Osmosis Updates from the Lab Recap, Capital Efficiency, May 04, 2022
Osmosis Updates from the Lab occurs every Wednesday at 1 PM EST (5 PM UTC) on the Osmosis Zone Twitter Space. Replays are available on the Osmosis YouTube channel or the podcast.
Greetings, all!
Sunny’s on the move this month, and you can catch him at the Gateway Conference in Prague on the 16th and 17th, a stacked Cosmos conference that has gone a bit under the radar. Some of the Osmosis developers will be there, as well as folks from Confio and Axelar, and they’re going to be having some whiteboard sessions on Isotonic and on bridge integrations, respectively. It will be exciting to hear what comes from those meetings! You can also catch Sunny speaking about superfluid staking at Permissionless in Miami on the 18th.
No guest this week, but plenty of Osmosis news! We also went in-depth on capital efficiency, in particular the different ways Osmosis might be able to use stablecoin deposits simultaneously in both Isotonic lending and stableswap liquidity pools. This would greatly cut down on incentive fragmentation, boosting APRs across the DEX suite.
Osmosis Updates
Osmosis v8: The Nitrogen upgrade is now scheduled to go on-chain May 18th. In addition to stableswap, the AMM refactor, multi-hop discounts, the custom CosmWasm bindings, and reducing fees on the ATOM/OSMO pool to 0.2%, the update will now also include the CosmWasm Token Factory, which will allow CosmWasm contracts on Osmosis to create SDK native coins.
Only native coins work in the AMM, since CW20 tokens would over-complicate the code and add attack vectors. Therefore, getting the Token Factory module launched will make it easier for external developers to build on top of Osmosis. As we’ve said in previous Updates the TWAP module will have to wait for the next upgrade.
Tooling: Speaking of getting more developers, we continue to build out the tooling available on Osmosis. We’ve mentioned Telescope before, a project making it easy to plug Osmosis into the front-ends of other apps. The latest news is that we are also building a CosmWasm smart contract development environment (like Hardhat or Truffle for Ethereum) with Boss, the creator of Terrain for Terra. A development suite auto-creates the boilerplate scaffolding for various smart contracts, provides tests and testing environments, and helps with deployment and front-end integrations.
Bridges & Bridged Assets: Axelar pools are being migrated to app.osmosis.zone. At first, users will continue to be sent to Satellite to perform the bridging transactions, but the Osmosis native-UI integrations will be live in the coming weeks. In other bridge news, talks are continuing with Wormhole to be the Solana bridge, since Axelar does not currently support them. As we noted in the bridge-off debates, Jump Crypto straddles trad-fi and crypto, and was largely formed by Certus One, a long-time Cosmos validator.
Info Site: Personalized dashboards are now available on the info site! They look fantastic. You can see your Staking and Liquidity Mining rewards over time, your exposure to different pools and assets, and the spot assets in your wallet. Kudos to the Imperator team.
Ion DAO: Ion.wtf is live on testnet. Expect a proposal soon to take this to mainnet.
Support Lab: The OSL has released 3 tutorial videos: preview them on the Osmosis YouTube.
Fiat on-ramp: Kado Money will enable Osmosis to provide UST on-ramping directly from our UI. Combined with our bridges this will enable users and apps to on-board fiat into any token with a back-end swap on Osmosis and transfer out through IBC/Axelar. At $2 per transaction (partially subsidized by Terraform Labs), the fees are quite low. Kado can be integrated once Terra upgrades their chain to allow CosmWasm IBC.
Capital Efficiency
With stableswap coming in a few weeks and Isotonic in roughly six, we need to plan how best to get stablecoin liquidity into both protocols. First, it will be hard enough to compete with Anchor’s “risk-free rate” of 18.21% (16.5% after May 31). For an idea of the scale, we can see that even after the recent peg test, there is $10.6 billion UST staked there. [Edit: These numbers have changed considerably since the writing of this piece, but the point remains that Osmosis still has to compete for liquidity with other top stablecoin yields.] Second, since as it stands now, they will be competing with each other for liquidity.
Capital efficiency — allowing stablecoin liquidity to be used in multiple Osmosis protocols at once— solves for both problems.
