Understanding and Managing Treasury-Token Interactions
The 2020-2021 bull run was a transformative period for the crypto market, marked by groundbreaking innovation in decentralized finance (DeFi). This era saw the exploration of uncharted territories in DeFi, with significant experimentation occurring even as protocols operated live. However, many errors were made, and numerous game-theoretic assumptions failed under real-world conditions.
OlympusDAO serves as a notable example. It offered exceptionally high staking yields, funded by unsustainable bonding mechanisms and a dilutive staking model. These flaws ultimately led to the DAO's decline, highlighting the challenges of executing ambitious concepts despite their initial promise.
A Retrospective on OlympusDAO
OlympusDAO was a initiative in DeFi, designed to establish a decentralized reserve currency protocol through its native token, OHM. The project aimed to create a digital currency that was not directly tied to fiat values but instead backed by a treasury holding a diverse basket of assets such as DAI and ETH.
Olympus faced two key challenges in growing its reserve-backed currency: increasing the total supply of OHM tokens while ensuring each was fully backed by the treasury, and distributing these tokens effectively. The founder, Zeus, introduced an innovative approach to address these issues. As the treasury grew, new OHM tokens would be minted and distributed to stakers, with the protocol offering a high APY derived from the treasury's surplus. This ensured each token was backed by $1.
For example, if there were 100 OHM tokens valued at $1 each and the treasury held $200, the surplus $100 would be distributed to stakers as additional OHM, resulting in a 100% APY. This high APY attracted significant attention to the token. However, since the APY relied on the treasury’s surplus, the treasury itself needed to expand. This led Olympus and its forks to confront a critical question: "How do we grow the treasury?"
Bonds
Olympus introduced bonds as a mechanism to grow its treasury. Due to high demand for the APY, OHM often traded at a premium above its intrinsic value. Bonds enabled users to purchase OHM directly from the protocol, with the premium serving as profit for the treasury, which was then redistributed as yield to stakers.
To encourage bonding over market purchases, discounts were offered on bonds, allowing users to buy OHM below market price. However, this created an arbitrage opportunity: users could buy discounted bonds and immediately sell the OHM on the open market, driving the price down. To mitigate this, a locking period was implemented, requiring users to hold their bonds for a set duration before redeeming them, thereby reducing the immediate sell-off pressure.
As a consequence to all this, a flywheel effect occurred: Sell bonds to grow treasury -> Higher yield -> More demand -> Bonds earn a higher premium -> Sell bonds to grow treasury, and so on.*
The key issue Olympus faced was that its staking was so lucrative that it undermined demand for bonds. Why bond when staking offered such high returns? This paradox revealed a structural flaw: staking relied on bonding to sustain itself, but low demand for bonds required increasingly steep discounts to attract participants.
Although the introduction of a locking period prevented immediate arbitrage, it still resulted in suppressed market prices—albeit in a more gradual manner. Crucially, the value lost through this price suppression was effectively transferred from holders to bonders. Zeus highlighted how this dynamic not only hindered Olympus’ growth but also destabilized the protocol, ultimately contributing to its decline.
Yet, Olympus was stuck giving this discount to bonders to keep the yield going because of the fact that the only demand for OHM in the beginning came from the APY. Most users did not realise that bonds were extracting value from them, essentially acting as hidden tax. Most of the forks did not even understand the intricacies behind their protocols.
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