Textbook on Token Models? A Brief Discussion on the Design of the Osmosis Token Model

Author: CYC Labs

Now it seems that the "silly" token economy of Cosmos at the beginning is actually viable. The initial distribution of over 67% of liquid tokens, combined with the departure of key figure Jae Kwon, has led to the project team having almost no control over Cosmos itself, resulting in the Cosmos hub token ATOM never experiencing a highlight moment similar to SOL and AVAX.

However, because of this, Cosmos has become an ecosystem driven from the bottom up, with a solid foundation similar to Ethereum. It is in this environment that textbook-like token design projects such as Osmosis have emerged. So today, let's take a look at what Osmosis's token economy looks like.

Overview of Osmosis

When we talk about the quality of a project's token economy design, we don't just look at the distribution. Instead, we consider what the token captures in terms of value for the project itself. This involves some of its core functions and target audience.

The Osmosis mechanism goes without saying. It is an AMM DEX. Thanks to the Cosmos "APP CHAIN" concept (applications as chains), its biggest feature is the use of Cosmos SDK's IBC, making it the first officially launched exchange to achieve cross-chain transactions at the protocol level (and currently the largest exchange in the Cosmos ecosystem).

Of course, being a chain itself, its unparalleled smoothness and zero gas fees are also among its features. Additionally, features such as Superfluid Staking (which allows investors to stake corresponding tokens on the same chain while providing LP, earning excess profits from a single chain), customizable weights, and support for multiple tokens in the same pool, similar to Curve's dashboard for reward distribution, are also highlights. There are many articles analyzing Osmosis's business and technology, so I won't elaborate further; interested readers can look it up themselves.

Osmosis's Ambition

Before discussing the token economy, let's consider which DeFi application currently has the best liquidity. Personally, I believe it is Uniswap. As the first protocol to implement AMM, it has the largest trading volume and depth, making Uniswap itself a candidate for becoming an ecosystem.

Therefore, we might refer to the services that Uniswap can provide to the ecosystem as "AMM as a Service," or AaaS. Currently, asset management protocols like IZUMI are utilizing AaaS to develop. However, this raises a question: while Uniswap itself is a great product, its value capture, or simply put, its token UNI is in a very awkward position.

The various fees charged by the exchange are essentially ETH, having nothing to do with UNI. This greatly wastes the value space of Uniswap as an AaaS infrastructure, leading UNI to become merely a stock token.

Of course, this is partly because the issuance of UNI was an emergency measure, but on the other hand, it also reflects Ethereum's own bottleneck: due to its architectural design, it is difficult for Ethereum to distribute rewards to its applications.

So, what might an ideal situation look like? Let's boldly imagine: if Uniswap, at its current scale, became a chain, using its token UNI as PoS to ensure security, while also having protocol-level cross-chain capabilities, cross-chain transactions would be as fast as transactions on the same chain. This would allow UNI to become a foundational asset, supporting thousands of applications built on it, such as lending, asset management, derivatives markets, etc.

Everyone would enjoy the liquidity and AMM provided by Uniswap (and here, AMM is programmable, customizable, and even allows other projects to add extra rewards to LP pools, as well as incorporate time-weighted parameters), while also inherently possessing cross-chain attributes. What does this represent? It means the entire DeFi could migrate to this chain. Just think about how exciting that would be. It is indeed quite exciting, especially for Osmosis, which then decided to do just that.

Now that we have clarified Osmosis's goals (oh, don't forget that investors can enjoy staking rewards while enjoying LP profits, which also ensures the chain's security), let's move on to the focus of today: the token economy. Let's see how it designs its tokens to achieve its goals.

OSMO Token Economy

To achieve Osmosis's goals, let's consider what conditions need to be met:

• Security. As an AMM HUB or DeFi chain, it needs to have reliable security like other chains. Specifically for PoS, this means staking the foundational assets on the chain.

• Sufficient liquidity. Regardless of whether it is a chain, the core attribute is "trading," so liquidity must be sufficient, meaning it needs to attract investors willing to act as LPs, and be long-term LPs.

• Cross-chain. Since it is a trading chain, it must have cross-chain functionality to ensure smooth capital flow.

The basic conditions are clear, and we find that, aside from the third point of cross-chain being inherently provided by Tendermint, the remaining aspects of security and liquidity require a well-designed "incentive" to continuously attract users. To put it bluntly, we need to look at how the token economy is designed. So, let's take a look at Osmosis's token, OSMO.

Basic Functions

First, let's look at the functions of OSMO:

• Governance voting (essentially the most basic function of various tokens; of course, for some projects, this is just a lazy way to implement a feature).

• Similar to CRV, it allocates mining rewards to LP pools (with CRV as a precedent, DEXs are learning from it).

• Transaction fees (gas fees, service fees, etc.).

It can be seen that the core idea of OSMO is designed around the most important role in AMM—LPers. Especially for those LPers willing to provide long-term liquidity support, they are granted significant rights and benefits (aligning with the two basic characteristics we mentioned above to attract liquidity).

