How OlympusDAO *Really* Works
Navigating DeFi Episode 1
Hi everyone and welcome to Navigating a DeFi — a new podcast that I’m starting this year. Every week, I will cover a single project or concept in depth so that hopefully by the end of each episode you have the knowledge required to be a power user of the project covered if you so choose or the knowledge required to understand the primitives underlying many of the projects in the DeFi ecosystem.
These newsletters will function as the show notes for each episode and the podcast associated with this newsletter can be found here:
What is OlympusDAO and what is OHM?
I know… there’s a ton of resources in the crypto-sphere about OlympusDAO and OHM, but let’s face it, most of them suck. As a result I wanted to focus the first episode of Navigating DeFi on explaining how OlympusDAO really works without the APY hype, “ponzi” grandstanding, and all the rest.
OlympusDAO’s goal is to create a decentralized reserve currency system that backs a free-floating reserve currency called OHM. Creating such a system isn’t as easy as deploying a token and hoping people see value in it. There needs to be other monetary and game theoretic mechanisms at play. In the case of OlympusDAO, the system relies on various mechanisms that include: Protocol Controlled Value (PCV), Bonding, and Staking — each of which I cover in detail throughout the episode.
Further reading:
Game Theory and (3,3)
For those who are unfamiliar, game theory is the process of modeling the strategic interaction between two or more players in a situation containing set rules and outcomes.
In the context of OlympusDAO, the primary game theoretic idea behind the entire system is the notion of (3,3). (3,3) — as described by OlympusDAO — is the idea that, if everyone cooperated in the OlympusDAO system, it would generate the greatest gain for everyone including OlympusDAO.
They have a chart (shown above) in the official documentation that applies a scoring system to certain actions, where ultimately the sum of all positive actions — or (3,3) — leads to the greatest outcome, but I don’t think it’s too helpful in describing what (3,3) is trying to imply.
Instead, I recently crossed a Twitter thread where the concept of (3,3) was compared to a game of BlackJack. I believe the BlackJack analogy is more useful in describing OlympusDAO’s underlying game theory, so I recommend checking it out.
Further reading:
Protocol Controlled Value
Within the Olympus system, Protocol Controlled Value (PCV) refers to the assets owned by the protocol’s treasury. These assets are used for three primary reasons:
To back each OHM in circulation with at least $1.
To provide a permanent source of liquidity for OHM holders.
To generate more income for the treasury, thus increasing PCV.
Protocol Controlled Value is what sets OHM apart from many other tokens in the DeFi ecosystem because it backs OHM with intrinsic value and fills the Olympus treasury with all kinds of assets such as stablecoins, LP tokens, and other DeFi tokens.
I found a reddit post by GHOST_08 that describes how PCV can be further broken down in to three categories:
Reserve assets
Non-reserve assets
Liquidity assets
Reserve assets are tokens like FRAX, LUSD, and DAI that contribute to the risk free value underlying each OHM issued. In other words, these assets can be used to conservatively estimate the amount of value backing each OHM in circulation. At the time of recording that value is $250M, giving each OHM an intrinsic backing of ~$56 — well above the $1 floor price.
Non-reserve assets are more volatile and risky assets like TOKE, CVX, xSUSHI, and others which diversify the treasury, create inroads for partnerships, give OlympusDAO governance power, and more. Non-reserve assets play a key role in establishing OHM’s power as a reserve currency within the DeFi ecosystem.
The last category is liquidity assets. Liquidity assets are LP tokens such as OHM-DAI, OHM-FRAX, OHM-LUSD, and others. These assets guarantee permanent liquidity for OHM—allowing users to enter and exit the market at will. And since OlympusDAO owns the liquidity themselves, instead of renting it like many other DeFi protocols, users can guarantee that there will always be liquidity to trade in and out of OHM. It’s worth noting that liquidity assets also contribute to the risk free value underlying each OHM, but are valued at a steep discount according to the following formula:
Bonding
Bonding is the process of trading assets to OlympusDAO for newly minted OHM. Bonds are how OlympusDAO acquires its Protocol Controlled Value. The way it works is simple: the protocol quotes an amount of OHM it’s willing to sell you — usually at a discount to market price — and a vesting period for the trade.
The bond discounts offered by OlympusDAO are variable and based on third party demand. Let’s say a bond starts at a 5% discount, if no one takes the bond at that price, the discount will slowly tick down until someone takes it. After someone bonds, the discount goes back up and can even flip to a premium if there is surplus demand for a specific bond.
OlympusDAO offers various bonds to capture various forms of value that then get added to the treasury to build up protocol controlled value. Any time OlympusDAO wants to acquire an asset — either strategically or out of necessity — they usually spin up a bond for that asset.
For the longest time, inflationary bonds have been the only form of bonds in the OlympusDAO arsenal, however that may be changing soon as the result of a new governance proposal set forth by the OlympusDAO policy team. OIP-76 aims to introduce inverse bonds, which will work exactly like regular bonds, except inverted. Though it’s worth noting that these bonds will only be available when OHM is trading below its intrinsic backing, which is defined as the market value of their treasury assets, divided by the circulating supply of OHM. Details here.
Further reading:
Staking
Staking is the primary value accrual and anti-dilution strategy of OlympusDAO. Stakers stake their OHM and earn what are called “rebase rewards.” The rebase rewards come from the proceeds from bond sales, and can vary based on the number of OHM staked in the protocol and the reward rate set by monetary policy.
Any time a bond is sold, the proceeds of that bond are considered revenue for the protocol. When that revenue is generated, OHM is issued against the risk free value of that revenue, then the newly minted OHM is sold via bonds and distributed to stakers — protecting them from the dilutive affects of bond issuance. Staking and bonding work in tandem to continuously expand / bootstrap OHM supply while accumulating PCV.
Remember: each OHM is backed by $1 of risk free value, so any time a bond is sold for say $100 / OHM, the treasury captures the premium and uses that to mint more OHM — which is used to facilitate more bond sales and to reward stakers. This cycle tends to make staking rewards quite high.
Over time as OHM slows its expansion phase, we can expect staking rewards to go down as the rate of dilution goes down. Since OHM’s launch, we’ve seen several staking rewards reductions and recently, the OlympusDAO policy team proposed a rewards reduction framework based on total OHM supply:
One thing I want to be clear about regarding OHM staking is that it’s not free money — it’s purely an antidilution strategy that guarantees that stakers won’t lose their portion of the total OHM supply as it continues to expand. By choosing to be a staker, you’re essentially betting that OHM will succeed in some capacity at becoming a reserve currency and are opting not to give up your ownership of the total supply.
The OHM Economy
Now that we’ve covered OlympusDAO’s underlying mechanisms, we should walk through what OlympusDAO is doing to solidify their role as a reserve currency throughout DeFi. Fortunately, OlympusDAO has released a post describing three key pillars of the OHM economy:
The Reserve Pillar — which is responsible for OHM’s growth and utility.
The Liquidity Pillar — which is responsible for increasing OHM’s liquidity and tradability.
The Utility Pillar — which is responsible for increase mass adoption of OHM.j
For the sake of time, I won’t dive into the specifics here. I recommend reading the post in full: https://olympusdao.medium.com/building-an-econohmy-a5cf4e8671de
Wrapping it Up
We covered a lot of material in this week’s episode around protocol controlled value, bonding, and staking that I think are crucial to understand as we move on to different projects in future episodes. That said, I’ve undoubtedly left out some information and nuance around these topics to make it easier to digest, so I highly recommend you do some supplemental research to verify any of the ideas brought up in the episode.
See you all next time!