Author: @!0xWang1| @RealResearchDAO

Foreword

U.S.Dollar-pegged stablecoins have become indispensable in the crypto market because they are less volatile than other coins like Bitcoin and Ethereum. Users will also feel more convenient trading with stablecoins, after all, they know that the amount they hold will have the same purchasing power today and tomorrow. However, this is a common myth that the dollar is owned by the U.S. government and controlled by the Fed, which means that the depreciation of the U.S.Dollar will also cause the devaluation of the stablecoin. Since stablecoins that are advertised as stable are not safe to a certain extent, is there a way to create a marker of true value stability? OlympusDAO came up with its own ideas and put them into practice.

What is Olympus DAO?

More than 10,000% APY and the once-hot (3,3) tag on Twitter seems to be the starting point for most people to know about Olympus DAO. But what exactly is Olympus DAO?

A beautiful vision for true stability

DeFi was born under the strong market urge for decentralized finance. Although it holds the beautiful vision of "decentralization", DeFi itself is inseparable from the support of stablecoins. Although the now widely used stablecoins such as DAI, USDT, and USDC, etc., are more stable than BTC or ETH, because their value is pegged to the US dollar, they reintroduce the dependence and risk on the US Dollar that the crypto space was trying to get rid of from the very beginning. The visions of anti-inflation, decentralization, and de-dollarization seem to be an illusion.

In this context, OlympusDAO (hereinafter referred to as Olympus) was born with a mission of trying to solve this problem and creating a real stable asset liquidity management protocol. 

Olympus addresses this dilemma by creating a free-floating reserve currency, the OHM. OHM is a "non-pegged stablecoin", which is a new model of the algorithmic stablecoin. It tries not to be pegged to any fiat currency and is less volatile than traditional cryptocurrencies. The value of OHM floats according to the value of the underlying assets and parameters set by the DAO (here, the OlympusDAO protocol). The protocol mints OHM when OHM is greater than its intrinsic value and burns OHM when OHM is less than its intrinsic value. In this way, the supply and demand of OHM is kept in balance.

Price stability or value stability? What is OHM’s innovation about algorithmic stablecoins?

The Logic of Algorithmic Stablecoins

Unlike the fiat stablecoin that directly pegs the value of the US dollar, the algorithmic stablecoin does not need to be directly collateralized with fiat currency assets but relies on various intelligent algorithms with sophisticated logic to subtly balance the supply and demand relationship of the currency itself to achieve stability. The algorithms stabilize the price of the stablecoin at a specific price or a range. Generally, the price of the fiat stablecoin is at 1 US Dollar.

Algorithmic stablecoins, as a derivative model of stablecoins, provide the market with a feasible solution in addition to fiat stablecoin transactions. When the liquidity of fiat currency assets is insufficient, the issuance of algorithmic stablecoins can timely meet the transaction demands of users in the ecosystem on-chain, meet the timeliness of ecological development, and ensure the smooth development of the ecosystem.

OHM enables a new model of algorithmic stablecoins

Unlike the stability promoted by the traditional fiat stablecoins, OHM, as a new algorithmic stablecoin, relies on the protocol’s contract to dynamically adjust the price based on market conditions, so that the intrinsic value of OHM remains relatively stable under different situations.

In Olympus DAO, each OHM is backed by 1 DAI, but not pegged. Since every OHM in the treasury is backed by at least 1 DAI, the purpose of the protocol is to achieve stability through algorithmic market operations. Whenever 1 OHM > 1 DAI, the protocol will sell OHM at a discount, increasing the circulating supply of OHM and bringing the price back down. Whenever 1 OHM < 1 DAI, the protocol will buy OHM, reducing the circulating supply and making the price go up. Since the sale price to OHM of the protocol is always higher than the purchase price, the protocol is always making a profit. 90% of the profits from these sales are shared with OHM holders, and the remaining 10% goes back to the treasury. OHM does not have a price limit, the floor price or intrinsic value is equal to 1 DAI. Usually, stablecoins are pegged to the US dollar, i.e. value = 1, whereas OHM that is backed by DAI has an uncapped value ≥ 1.

Equation: OHM price = 1 DAI + premium

• The protocol has expanded the treasury to include other assets. It can be seen that there are at least 5 assets in the portfolio of OHM treasury, and the price of OHM is also supported by these 5 cryptocurrencies.

