Olympus DAO: The Decentralized Reserve Currency
Cryptocurrencies were born out of the willingness to regain power over our finance, sovereignty, and privacy. Bitcoin’s first block, known as the Genesis block, contained the following message “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”, which expressed that vision. More than ten years later, the cryptocurrency market grew to over $2.75 trillion, spreading to many more industries but still based on the same primitives. Bitcoin’s final block subsidy of 12.5 BTC contained the following message: “NYTimes 09/Apr/2020 with $2.3T injection, Fed’s plan far exceeds 2008 Rescue”. Even though the willingness to get out of the fiat system is so strong and prevailing in crypto, the largest sector within the ecosystem is the stablecoin market with over $140 billion in total supply, primarily based on the US dollar.
Olympus DAO wants to take on the stablecoin market by coming back to Bitcoin’s initial vision. Olympus is a decentralized reserve currency protocol based on the OHM token, a fully backed, algorithmic, free-floating asset managed by the protocol’s treasury of assets.
It functions similarly to a Central Bank, except that the currency is OHM here, and the treasury asset is a basket of cryptocurrencies (DAI, ETH, BTC, OHM, etc.). Like Central banks, Olympus implements its monetary policies, known as bonding and staking, to manage OHM’s supply. Moreover, when OHM trades above its backed assets, the protocols mint and sells new OHM, increasing supply; conversely, when OHM is trading below its backed assets, the protocol will buy back and burn OHM. This way, it should have a stable floating value around its intrinsic value (at least in practice).
Olympus DAO manages the expansion of its treasury principally through its bonding mechanism and the supply of OHM that goes to the market through staking. Both bonding and staking are managed by the protocol governed policy tool.
On Bonding:
Bonding is the process of trading an LP share to the protocol for OHM token. The protocol incentivizes LPs by giving them OHM token at a discount to its market value. For example, an LP can fund the OHM-DAI liquidity pool on Sushiswap with $1000 of OHM and $1000 of DAI and sell that liquidity position to Olympus for a bond. The protocol governs through its policy tool the premium charged for the bonds. A lower premium means a higher discount and a higher incentive to bond (less profit to the protocol). This happens when fewer bonds are outstanding, and the protocol needs to incentivize LP to bond further. This policy tool is called the “bond control variable” (BCV). The protocol also controls the vesting term for the bond to be fully redeemable. A longer vesting term means lower inflation and lower bond demand. Additionally, since Olympus DAO accepts many different assets in its treasury that are not stables, it marks the treasury down to a risk-free value (RFV), the point at which the pool is balanced. Therefore, OHM is backed by the treasuries RFV, even though the treasury’s market value is a lot higher.
Through bonding, the protocol controls the supply of OHM and lock in the liquidity to the treasury (also called “protocol-controlled value’ (PCV)). PCV unlocks a ton of new functionality but also opens new opportunities for protocol value creation.
On Sales:
As mentioned above, the protocol will mint and sells new OHM if it trades above its backed assets and do the opposite when it trades below. Sales are controlled by a scaling factor, the “deflation control variable” (DCV) that defines the buying pressure determined by the protocol. A higher DCV will increase buying pressure and lead to higher deflation as OHM burns, and the supply decreases. In contrast, a lower DCV lead to a lower deflation.
On Staking:
Stakers stake their OHM to earn rebase rewards, increasing their balance of OHM over time. Essentially, when sending their OHM to the staking contract, stackers receive sOHM on a 1:1 basis. Every time the protocol generates profits, it will mint and back OHM tokens, then send them to the staking contracts. There is now an imbalance between OHM and sOHM for the profit’s amount; therefore, the supply of sOHM needs to increase to return to balance. The increase in sOHM is the rebase reward earned by stakers. Those rebase rewards come from the proceed from bond sales.
By staking their token, the floating supply of OHM token virtually decreases, putting increased price pressure on the OHM. Olympus DAO incentivizes token holders to stake by offering a staggering 7,344% APY.
The reward rate combined with the amount of bond sales sets the pace of supply inflation for OHM.
