Osmosis: A Hub AMM

In recent months, there has been much discussion within the Cosmos community about the potential for a Cosmos Hub-based AMM platform. The potential for such an AMM is what inspired us to begin work on Osmosis in the first place, and we remain committed to making Osmosis the best AMM secured by the Cosmos Hub.

We originally considered building Osmosis as a module on the Cosmos Hub directly, but after long analysis, determined that this was not the optimal path for the success of both Osmosis and the Cosmos Hub. In the post, we’ll lay out some of the reasons we came to this conclusion, and explain our vision for the future of the Cosmos Hub and Osmosis’s synergistic relationship with it.

Iterate Fast

Before we move forward, it’s important to understand the design philosophy of Osmosis to understand the full context.

Osmosis is an AMM laboratory: an active testing ground where experimentation on optimizing AMMs for a wide variety of financial assets takes place using the same scientific method which drove human progress forward:

1. Asking a question
2. Hypothesizing a solution
3. Experimenting
4. Collecting and analyzing the data
5. Drawing a conclusion
6. Iterating based on findings

Osmosis isn’t the answer to, but rather the process of, bringing discoveries, innovation, and refinement in the DeFi space.

The liquidity providers are the DeFi scientists. Each may have identified problems and inefficiencies that exist in the DeFi market, and have come to hypothesize a diverse set of solutions.

The modularity and customization that Osmosis AMM offers is the large array of scientific instruments that scientists use to conduct a wide range of experiments. Through this process (and the tools they have access to), breakthrough innovations in pricing, slippage, and impermanent loss can be observed, shared and eventually move the entire AMM space forward.

In order to consistently provide liquidity providers with the latest and greatest tools, the base layer protocol needs to iterate. Fast.

The platform will need to frequently add new modules and features such as integration of novel VMs for curve creation, batched transaction pricing, liquidity incentive distribution logic, and advanced x/gov extensions for LP governance. And beyond just the SDK module level, the ideal AMM protocol will need to be able to move quickly on adopting custom low-level features such as threshold decryption for frontrunning resistance, shielded pools for privacy, and validator-backed price oracles for use in custom AMM algorithms.

We intend for these new features to come through a rapid series of software upgrades (potentially as frequent as on a monthly basis), which in our opinion isn’t realistic, nor optimal, for the Cosmos Hub. An application deployed on the Hub means that no matter how quickly developers are able to ship new features, the speed of the product’s iteration ultimately depends on how quickly the Cosmos Hub stakeholders are able to assess the risks and come to agreement on deployment.

Specialized Governance and Incentive Alignment

Beyond software and feature upgrades, Osmosis requires regular participation in more fine-grained on-chain governance of the protocol such as determining the distribution of liquidity mining incentives on a weekly basis, changing global AMM parameters according to market conditions, and the spending of the community pool to encourage the growth of the ecosystem, and more.

To succeed at this, Osmosis requires a highly engaged, highly active set of governance decision-makers. While a subset of Cosmos Hub stakeholders may fall into this category, we believe that the best governors of a protocol are its users — those who interact most closely with the protocol.

Osmosis is an AMM protocol built for liquidity providers, therefore it should be governed by liquidity providers. This is why the OSMO governance token is necessary so that it can be distributed over time to the ideal set of governance participants. This governance token distribution also serves a dual purpose of acting as a protocol-level liquidity mining incentive, a way to reward those who provide liquidity to the system by giving them an ownership stake in the protocol which they can then use to help guide its direction.

Hub as an Application-Specific Blockchain

We’ve discussed the social scalability constraints of the Cosmos Hub, but we should also take into consideration the technical scalability limitations as well.

As great as the strengths of Tendermint Core and the Cosmos SDK are, on their own, they are not a magic key to infinite scalability. The Cosmos strategy for scalability is through specialization, and it is important to remember that at its core, the Cosmos Hub, is still an application-specific blockchain, albeit a special one.

The Cosmos Hub has several high-value characteristics that no other zone has been able to replicate: decentralization, economic security, reliability, and liquid fiat gateways, and a schelling point for innovation on IBC and core protocol developments.

However, this doesn’t mean that Cosmos Hub should add every feature onto the hub to leverage its strength. Additional complexities on the hub may cause potential issues with security and reliability. They certainly increase the cost of running the full node software and the complexity of ensuring state correctness. Eventually, the Hub will run into scaling constraints on throughput for its core functions. Rather than trying to host a trading protocol that will create a bottleneck at scale, the Hub should dedicate its throughput and capacity towards the use cases it was designed for.