The detailed explanation of the mechanism behind Olympus, the pioneer of DeFi 2.0

The Dilemma of Early DeFi

Since its birth, DeFi has made its fame in the history of the crypto industry. The new and interesting mechanisms have made all kinds of funds flood in. The prosperous scene of DeFi Summer is still lingering in the memory of the market. As time passes, the once crazy DeFi projects have also undergone various tests. Under the appearance of decentralization and the convenience and freedom of capital, some classic problems of DeFi have also emerged:

1. Users have developed a fixed habit of mining, withdrawing, and selling tokens, and the project may face constant token selling pressure at the beginning of the project;

2. Incorrect control of user incentives. The sole means of attracting users for many projects is the high APY reward of the LP pool and other token incentives. Such means were once understandable. The problem is that these incentives lack a strong correlation with the protocol itself, and the value of project tokens is not captured by the project itself. Users are not loyal at all. Moreover, behind the high rewards is the high cost of the project party, which makes the rich rewards unsustainable in the long term. Once the incentives drain, users will just leave. The reward token will be facing heavy selling pressure;

3. Impermanent loss. Impermanent loss is also a common topic in DeFi. When users deposit LPs, the token prices will change due to market fluctuations. When withdrawing LPs, users may suffer impermanent loss. In DeFi 2.0, some projects such as Tokemak, Alchemix, etc., use smart contracts to avoid impermanent losses.

4. Lack of new capital influx. For high-yield DeFi protocols, there will be obvious differences between the benefits of early entrants and late entrants. Early users will receive huge returns in the early stage of the protocol, while later users will face the scenario of being harvested by the early big players. As a result, many DeFi protocols are faced with the dilemma of no new funds entering, resulting in the collapse of project tokens and the dilemma of liquidity drying up.

Olympus, the icebreaker of the liquidity dilemma

How does Olympus deal with the challenges of DeFi?

The Olympus protocol controls the supply and price of OHM tokens through the protocol-owned liquidity (POL), the unique bond mechanism (Bonding), and the staking mechanism.

Protocol-owned liquidity (POL) to determine its own fate 

The unique protocol-owned liquidity (POL) of Olympus is different from the liquidity mining in general DeFi protocols, which can be deposited and withdrawn at will. Olympus enables users to deposit liquidity by selling bonds at a discount. Once deposited into the protocol, it cannot be unilaterally withdrawn by the user, which is the support for the Olympus protocol to control liquidity. When users exchange LPs (such as OHM-DAI, OHM-FRAX, etc.) for discounted OHM tokens, they essentially hand over the LPs in their hands to the protocol. Generally speaking, the LP is controlled by the user, namely the Farmer. In Olympus, most of the LP is held by the protocol and generates revenue.

Based on POL, Olympus does not have to implement a costly and unsustainable incentive model to attract users to deposit liquidity, not to mention that the model attracts mostly casual users and does not help increase user loyalty. Firm control of liquidity is one of the hallmarks of DeFi 2.0 projects. Through the Bonding mechanism, the protocol accumulates a large amount of liquidity that can be independently controlled. When the POL reaches a certain amount (singularity), the protocol will not have to rely on external liquidity anymore.

Save it or lose it - the staking mechanism of high APY

Olympus locks the vast majority of liquidity by combining the OHM token staking model of the (3,3) design of the Nash equilibrium. When users deposit OHM, the protocol will mint more OHM according to the current price of OHM (1+ premium), 90% of which is used as a staking reward for users, and 10% is deposited into the treasury.

For example,

If the current OHM price is $1000, when user A buys an OHM by depositing 1000 DAI through reserve bonds (mentioned below), the protocol will mint 1000 OHM according to the mechanism that DAI provides price support for OHM. 1 of the 1000 OHM is given to A, 10% of the remaining 999 is returned to the treasury, and 90% is used as staking rewards for all OHM users. This distribution mechanism is the "rebase" mechanism in Steak, and rebase occurs every 8 hours, 3 times a day, which is one of the reasons for the exaggerated APY at Olympus.

The formula for the rebase calculation here is: F=P*(1+i)^n, P represents the number of staked OHMs, I represents the single rebase ratio, n is the number of rebasing cycles, 8 hours per cycle. 

Olympus's unique staking mechanism makes the users who staked in the early stage extremely profitable, and users who later can also enjoy super high APY, but it is the long-term staking of early users that guarantees super high APY in the end. The vast majority of OHM holders only need to stake OHM to bring continuous high returns through high APY. The more they stake, the firmer the protocol's grasp of OHM, hence less market liquidity, and less token selling pressure.