At the same time, OSMO adopts a completely fair launch approach, maximizing the distribution of tokens to those it aims to reach, namely those who can help achieve the above goals. Who are these people? This can actually be seen from its airdrop targets.

Fairdrop

The initial supply of OSMO is 100 million, with 50% allocated through a Quadratic Fairdrop airdrop (according to the formula below), and the other 50% reserved for strategic purposes.

It can be seen that the airdrop targets are ATOM holders and those staking on the Cosmos hub. This group of people has remained steadfast in the Cosmos ecosystem for many years without significant progress, demonstrating a unique faith in the Cosmos ecosystem. However, just looking at this airdrop target doesn't reveal much; that's when OSMO's clever operation comes into play:

I airdropped to you, but claiming it isn't that simple.

To turn these ATOM holders, who already have a fundamentalist mindset, into users of Osmosis, only 20% of the airdrop is directly given to users; the remaining 80% requires completing four on-chain tasks within two months to fully unlock. Each completed task will unlock 20% of the airdrop quota. These four tasks are:

• Swap on Osmosis.

• Add LP to Osmosis.

• Stake OSMO.

• Participate in governance voting.

These four tasks are quite interesting. They cover several of its main functions, showcasing its excellent features: Osmosis's gas-free trading, while also experiencing IBC's almost real-time cross-chain capabilities.

The second and third points not only allow users to experience basic functionalities but also provide a high APY for a pool with sufficient liquidity (in addition to market maker fee earnings, there are also OSMO rewards), as well as governance functions for protocol upgrades. This entire process allows users to obtain complete tokens while experiencing its advantages, and most importantly, it will significantly boost the project's TVL, which in turn will attract more participants, creating a positive feedback loop.

This approach has another benefit: we all know that for most people, participating in mining is about the type of tokens and APY (most of the time, APY tends to weigh more). The process of referencing token types itself promotes further understanding of the Osmosis ecosystem; smart individuals will think about how to combine their assets to achieve higher APY and more airdrops, especially if the experience is good enough.

Ultimately, some users who initially came just for the airdrop will choose to stay and become the true core users of Osmosis (this ratio should be quite high. Because Cosmos has been quiet for too long, many users do not have a use case for their tokens, and Osmosis has provided them with this opportunity). This can actually be seen from some clues in Osmosis's liquidity and TVL.

However, this is still not enough. If the unique features of its token economy are limited to airdrops, it will still lack long-term appeal to investors. Therefore, we need to look at other parts of its token economy.

Token Distribution Strategy

In addition to the initial 100 million tokens, the OSMO token model is essentially designed to release tokens in a manner that mimics the BTC halving cycle. The basic timeline is as follows:

Essentially, tokens are released at a rate of one-third less than the previous year until the maximum supply of 1 billion is reached. Additionally, unlike other Cosmos SDK chains, OSMO adopts a daily Epoch for token release. New tokens are distributed as follows:

• Staking rewards: 25% (to ensure security, which is the primary purpose of the chain and one of the two characteristics mentioned above, requiring sufficient attractiveness to draw users to ensure the chain's security).

• Developer allocation: 25% (to ensure the sustainability of the ecosystem, preventing it from becoming stagnant).

• Liquidity mining incentives: 45% (the core of a DeFi chain, liquidity).

• Community pool: 5% (various miscellaneous purposes).

The logic behind this is quite clear, so there's no need to elaborate further. It appears democratic, but behind it, the project team still holds significant control. For example, the initial 50 million tokens in strategic reserves are decided by a multi-signature agreement among several Osmosis developers, nominally not for trading, but can be coordinated through voting for long-term partners, rewarding the project team, etc.

There are many nuances here, and Osmosis has accepted investments from institutions like Paradigm. Another point is that within the tokens released each epoch, the portion allocated for developer rewards (about 225 million) could still potentially be used for insiders to fund their own projects.

However, an interesting point is that to maintain "decentralization," if the development team of a target project changes, the unallocated tokens can be redirected to the new development team through community voting (which is inherently a linear unlock).

The main focus on LP rewards, due to the existence of a voting distribution mechanism similar to Curve, inherently creates a "holding positive cycle" and a game of "governance attack," as well as incentives for new trading experiments (don't forget, Osmosis supports various customizable trading functionalities).

This could potentially lead to new governance rights lending products or specialized asset management products. This is something to observe (it may already exist, but I haven't looked closely; the focus here is on the token economy design itself).

Of course, to ensure that liquidity is sustainable, Osmosis has a series of measures such as LP exit fees, Bonded Liquidity Gauges (similar to Curve's locked LP rewards with lock-up periods of one day, one week, and two weeks), and support for "external added rewards." This ensures that these rewards can be given to genuine protocol users and supporters.

This is roughly what the token economy looks like. Essentially, this token economy almost perfectly utilizes the characteristics of the Cosmos architecture. The team is quite clear-headed; whether it's the airdrop or the overall token distribution, both are textbook examples of rationality and effectiveness. However, after praising it for so long, if there is no data to support my claims, it would still seem thin. So let's look at whether the data related to Osmosis supports my views.

