Initial thoughts on Olympus' Bond-Centric Paper
First of all, I highly encourage you to read the paper by yourself and think about all the different implications that it can have.
I have personally read it a couple of times, and I will try to share the ideas that came to my mind after doing so.
It is not to say that this innovative approach increases the complexity of the protocol and also opens numerous possibilities. Because of that, you can’t expect a single person (not even Zeus) to have all the answers. That is the main reason why you should read the paper and try to think about it by yourself.
Olympus has historically achieved incredible growth by following an aggressive strategy mainly led by high staking reward rates. These high yields aim to prevent staker dilution resulting from bonding activities.
The protocol is currently facing two main issues:
After the first token migration, staked OHM became fully liquid. Composability opportunities emerged, but those who were supposed to lock their tokens in exchange for rewards gained the ability to sell them. Since the protocol had to account for scenarios in which 100% of the supply could fight against it, the risk-free value concept was created.
Although POL has been proven to work, it does not only come at the cost of staker dilution. A common behavior among market participants is to unstake OHM, exchange it for the treasury’s desired asset, and bond it to increase their share of the supply. Note that this behavior limits the treasury's ability to issue bonds due to the produced selling pressure.
Finally, it is also important to take into account that Olympus has successfully managed to bootstrap a lot of liquidity/reserves and is starting to transition from the growth phase to the utility phase.
A New Paradigm
Internal bonds aim to leverage one of the core mechanisms to shift the current protocol dynamics. If properly implemented, the bond-centric approach will address the two main issues that were previously described.
A significant portion of the total supply will become illiquid and the treasury will know when this supply will become liquid again. On top of that, the treasury will influence the rate at which supply becomes liquid/illiquid by setting expiration dates and capacities for the internal bonds.
Since the treasury will start accepting OHM in the form of internal bonds, users will have the ability to increase their share of the total supply without creating selling pressure.
The base reward rate for “naked” staking will be reduced, forcing participants to embrace illiquidity if they want to achieve higher rewards.
This mechanism transfers the determination of the reward rate value from the protocol to the market. Since this environment will be driven by competition, it is to be expected that yields go down progressively as the market matures and sophisticated players join. Note that this phenomenon will reduce the cost of capital for the protocol.
Liquid secondary bond markets will ensure illiquidity at a protocol level while granting users the ability to access liquidity. Note that if the protocol provides more liquidity to the bonds that will expire sooner, the market will probably be willing to pay less for this illiquidity premium.
My biggest concerns erase from the fact that the bond-centric approach adds a great amount of complexity.
Although it is true that, in this case, more complexity should imply more efficiency and robustness in the system, it also implies some consequences that should be addressed.
Complexity can easily evolve in a lack of market participants. The lack of market participants means that those who are active will capture most of the rewards without competition. In that case, there would be an important risk of power monopolization in hands of a few players, where the future of the protocol would be at the mercy of the will of these actors.
Complexity can also imply a lack of market comprehension and therefore poorer competition, leading to suboptimal rates. Since in this new system reward rates are market-driven, an inefficient market would increase the ratio of OHM that is injected into the market vs the amount of OHM that the treasury is able to take in. This behavior would highly increase the cost that the treasury has to incur in order to absorb OHM.
Expected Outcomes - Vaults
As outlined in the paper, vaults that automate bond strategies to market participants are to be expected. Because of all the implications that the internal vault mechanics can have, I expect the appearance of different vaults with different attributes. Since I also expect market participants to join vaults based on compatibility between their priorities and the vaults’ attributes, it seems important to explain those attributes:
Risk profile: Because of the illiquid nature of bonds, we can’t expect the secondary markets to provide enough liquidity for all the market participants. Because of that, bonds with different risk profiles will likely exit. Generally, the higher the illiquidity risk that a user aims to take, the higher the yield that they can expect.
Decentralization: Since vaults will gather substantial voting power, we can expect market participants to take into account the decentralization levels that the vaults offer. Personally, I would encourage all vaults to have an internal voting system where depositors can democratically express their opinion before each OIP. Although no one can force vaults to follow their depositors’ will, I would expect centralized vaults to receive significantly fewer deposits due to users losing their voting rights.
Ideology: Instead of users wanting to maximize their returns and deposit on the best-performing vaults, I would expect that some users will not be willing to risk lending their votes for a cause that they don’t believe in.
Note that even if a vault is decentralized, if the user’s preferred option loses in the vaults’ vote, their voting power will be used against their will on the official OIP.
Because of that, we can expect groups of participants to gather and create vaults with certain ideologies.
Until now the options that users had when interacting with Olympus were quite limited. As showcased in the previous sections, the extra complexity that a bond-centric approach carries will allow for new layers of utility and yield to be built on top of Olympus. With every new layer exponentially increasing the things that users can do with their OHM.
After identifying the two challenges that were previously showcased in this piece, Indigo and Zeus came up with an innovative idea that aims to address them.
In my opinion, it is important to realize that while the market seems to be shifting to veTokenomics, Olympus has come up with a custom idea that perfectly fits the protocol and does not have the ve model flaws1. Because of the veTokenomics mechanics, and since Olympus already has high emissions, this new approach seems to be better suited.
The brilliantness of this approach is that by reducing the base staking rewards and moving part of these rewards to internal bonds, the protocol is able to effectively remove supply from the market and reward those actors who incur illiquidity. On top of that, this approach can reduce the overall protocol inflation, is compatible with OIP-18, and still maintains the possibility to earn high yields by playing the internal bonding markets.
As it has been discussed before, the success of this shift in core protocol mechanics must be followed by a strong educational campaign to ensure the maximum amount of participants comprehends the new internal dynamics of the protocol.
Finally, I want to share a parallelism that can be made with CeFi, to showcase that this mechanism is really powerful and will bring Olympus closer to becoming a real econohmy thanks to the new layers that will be created.
We can think of internal bonds as the DeFi version of treasury bills. Note that the protocol is essentially borrowing OHM from the market, similar to what the US government does with US Dollars.
It is interesting to realize that the treasury’s only purpose, to begin with, is to reduce the circulating supply. This is a powerful objective, but it does not mean that other purposes can not exist. In fact, in the future, I expect the borrowed OHM to be used in ways that benefit the econohmy even further.
I personally believe that the internal bond approach will mark the end of the frenetic-growth phase and will transition the protocol into the utility phase, with a much more efficient and controlled growth. I expect this new paradigm to unlock plenty of integration opportunities and the creation of value for the econohmy.
Protocols adopting veTokenomics are generally forced to have continuous emissions in exchange for token illiquidity. Despite this model is working so far, it can present issues in the future since it is basically postponing the token unlocking at the expense of extra rewards.