With a large number of OHM minted in the protocol, the only option for OHM holders seems to be to stake OHM, otherwise, the OHM they hold will depreciate rapidly due to the crazy minting speed. Olympus uses this mechanism to control a large amount of OHM.

Injecting value support into OHM - Olympus Bonding which utilizes bond mechanics

From the previous article, we know that when the price of OHM is >1, the protocol will sell OHM at a discounted price, increasing the circulating supply of OHM and bringing the price back down. Whenever 1 OHM < 1 DAI, the protocol will buy OHM.

So where did the treasury funds to buy OHM come from? It is not that the protocol is generated out of thin air by magic, but the LP token or single token is collected from the users in the form of a discount bond, and the income is credited to the account after 5 days (that is, 15 rebase cycles in staking). The whole process is equivalent to the user buying a bond from Olympus with a term of 5 days and a discount as interest. Therefore, the Bonding mechanism is divided into two forms, namely

1. Reserve bonds: Deposit a single asset (such as DAI, FRAX, or LUSD) in exchange for OHM

2. Liquidity bonds: Deposit LP tokens in exchange for OHM, the most important liquidity bond is the OHM/DAI SLP on Sushiswap

How ​​does Bonding generate OHM? Take a look at an example,

Assuming that the current OHM price is $1000, user A has DAI with a market price of $1000, and 1000 DAI is deposited into an OHM-DAI SLP in Sushiswap, and then the SLP is deposited into Olympus as a liquidity bond, and the OHM bond is then exchanged at a discounted price.

After the protocol receives the SLP, it will be deposited into the treasury, and the corresponding Risk Free Value (RFV) of the SLP will be calculated as $44. According to the rules that each OHM provides value by 1 DAI, 44 OHMs will be minted in the treasury, of which

• 1 will be given to A (after five days)

• 90% of the rest 43 will be distributed to users who staked as staking rewards, and 10% will be kept in the treasury

For A, it is equivalent to buying 1 OHM worth $1000 with $900 at a 10% discount (900/1000=90%), but it will take 5 days to arrive.

For the protocol, an asset with a market price of $900 was received, and after the asset was devalued, the corresponding amount of OHM was minted.

You might be wondering, what is RFV? 

Where is the lower limit of LP? RFV calculation will tell you

Unlike staking a single stablecoin asset, the price of LP will fluctuate greatly in value due to market conditions. If the value of LP is determined according to the market value at the time the corresponding amount of OHM is issued, when the price of OHM falls, the supported value of the OHM will be lower than 1 DAI. When determining the value of LP tokens, the protocol adopts a conservative asset evaluation method to ensure the safety of treasury funds and will pre-consider the impact of price declines and make impairments in advance. At the same time, the RFV determination method for reserve bonds and liquidity bonds is different.

Risk Free Value (LP BOND) = 2sqrt(Constant Product) * (% ownership of the pool)

Since reserve bonds are generally deposited in stablecoins, impairments are not considered.

Due to the existence of the RFV mechanism, reserve bonds can more effectively promote the minting of OHM. If the current OHM price is $1000, A has 2000 DAI in hand:

• Liquidity bonds: A deposits 1 OHM and 1000 DAI, the market value is $2000, the RFV is $62 (calculation formula: 2*sqrt(1*1000)*99%), and only 62 OHM can be minted.

• Reserve bonds: RFV and market cap are both $2000, and 2000 OHM can be minted.

When there are too many reserve bonds, OHM will be minted in large quantities, which can lead to large selling pressure on OHM, so when there is a large demand, the discount rate of reserve bonds will decrease, and the discount rate of LP bonds will increase. As the trading pool continues to deepen and the protocol is better able to handle the increase in OHM supply, the price stability of LP bonds will also increase.

Bonding is an important implementation of OlympusDAO owning and controlling liquidity. When users sell their LP tokens, users will be incentivized to buy OHM at a discounted price, and LP tokens will bring better depth and liquidity to the treasury, lifting the lower limit of OHM prices. The protocol captures LP tokens that provide liquidity, and in fact, the protocol controls the liquidity itself. By owning and controlling liquidity, OlympusDAO becomes its own market maker. LP token liquidity creates income for the protocol, and OlympusDAO will receive market maker commissions from trading pairs, realizing the profitability and sustainable development of the protocol. OlympusDAO has over 99.5% of its own liquidity in the market.

Quoted from "读懂OlympusDAO：Defi2.0的扛旗者 不稳定的算法稳定币" by @刘全凯

Staking or Bonding - A Comparison

Suppose the OHM price is $1000, you have 2000 DAI as principal, and the current rebase reward is 0.404%.

