price points at which to scale out of their exposure to one asset in favor of another.

Example
Bob wants all his OSMO to be sold off by the time it reaches $20, and he wants to go all in on buying OSMO if it hits $0.70.

A OSMO/USDC LP position with that same range will accomplish this. If OSMO goes up from its price at the time of LPing, the OSMO is sold to buy dollars. Conversely, if it goes down, dollars are sold to buy OSMO. If the price goes out of range, the position will be all OSMO (if the OSMO price goes down), or all dollars (if it goes up).

More complicated strategies can be built on this basic concept. For instance, liquidity could be provided at various overlapping ranges in order to hedge or to change the rate at which an asset is sold. Volatile assets can be used instead of a stable/volatile pair. For all these strategies, most users will likely end up using automated, managed vaults so that they can invest relatively passively.

Cross-chain Swaps

The swap router for cross-chain swaps is about to be uploaded to the chain. But what exactly is a cross-chain swap? It just sounds like a fancy name for an IBC transfer?

Not exactly. Cross-chain swaps bring the power of Osmosis to any other chain that enables them. Currently, if Alice has an asset on another chain, e.g. ATOM on the Cosmos Hub, and she wants to trade it for another asset, e.g. JUNO, she would have to manually transfer the ATOM to Osmosis, make the swap, and manually send the JUNO to its destination chain.

Cross-chain swaps can bundle all these transactions into one. And they can be made from any chain equipped to interact with the Osmosis cross-chain swap router.

Cross-chain swaps function by including an entire set of transactions in the metadata of a single IBC transaction. Each piece executes and then forwards the remaining transactions. In our example, turning Alice’s ATOM on the Hub into JUNO on the Juno chain can now be done in a single cross-chain swap transaction, either from osmosis.zone, or any other front-end that allows it.

Further updates to cross-chain swaps will allow the router to interact with Axelar’s General Message Passing (GMP) in order to allow swapping across Axelar bridges. Once that is enabled, Alice could, for instance, directly swap Ethereum ETH to dy/dx USDC in a single transaction and be instantly ready to go perpetually long on the interchain.

Regen Network

Regen is finishing its custom Polygon bridge in the next few weeks, which will at last allow Osmosis to host the Cosmos carbon market that was approved last March.

A custom bridge was required to bring over $NCT, the token of the Nature Carbon Tonne. NCTs are digitized and fractionalized versions of real-world carbon assets. (For further background on how Regen works with various protocols to source NCTs, see this UftL recap from last March.)

Since the bear market intervened while the bridge was being built, there will be less liquidity in the pools (NCT/REGEN and NCT/OSMO) than was originally hoped. However, Osmosis will still use NCTs to go carbon neutral, and the NCT/OSMO will be heavily incentivized using some portion of the 2021 grant to the Osmosis DAO of 1.4m REGEN.

Governance Corner

Props are passed or passing unless otherwise mentioned. Voting end date in parentheses.

• Prop 417 — Whitelist an Apollo DAO multisig to freely upload CosmWasm contracts “relating to the function of Apollo DAO’s LP Vaults.” (Feb. 5)
• Prop 415 — Bootstrap MARS/OSMO with 310,000 OSMO from the Osmosis Community Pool. These will be transferred to a 2/3 multisig, which will then distribute them to 14-day bonded liquidity in the pool over 90 days. These will presumably be treated as external incentives, along with whatever MARS external incentives Mars governance chooses to add. Native incentives for the pool will be a matter for future governance. (Feb. 2)
• Prop 414 — Whitelist an address administered by Delphi Labs to freely upload CosmWasm contracts “relating to the function of a Mars Protocol Outpost.” (Feb. 2)
• Props 412, 413, and 418 — IBC channel recoveries/reopenings with IXO, FUND, and CTK (Shentu). (Feb. 1-6)
• Prop 411 — Upload SwapRouter Contract. This is a CosmWasm contract from Osmosis Labs that will facilitate cross-chain swaps by taking received tokens, swapping them via a swaprouter contract, and sending them on to an IBC receiver. (Feb. 2)
• Props 408, 409, & 410 — Admit AVAX/OSMO (899) to native incentives, as a MAJOR asset, and bootstrap with 0.5% of liquidity mining incentives. (Jan. 30)

Incentives Optimization Plan: A new model of incentives is currently under discussion before being revised and put to a vote. It was developed by Hathor Nodes in conjunction with Chaos Labs (dashboard here) using a grant from the OGP.

The new model aims to minimize liquidity mining incentives by tuning them to the Target Pool Liquidity. This Target is arrived at by calculating the liquidity necessary to ensure that price impact is less than 1% for 95% of the swaps in a pool and less than 10% price impact for the average whale swap.

There are many important sub-features of the proposal that will require collective thought on the part of the DAO. Some of these include:

• Savings: the optimization would save around 5.3K OSMO/day to start
• External incentive matching: reduced to 10 cents on the dollar
• Targeting lower Osmosis TVL: may affect OSMO price negatively. Even if it does not, it could negatively affect the Osmosis brand, even though TVL is widely thought to be a poor metric of DEX success. On the other hand, CL was in all likelihood already going to reduce TVL, and if volume is high and increasing, the brand should thrive.
• Removal of the Asset Category Incentive System: incentives will return to a totally neutral, automatic system (similar to what was in place before the Terra crash), removing a lever of DAO control.
• Concentrated Liquidity: major incentive changes are also happening in conjunction with Concentrated Liquidity (as described above).

Read the full research post from Hathor, and check out the discussion on Commonwealth. Then, make your voice heard!

That’s all for this time. See you again on Feb. 8 for the Mars Red Bank Outpost extravaganza!

Enter the laboratory at Osmosis.zone, the first decentralized exchange powered by the Cosmos SDK and IBC. See our published lab reports at the Osmosis blog, our bench notes at Github and help plan future experiments in our Commonwealth

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