Overall Data Performance of Osmosis

Setting aside the OSMO token itself, let's first examine how Osmosis's business-related data performs. Since Osmosis is an AMM HUB, let's see how its liquidity looks:

Looking at the data alone, it looks very impressive; in less than a year since its launch, it has achieved $1.7 billion in liquidity. If the majority of people were just there to grab airdrops and leave, the data should show a peak followed by a decline. If many people choose to stay, the data would show a continuous upward trend. Of course, some might say that perhaps a few whales are staying, and the real user count is low. This can be ruled out from two aspects:

1. The number of wallet addresses holding ATOM and the number of whales (from the initial airdrop).

2. The number of users on Osmosis (real users).

Alright, I admit I haven't found these two official data points. Friends who can find the data are welcome to contact me.

Setting aside this uncertainty, we also need to look at the composition of tokens on it:

Simply looking at Osmosis might make one feel that the proportions of the first few tokens are too large, with tokens from its own chain, parent chain, and related brother chains. However, if we compare the data with Uniswap, we can see that the top trading pairs of both are highly similar, which is also a characteristic of DEXs:

However, it should be noted that currently, only UST is a stablecoin on Osmosis. Part of the reason is that both are Cosmos SDK chains, and another reason is that UST's strategy is to penetrate various chains to spread risk.

On the other hand, the reason is still that the current IBC has many aspects to observe regarding EVM assets, and it is not as convenient as using IBC for cross-chain transactions, which has led to tokens like USDT, USDC, ETH, BTC, etc., not being launched yet. However, according to the official pace, once they release the token pools, they will be well-prepared.

So, with such high liquidity, what is the daily trading volume?

It seems to be significantly lower than Uniswap. One reason for this, as mentioned above, is that EVM assets have not yet been launched and it hasn't supported MetaMask yet. On the other hand, you have to consider who the competitor is. For example, according to CoinMarketCap's DEX trading volume rankings, Osmosis surpasses Curve and Sushi, ranking 12th. This is quite remarkable for an exchange that has been online for less than a year, rooted in a non-EVM structured chain that is still not compatible with MetaMask (the core developers have stated they are currently testing MetaMask).

Of course, are there potential risks? Certainly. The potential risks here include unquantifiable factors such as whether EVM cross-chain assets can be launched and how many developers are willing to build projects on it. Personally, I believe the biggest risk lies in the guarantee of security. This involves not only cross-chain security but also the security of the chain itself. Specifically, let's look at Osmosis's staking data:

It can be seen that its staking rate is only 32.82%. Although this is partly due to high LP reward incentives, leading most people to prefer putting OSMO into pools, and the existence of Bonded Liquidity Gauges has provided another way to lock OSMO.

However, if in the future, LP rewards decrease and the staking rate still does not increase (currently, the staking reward is already over 70%, much higher than Polkadot and Ethereum, yet the staking rate is so low), it raises concerns about whether the attractiveness of staking can be maintained.

Especially since the speed of staking and LP rewards is currently quite fast, whether there will be selling pressure is uncertain. Herein lies a significant risk. A PoS chain with a staking rate below 50% is relatively easy to attack. However, I personally believe that due to the high demand for liquidity in the AMM HUB, it is quite normal for LP rewards to exceed staking rewards. I still have confidence in this team, and I believe they will implement corresponding measures moving forward.

Conclusion

I have kept it simple here because many people have discussed this project before. In reality, Osmosis has a profound understanding of stimulating liquidity and its operational methods, and it clearly knows what it should and shouldn't do. For example, not issuing stablecoins allows it to maintain basic neutrality like Ethereum, facilitating the inflow of stablecoins like UST and DAI into the ecosystem.

For instance, considering that the same token can become different tokens when crossing chains through different bridges, which is detrimental to liquidity management and concentration, they have devised corresponding solutions, etc. I won't elaborate further on the business itself.

Of course, some funds will definitely notice Osmosis's high TVL, but through Osmosis, they will also understand the characteristics of Cosmos, leading to inflows into other hubs like Juno and Secret, thereby positively impacting other brother chains.

However, regardless of the final outcome, whether it succeeds (if it can succeed, it undoubtedly sets the best example for other DEXs) or becomes a pioneer, its token economy design is almost a textbook example of DEX token economies.

From airdrops to token distribution, to fee design (swap fee, gas fee, LP exit fee), and the incorporation of Bonded Liquidity Gauges, Superfluid Staking, etc., it encompasses almost all value capture that a DEX can achieve, and due to its basis on the Cosmos SDK, it is also extremely smooth to use.

However, upon closer examination, the project team still holds significant influence over the circulation of tokens (for example, the strategic reserve occupies 50% of the genesis tokens). Overall, for the Cosmos-related ecosystem, "digging deep and accumulating grain" has already been achieved; can it "slowly become king"? We shall see.