How OlympusDAO tries to solve the DeFi liquidity problem
DeFi 2.0 is an improved version of decentralized finance as we know it, but what makes it different? When something doesn’t work exactly the way we want, we don’t give up and try to improve it. DeFi 2.0 needs to become better, faster, more decentralized, liquid, secure, scalable and accessible than the version of DeFi as we know it.
The ambitions of decentralized finance, or DeFi, is to make the technology accessible to everybody. Even though DeFi has done many things right, there are still problems with onboarding the world’s population. This is where DeFi 2.0 comes into play.
To understand what DeFi 2.0 is, it makes sense to go back to where it all began – the rise of decentralized finance (DeFi). A system where financial assets are available on a blockchain network that is open to the general public while skipping intermediaries, DeFi started its ascend in 2020. It was led by early pioneers like Aave, Uniswap, Bancor, MakerDAO, and Compound. Now, as DeFi 2.0 grows in importance, the original wave has become known as DeFi 1.0.
Like in DeFi 1.0, the key feature of DeFi 2.0 is liquidity mining. In this process users put their liquidity provider (LP) tokens in automated market maker (AMM) decentralized exchange (DEX) protocols. Yes, you put your LP tokens in an AMM on a DEX. In simpler terms, it is a process in which users are rewarded with platforms’ native tokens when depositing in it the resources that another user may borrow or trade. You support a financial service with tokens, and get to earn something new based on your position.
Among other things, DeFi 2.0 aims to solve the problem of liquidity that has long plagued the DeFi 1.0 space and hindered wider adoption.
The liquidity problem explained
To provide users with a strong liquidity source that would allow them to trade their tokens on AMM protocols, DeFi teams require access to a large pool of funds. When there isn’t an adequate level of liquidity, the slippage in trades deters users from taking part in the DeFi project. In other words, the lack of liquidity leads to unfavorable trading rates for cryptocurrency traders, which discourages participation.
So far, there have been multiple attempts at solving this problem, but none of them have fully solved it yet. One of the most popular solutions is yield farming. In this reward mechanic, individuals facilitate liquidity by providing equal amounts in USD value of two cryptocurrencies to contribute to a liquidity pool on an AMM protocol. Their trouble is rewarded by an LP token which they can stake for returns in the project’s native currency.
But despite its high effectiveness, yield farming has its limitations, such as supply dilution. Namely, the DeFi teams typically allocate native tokens to liquidity providers and offer supplemental sources of yield to motivate these users to keep their liquidity locked in AMM pools. Unfortunately, with more tokens distributed to liquidity providers, more of them end up in rented liquidity. Thanks to this, liquidity providers can remove the tokens whenever they feel like it, selling their acquired LP staking rewards.
This puts the founding teams in an unfavorable position where they can’t be sure if liquidity providers will stick around if staking rewards diminish. However, retaining these rewards high for a long time progressively dilutes the supply of the native token. What to do? What to do?
OlympusDAO and its solution
At the forefront of the DeFi 2.0 wave is OlympusDAO, a decentralized autonomous organization (DAO) whose OHM (stablecoin) token and bonding model focus on protocol-owned liquidity (POL). As such, it promises to solve the existing liquidity problem by revolutionizing yield farming.
And here’s how it plans to do this. Renting liquidity through yield farming initiatives that increase the native token supply will be replaced by bonds, which very much resemble their traditional counterparts. A short-term profit approach, Olympus bonds allow users to buy discounted OHM tokens. USers do this by giving their LP tokens or other crypto assets, like DAI, FRAX, LUSD, and wETH.
This allows Olympus to own the reserve assets and liquidity entrusted to it. The sales of bonds leads to profits for the Olympus Treasury, which can then pile up its own liquidity. Users of the Olympus platform receive bonds for DAI, FRAX, wETH, OHM-DAI LP and OHM-FRAX LP.
Judging by the example of OlympusDAO, DeFi 2.0 projects are working diligently on solving DeFi 1.0 problems that are preventing the technology from entering the mainstream. To this end, they are developing and deploying highly innovative approaches and tools. However, the full extent of their success remains to be seen. OlympusDAO isn’t the only project experimenting with this pioneering take on DeFi, as Jade Protocol became the first fork launching on Binance Smart Chain just one month ago.