Strategy 1: Direct Staking

• Buy 2 OHM directly and stake, after 5 days, you will hold 2.1247 OHM

Strategy 2: Deposit LP token in bonding

• Buy 1 OHM and use the remaining $1000 DAI to get an OHM-DAI LP

• If the current bond price is $950, get 2.105 OHM after 5 days

• If the current bond price is $900, get 2.22 OHM after 5 days

During the same period, when the discounted price of the bond is greater than the earnings of 15 rebase cycles, users can choose to purchase OHM in the form of Bonding.

What is the Nash Equilibrium (3, 3) in Olympus?

In the protocol, the different behaviors of users will have a more or less impact on other users who jointly participate in it.

The protocol's high degree of control over OHM also depends entirely on the user's staking of OHM. Therefore, Olympus combined game theory to propose the consequences of users' different behaviors in the protocol:

Olympus assigns different weights to the benefits of three user actions:

• Staking: (+2)

• Bonding: (+1)

• Selling: (-2)

Staking and bonding are seen as beneficial to the protocol, while selling is undermining the development of the protocol. Staking (we regard the purchase of OHM from the market as the premise of staking, so it will cause price fluctuations) and sales will cause price fluctuations, while bonding behavior will not affect the price. If both actors A and B act in favor of the protocol, the actors can both get half the benefit (+1); if the two actors conflict with each other, the bad actor gets half the benefit (+1), and the good actor loses half of the benefit (-1).

If both actors act bad to the protocol, meaning that they choose to sell, both lose half of their profits (-1). The following table shows the actions that two actors can take and their impact on the protocol in all scenarios.

Assuming that there are two people A and B in the current market, the three behavioral combinations of the two people can produce a total of 9 results:

If both parties stake (3,3), this is the best scenario for us, and the protocol (3 + 3 = 6)

If one of them stakes and the other buys bonds, it's also a good idea, because the staking behavior will move OHM out of the market supply into the protocol, and the bonds will provide liquidity and increase DAI in the vault (3 + 1 = 4).

When one of them sells, this will weaken the effort of the party that stakes or buys the bond (1 - 1 = 0).

When both parties choose to sell, this will have the worst consequences for the user and the protocol (-3 - 3 = -6).

However, in order for the project to achieve the ideal (3, 3) results, the premise must be a one-round game. Once the protocol enters multiple rounds of the game, the optimal solution for each person will begin to change until the earliest participants whose profit is far greater than the later participants who staked sell and exit.

A simple game model cannot fully represent the entire Olympus game. The development of the protocol will dynamically change based on premiums, market prospects, macro environment, and a series of other factors. Don’t take these numbers too seriously. The model provided by Olympus is to provide positive incentives to users participating in the protocol, encouraging users (3, 3) to jointly promote the positive benefits of the protocol.

The Dilemma of Algorithmic Stablecoins

Since the algorithmic stablecoins have no "bottom" itself (that is, solely relying on the algorithm, without fiat assets as collaterals), once there is a loophole in the mechanism/algorithm that will result in the insolvency of the stablecoin, the holders will not be not interested anymore. When trust is broken, there will be a lot of selling, and the algorithmic stablecoin itself will fall into a death spiral of "price drop → market consensus collapse → massive selling → price drop".

Algorithmic stablecoins seem to have the magic of "making money out of thin air". When their value is greater than the value they need to be pegged, there will be various mechanisms for making money. This part of the profit is actually an advance of the principal of those who did not exit after entering the death spiral.

For OHM, the source of income depends on the number of people entering the future. The high APY is the redistribution of funds from new entrants, making short-term incentives more effective and allowing early project participants to gain huge benefits. How to find a balance between high APY, token price drop, and user retention is a problem that OlympusDAO cannot avoid.

Conclusion

OlympusDAO attracts the market with its innovative and interesting game model while taking OHM's stability test as the first step of its vision practice, working hard for its ambitious idea-creating a decentralized central bank. For OHM to continue to develop, it also requires the market to agree on the consensus that "a DeFi bank is needed".

Now, it's a nested money game. But maybe someday in the future, it will become the main force of the DeFi world. Yes, it could be a Ponzi scheme. But who can predict the final direction? The same is true for the US Dollar, and for any currency. Of course, when there is an unpredictable black swan event in the market, the (3,3) game theory that Olympus relies on cannot stop the torrent of complex human nature. As for what the market outlook is, and where Olympus' ambitions can go, it still needs to go through the test of time.

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