What is Osmosis?
Osmosis is an advanced automated market maker (AMM) protocol that allows developers to build customized AMMs with sovereign liquidity pools. Built using the Cosmos SDK, Osmosis utilizes Inter-Blockchain Communication (IBC) to enable cross-chain transactions.
Osmosis allows users to launch liquidity pools with unique parameters, like bonding curves and multi-weighted asset pools. The incentive structure of Osmosis is also adaptable. Governance implements liquidity reward (LP) rewards for specific pools, allowing for strategically targeted incentives.
Osmosis is a fair-launched, customizable automated market maker for interchain assets that allows the creation and management of non-custodial, self-balancing, interchain token index similar to one of Balancer.
Inspired by Balancer and Sunny Aggarwal's 'DAOfying Uniswap Automated Market Maker Pools', the goal for Osmosis is to provide the best-in-class tools that extend the use of AMMs within the Cosmos ecosystem beyond traditional token swap-type use cases. Bonding curves, while have found its primary use case in decentralized exchange mechanisms, its potential use case can be further extended through the customizability that Osmosis offers. Through the customizability offered by Osmosis, such as custom-curve AMMs, dynamic adjustments of swap fees, multi-token liquidity pools–the AMM can offer decentralized formation of token fundraisers, interchain staking, options market, and more for the Cosmos ecosystem.
Whereas most Cosmos zones have focused their incentive scheme on the delegators, Osmosis attempts to align the interests of multiple stakeholders of the ecosystem such as LPs, DAO members, as well as delegators. One mechanism that is introduced is how staked liquidity providers have sovereign ownership over their pools, and through the pool governance process allow them to adjust the parameters depending on the pool’s competition and market conditions. Osmosis is a sovereign Cosmos zone that derives its sovereignty not only from its application-specific blockchain architecture but also the collective sovereignty of the LPs that has aligned interest to different tokens that they are providing liquidity for.
On customizability of liquidity pools
Most major AMMs limit the changeable parameters of liquidity pools. For example, Uniswap only allows the creation of a two-token pool of equal ratio with the swap fee of 0.3%. The simplicity of Uniswap protocol allowed quick onboarding of the average user that previously had little to no experience in market making.
However, as the DeFi market size grows and market participants such as arbitrageurs and liquidity providers mature, the need for liquidity pools to react to market conditions becomes apparent. The optimal swap fee for a AMM trade may depend on various factors such as block times, slippage, transaction fee, market volatility and more. There is no one-size-fits-all solution as the mix of characteristics of blockchain protocol, tokens in the liquidity pool, market conditions, and others can change the optimal strategy for the liquidity providers and the market makers to carry out.
The tools Osmosis provides allow the market participants to self-identify opportunities and allow them to react by adjusting the various parameters. An optimal equilibrium between fee and liquidity can be reached through autonomous experiments and iterations, rather than setting a centrally planned 'most acceptable compromise' value. This extends the addressable market for AMMs and bonding curves beyond simple token swaps, as a limitation on the customizability of liquidity pools may have been the inhibiting factor for more experimental use-cases of AMMs.
Self-governing liquidity pools
As important as the ability to change the parameters of a liquidity pool is, the feature would mean very little without a method to coordinate a decision amongst the stakeholders. The pool governance feature of Osmosis allows a diverse spectrum of liquidity pools with risk tolerance and strategies to not only exist, but evolve.
In Osmosis, the liquidity pool shares are not only used to calculate the fractional ownership of a liquidity pool, but also the right to participate in the strategic decision making of the liquidity pool as well. To incentivize long-term liquidity commitment, shares must be locked up for an extended period. Longer term commitments are awarded by additional voting power / additional liquidity mining revenue. The long-term liquidity commitment by the liquidity providers prevent the impact of potential vampire attacks, where ownership of the shares are delegated and potentially used to migrate liquidity to an external AMM. This provides equity of power amongst liquidity providers, where those with greater skin-in-the-game are given their rightful power to steer the strategic direction of its pool in proportion to the risk they are taking with their assets.
As AMMs mostly guarantee a level of constant total value output, those who may disagree with the changes made to the pool are able to withdraw their funds with little to no loss of their principles. As Osmosis expects the market to self-discover the optimal value of each adjustable parameter, if a significant dissenting opinion exists–they are able to start a competing liquidity pool with their own strategy.
AMM as serviced infrastructure
The number and complexity of decentralized financial products are consistently increasing. Instruments such as pegged assets, derivatives, options, and tokenized leveraged positions each have their own characteristics that produce optimal market efficiency when paired with the correct bonding curve. That being said, the traditional notion of AMMs have evolved around putting the AMM first, and the financial product being traded second.
As AMMs substantially increase the market accessibility for these instruments, assets with diverse characteristics either had to:
- Compromise efficiency and trade on existing AMMs with non-optimal bonding curves or
- Take on the massive task of building one's own AMM that is able to maximize efficiency
To solve this issue, Osmosis introduces the idea of an 'AMM as a serviced infrastructure'. Fairly often, adjustment of the value function and a few additional parameters are all that's needed to provide a highly-efficient, highly-accessible AMM for the majority of decentralized financial instruments. By providing the ability for the creator of the pool to simply define the bonding curve value function and reuse the majority of the key AMM infrastructure, the barrier to creating a tailor-made and efficient automated market maker can be reduced.