How might we do this? Sunny proposed three options, in order of increasing complexity/risk and potential rewards. Note that these are ideas for v2 versions of the protocols, so we have time to consider how bold we want to be and what risk mitigation strategies will work best.
1 - Feed idle Isotonic stablecoin deposits (i.e. those not being lent out) into stableswap liquidity pools. This is the simplest, least risky solution. We can estimate how much extra stablecoin liquidity is likely to be available by looking at Anchor again. Deposits are $10.6b and borrows are $2.2b, giving a usage rate of around 20%, which means there would likely be a high percentage of Isotonic liquidity available to inject, even with a substantial safety margin. If we beat Anchor’s usage rate, it would be because there was considerable demand for borrowing, an excellent scenario. High usage would indicate a healthy protocol, and it would organically drive up lending APRs without the need for extra OSMO incentives, thereby attracting further liquidity.
The dangers of this model are limited. One (solvable) problem is that depositors might either be forced to redeem different stablecoins than they deposited, or else have to pay a swap fee to convert back to their preferred stable. However, swap fees for stables should be set low, and a mechanism for un-gameably subsidizing these forced redemptions could likely be devised. Their are no issues with de-pegging under this model as long as depositors are not forced to accept a de-pegged stable that they did not deposit.
2 - Turn Stableswap LP shares into Osmosis dollars (OSD). Assuming the stables are at a 1-to-1 ratio, deposits locked into USDC/UST and other stable pools would create OSD on a dollar for dollar basis. OSD would then be the required (and incentivized) stablecoin for Isotonic as well as for other parts of Osmosis.
This method fungifies Osmosis stablecoins while maintaining the deposits in separate pools. The initial engineering lift should not be too high; the complexity and risk comes from incentivization and potential de-pegs.
If we only incentivize OSD (at the expense of non-native stables), people will most likely supply the riskiest assets that the DAO allows to count as OSD, and if there is ever a peg loss of, say, UST, then people may attempt to flee to the relative safety of USDT and USDC, leaving the Osmosis pools and Isotonic with more and more of the de-pegged dollars. This could cause a mass exodus of liquidity.
However, these risks are manageable. The DAO can put collateralization limits on riskier assets, just as we will be doing for Isotonic deposits, such that, to make up an example, you might only get 80 cents on the dollar for certain stables. Coming at it from the other end, we are not obligated to complete de-incentivize all stables: if we like some more than others, we can incentivize them. Or we might not have to because while Osmosis may not directly subsidize stables beyond OSD, stablecoin projects seeking adoption will almost certainly continue to provide external incentives.
3 - Create Osmosis Dollars by using Isotonic CDP positions. In this scenario, users would deposit assets into Isotonic not to borrow UST or some other non-native stable, but in order to mint OSD. In this scenario, Osmosis would no longer need to incentivize non-native stables in Isotonic. Users would deposit assets for the same reason they would already be using Isotonic: to use borrowed stables to leverage up by buying more assets or earning yield elsewhere.
This method of creating OSD could also be combined with method two, using stableswap shares to mint OSD, which would allow us to increase the OSD supply at a greater rate than the demand for Isotonic leverage. Further hybridizations of the stablecoin design might also be possible if we wanted to explore the algorithmic and protocol-owned liquidity design spaces of Frax, Ohm, and Terra. Entering the stablecoin competition is risky, but the rewards are great.
Creating Wosmobux is just the sort of outrageously ambitious lab experiment we’ve come to expect at Osmosis, but we will want to think carefully about how best to approach it. Fortunately, we have ample time for discussion and debate.
We’ll leave off this week with a last pair of capitally efficient ideas unrelate to any potential OSD. 1) What if we took the unused Isotonic UST and deposited it into Anchor to earn yield? This would potentially reduce Anchor yields, but it could be good for Osmosis. 2) Even riskier, we could re-hypothecate the UST locked on the Terra-side IBC channel in order to mint UST on Osmosis (potentially on the order of $1 billion), and use that to earn yield on Anchor. Et voila, Osmosis is using decentralized fractional reserves to benefit its users and the DAO.
Thoughts? As always, let us know on Commonwealth or social media, or come ask us on the next Updates from the Lab.
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