We now have a basic understanding of Olympus DAO and its policies. However, even though OHM aims to be a reserve currency, Olympus’s short-term goal is not for it to be stable, as it understands that the protocol is in its bootstrapping phase and volatility at this point is a feature, not a bug. To this end, its current goal is to grow through its bonding mechanism that reduces liquidity fragmentation within the DeFi space with protocol-owned liquidity.
Attacking the Liquidity Mining Problem in DeFi:
Defi’s first cohort growth was catapulted by liquidity mining when Compound first implemented it in summer 2020. The incentive design behind liquidity mining enabled those protocols to bootstrap initial capital and community participation while distributing their token supply. While very attractive short term, this led to mercenary capital jumping between protocols to maximize their yields, creating a sunk cost for protocols. The idea that part of that capital would convert to long-term community holders didn’t materialize as planned. Renting liquidity in a space characterized by low switching costs has proved to be an unsustainable long-term strategy. Furthermore, most of the revenue generated by protocols is flown to depositors.
Altogether, the resulting negative consequences of liquidity mining stem from an incentive system optimized for temporary, market-owned liquidity. Olympus DAO flipped the model on its head by introducing bonding with unique economic and game-theoretic dynamics to convert this market-owned liquidity to permanent, protocol-owned liquidity.
By owning its liquidity through bonds, the protocol can guarantee liquidity, absorb large trades and market drawdowns, and generate revenue from assets in the treasury. Indeed, upon receiving the token that backs OHM, the protocol will lock a small percentage of the reserve to maintain its liquidity and plug the rest into yield aggregators for revenue generation. Using this strategy, Olympus has purchased +99.9% of its two main trading pools (OHM-DAI and OHM-FRAX) since inception, with a market value of treasury assets of more than $800 million. Furthermore, those revenue-generating assets earned Olympus DAO $6.5 million in fees over the last seven days.
Olympus DAO Flywheel:
Through economic and game-theoretic dynamics, Olympus DAO lock-in LPs inside its protocol in a way that getting out of it represents an opportunity cost. The bonding mechanism increases the protocol treasury, which enables it to continue offering high APY to stakers. A new bonder receiving OHM is better off staking than selling its OHM, as the 7,344% APY allows it to double its OHM balance in only a few days. Plus, the staker should be confident that it will at least break even in the case of a drawdown because of the combination of a higher balance earned through rebase rewards and the protocol’s treasury giving OHM a floor.
Olympus DAO expressed that when it memed the prisoner’s dilemma game theory set up (3,3) to demonstrate that Olympus participants are better off collaborating (staking) than taking any other action (selling or bonding).
Given Olympus DAO high APY, participants are incentivized to stake to earn yield. To do so, they first need to buy OHM (either by bonding or in the secondary market), creating a buying pressure for OHM. OHM’s increased value enables the protocol to sell higher, increasing its revenue and bonds discount. A higher discount increases the capacity for new bonds and improves liquidity and functionality. The expanded protocol’s treasury gives more sustainable yield to stakers and provides a more elevated runway in case of a downturn, both giving more faith to stakers.
However, this feedback loop works both ways, in that if demands for OHM dries up, the price will go down, as will do staking reward and bond capacity, further lowering demand. However, as mentioned before, this downward spiral can be mitigated by the protocol’s treasury that provides a floor for OHM. If the OHM token trades below its backed assets, the protocol will buy indefinitely until the price rises to its parity with backed assets.
Going further down the flywheel analogy, let’s explore the worst-case scenario where Olympus suffers a bank run. If most staker lose faith in the protocol and unstake their OHM to sell them, and that inflow of capital through bonding dries up, then the remaining stackers will be the beneficiary of the protocol runway treasury as reward rebase. The runway treasury is calculated as the RFV treasury ($178,890,503) minus the total OHM supply ($5,871,000), which currently gives a $173,019,503 reward to the stakers that didn’t lose faith. The more participants lose faith, the bigger the pie for the ones left staking. As the opportunity cost of not staking grows, economic incentives should bring new participants to take advantage of those yields. Olympus has close to 400 days of a runway at the current reward rate, given its treasury, which means it can maintain its current reward rate without additional revenue for 400 days. However, note that this only puts a floor on the downside reflexivity, but it remains to be seen if, after a downturn, Olympus can turn back the flywheel on in the positive direction.