So what are these applications that the Cosmos Hub should be focused on? We identify three:

Shared Security

Staking Derivatives

Universal IBC Adapter

Shared Security: The Killer Feature

Adding complexities to the Hub is a short-term solution which merely delays finding the right solution to a long-term problem: the coexistence of permissionless innovation and incentive alignment. Currently, for a new application to be deployed within the Cosmos ecosystem it must launch as a sovereign zone with its own staking token.

While a sovereign zone offers the ability to quickly iterate based on the decisions of highly engaged stakeholders, this comes at the cost of network security guarantees which can bottleneck the number of assets it can safely custody.

The solution to this is shared security, which will allow permissionless innovation to happen with the security of the Cosmos Hub.

Shared security will allow zones to delegate their consensus security to the Cosmos Hub validators, by allowing delegators to use their ATOMs to secure multiple chains, earning fees and rewards for each chain secured. This offers incentive alignment across a heterogeneous spectrum of application architectures, rather than forcing a decision on the ‘one perfect design’ (which likely doesn’t exist).

There is no one perfect DEX model, one perfect smart contracting model, or one perfect stablecoin design.

The Cosmos Hub is meant to be a platform, not an application. As such, it should be focused on building the best possible shared security model that will provide a novel alternative to other shared security base layers such as Polkadot and Ethereum 2.0. This is a much more compelling and high value-add application for the Cosmos Hub, tailored to its strengths, rather than making it yet another AMM application.

Credible Neutrality

The value of shared security is dependent on the trust in the Cosmos Hub’s credible neutrality.

If the Cosmos Hub provided its own direct competitor to a given chain’s product, this makes shared security much less compelling for that chain. Ethereum was able to become a hotbed for innovation because the base layer chain was incredibly neutral. If it had its own native built-in stablecoin, this would have been a disincentive for projects like Maker and Fei to innovate and build on top of it. If Ethereum had ordained a specific DEX as its “native DEX”, this would have been a disincentive for projects like 0x and Uniswap to build on top of it.

To be the best possible platform for people to build on top of, the Cosmos Hub shouldn’t try to pre-emptively define the winners, and it must instead minimize fears that it will compete with the applications that are trying to build on top of it.

Base Money and Staking Derivatives

However, one of core functions that the Ethereum base layer does try to compete on is being the reserve asset for the DeFi ecosystem built on top of it. ATOMs are one of the highest market cap IBC-enabled assets, positioning it to be a strong competitor in this space. For example, we predict ATOMs will likely be one of the most popular liquidity pairs within Osmosis. By developing features like Staking Derivatives, this will allow staked ATOMs to flow into other chains to be a core asset, while still accruing staking rewards from the Cosmos Hub and other shared security chains.

The combination of liquid staking with DeFi applications innovated on Cosmos zones will be a killer feature for the Cosmos DeFi ecosystem.

How will Osmosis launch?

Osmosis is launching with a quadratic fairdrop of its entire genesis supply to ATOM holders in order to best align the interests of Osmosis and the Cosmos Hub. The Hub has the most decentralized token distribution amongst all Cosmos chains, secured by high-quality validators and a robust community. Furthermore, the high liquidity and the fiat gateway that the ATOM provides makes it an attractive base asset for many liquidity pool pairs–and even more so once liquid staking is adopted on the Hub.

Once shared security is available on the Cosmos Hub, we’d like to see Osmosis transition to using this feature in order to further create synergistic relationships with the Cosmos Hub. Because the security of the Hub is something that is not easily replicated, Osmosis will be able to lease this from the Hub. Meanwhile, stakeholders of the Cosmos Hub will get to benefit from the success of Osmosis through staking rewards and fees, making the two protocols economically aligned.

When shared security is ready, it will be up to the OSMO token holders to vote on the switch to shared security backed by the hub. We hope that the Hub will remain credibly neutral so that the choice of switching to this new paradigm is a no-brainer for the Osmosis community.

A multitude of AMM platforms will arise in the Cosmos ecosystem and compete with a variety of models, both as sovereign chains and secured by the Cosmos Hub. And of course, we intend that Osmosis will rise to become the predominant and most powerful AMM protocol, and hope to share this journey with the Cosmos Hub.

Osmosis isn’t a module on the Cosmos Hub. But it will be a chain of the Cosmos Hub. It is a Hub AMM.