On Valuation:
Currently, Olympus has a market capitalization of over $4 billion, while the market value of treasury assets is almost $840 million, which means that it trades at a 4.7 multiple (Price to Book). If we compare its market capitalization to its RFV of treasury assets, it trades at a 22 multiple. How can it justify such a high valuation?
As a revenue-generating protocol, a discounted cash flow analysis could be used. Therefore, the protocol’s premium to its treasury value could be explained by the discounted value of its future cash flow. Last Tuesday (25/10), the protocol’s total revenue amounted to over $4 million, with a seven-day moving average total revenue of $6.6 million. Going even further, if Olympus DAO is valued like a growth-stage startup, it should be valued at some multiple to its DCF.
Furthermore, Olympus DOA has additional sources of revenue, such as its Olympus Pro product.
On Olympus Pro:
Building on the success of its bonding mechanism, Olympus DOA has launched a service for protocols looking to benefit from bonds. With Olympus Pro, protocols have access to Olympus DAO infrastructure, expertise, and exposure to generate bonds in exchange for a 3.3% fee on volume. Project apply to have their bonds listed on Olympus’s site. Participants who want exposure to a specific project bring liquidity to it and earn in the native token of that project.
Olympus Pro aligns incentives between protocols and their community while opening new functionalities. Notably, improving liquidity retention is particularly important to DeFi protocols. By owning their liquidity, protocols rely less on mercenary LPs such that they can lower their liquidity rewards and bring an additional source of revenue. Taking the analogy of equities, protocols had it backward by redistributing earnings to shareholders through dividends instead of investing in R&D, as early-stage startups should do. Back to DeFi, most protocols act as a marketplace connecting two sides and extracting a fee. Think of decentralized exchange like Uniswap (fee on trades), lending protocols like Compound (fee on interest), and asset managers like Yearn (fee on yield). The more liquidity they accumulate, the better they can support larger trades and provide greater price and liquidity stability. Finally, accessing Olympus Pro partnership gives extra exposure through the Olympus Pro X bond marketplace.
Furthermore, the protocol is not the only one benefiting from Olympus Pro. The community now has access to discounted tokens when they bond with Olympus Pro. Additionally, by staking on Olympus Pro, they are no longer exposed to the impermanent loss they would have on AMM protocols such as Uniswap or Sushiswap. Finally, protocols having a growing treasury of assets decrease the downside risk for holders holding the token.
However, Olympus Pro’s appeal to DeFi protocols around liquidity fragmentation begs the question of its defensibility given its 3.3% fee on bond-generated volume. As the saying goes in crypto, “your take rate is my opportunity”. In DeFi 1.0, it was initially believed that Compound liquidity program would enable the protocol to reach a critical mass of users leading to escape velocity for the protocol to leave off its network effect. Although Compound is one of the largest lending protocols today, it was surpassed by Aave. Will Olympus be able to support these fees while being surrounded by forks with a lower take rate? In another world, does Olympus Pro have defensibility?
It’s important to note that Olympus DOA, even if the playbook is theoretically replicable, depends on many experts in their given field setting up the protocol’s policy tool, which cannot be forked. The policy tools include bond control variable, maximum bond size, and vesting term, each determined to ensure a healthy balance of supply and demand for the protocol’s bonds. This level of expertise necessarily has a cost, which brings a floor (could be lower than 3.3%) to which the take rate forks will have to settle. Additionally (but to a lesser extent), the 3.3% fee can be seen by protocols as an investment by Olympus PRO, as it will put that into its reserves and essentially lock in that supply. The bigger a protocol grows inside Olympus Pro, the further aligned both protocols are with each other.
Finally, Olympus Pro should be key to Olympus DAO’s long-term goal of cementing OHM as a reserve asset for the crypto economy. In the last seven days, WETH-OHM and OHM-DAI were the first and third biggest pair on Sushiswap. Conscient of the opportunity Olympus Pro gives to OHM, Olympus DAO plans to further accelerate Olympus Pro by offering rebates to protocols accumulating OHM or OHM-X SLP pair and offering co-bonding opportunities to protocols using OHM as payment. Indeed, the more protocols integrate into Olympus Pro for their liquidity; the more OHM is promoted as a treasury asset and liquidity pair for other protocols.
We now understand Olympus’s ecosystem well and how its short-term strategy of democratizing its bonding mechanism in DeFi through Olympus Pro will help it achieve its long-term goal of setting OHM as a reserve asset. I’d now like to look at controversial takes that blur the line between ponzieconomics and master class tokeneconomics.
On the controversial tokeneconomics of Olympus DAO bonds and its treasury:
Being the expansionist monetary policy tool in the hand of Olympus DAO, bonding sounds a lot like a perpetual fundraising mechanism (hello Fed), allowing the protocol to offer stakers a staggering APY. At the same time, this APY induces a high rate of continued inflation for the supply of OHM, making one wonder about the dilution caused to OHM holders.
However, in practice, through the rebate mechanism mentioned in the staking section above, stakers should suffer almost no dilution. Indeed, as they stake, they earn rebate rewards in the form of OHM, corresponding to the profit the protocol made, at the prorate of their holding in the pool. This should protect them by constantly holding the same percentage amount of OHM given its supply. The only participant in the ecosystem suffering from dilution would be non-staking OHM holders. However, it seems that OHM holders are aware of that since over 90% of OHM are staked (or maybe they only care about high APY).
Those at risk might be the bonders, who supply a set of tokens in exchange for OHM tokens. Even though they get OHM at a discount, as seen in the valuation section, OHM still trades well above the treasury’s RFV, which is considered its intrinsic value. If OHM were to collapse at its intrinsic value, those bonders essentially brought liquidity to the protocol to pay stakers high APY while they were exchanging capital for what might be an overvalued token. In essence, bonders need to ensure that OHM’s valuation is backed by its future cash flow or any other valuation method they think is a better fit. In this configuration, bonders would only bond if their valuation methods put OHM at a value superior to or equal to the discounted OHM they receive when bonding.
Going even further, protocols being added to Olympus Pro are generally newer, less battle-tested projects. Indeed, blue-chip DeFi protocols such as Aave and Compound have lower cost of capital due to their size and long history and thus might need Olympus Pro to a lower extent. Therefore, accumulating reserve of those newer tokens begs the question of how Olympus calculates its RFV treasury. Especially as those more recent projects have only been around during a bull market, and it is tough to predict how they’ll behave in a bear market. There could be a case wherein a downturn, Olympus’s RFV treasury is marked down, leading to more panic. At this point, with a treasury of only $530,909, Olympus Pro is not big enough to create systemic risk for Olympus DAO. However, if Olympus’s strategy to grow OHM through Olympus Pro materialized, this might be an increasingly important factor to consider.
On critics of algorithmic stablecoins:
Olympus DAO seems to have built mechanisms to counter the prominent critics around algorithmic sablecoins. The main open question around them is the path to achieve stability out of “nothing”. When a developed liquid capital market is reached, those stablecoins are susceptible to speculative attacks (like borrowing a large amount of stablecoin and dumping on the market: hello George Soros!). The second question would be inherent to their both ways reflexivity, impeding their stability and thus viability as a stablecoin long-term. This is further emphasized in the crypto space characterized by cycles (reflexivity amplifies the directional momentum).
However, as explained above, Olympus DAO treasury acts as a counter-cyclical force, minting and selling OHM when it is above the value of its backed asset and buying and burning OHM when it’s below the value of its backed asset. The more the RFV of its treasury assets grows, the more it should counteract reflexivity and possible speculative attacks. Notwithstanding, Olympus DAO has no means to be stable over time, nor is its goal, as it is stated to be a free-floating reserve currency. It remains to be seen how this will play out in real-time. Olympus DAO goals for OHM are very ambitious and, if materialized, will represent a complete shift from the traditional world.
