The Battle of Mount Olympus
Level 3 - DeFi Virgin Analyst
Welcome Avatars and Ohmies! Over the last few weeks, people have asked for updates on the DeFi Education team’s thoughts on OHM. Questions have ranged from “how long can Olympus continue to provide 8,000% APYs” and “what should we do when APY goes down” to “how should we think about forks” and “is OHM still the best?”
In this article, we aim to answer all these questions. While we have lost count of how many times OHM has been forked at this point, one thing is clear: the coming months are of critical importance to the Battle of Mount Olympus.
We’ve honed in on what we consider to be the most important dynamics at play from an investment perspective in the near to medium term – the upcoming reward rate reduction and where the value of OHM comes from.
Reward Rate Reduction
First off, let’s go over the reward rate reduction, starting with a review of Olympus Improvement Proposal 18 (“OIP-18”).
OIP-18, passed in August 2021, outlined the framework below to reduce the OHM reward rate earned by stakers at certain supply milestones.
The current supply is ~5.2 million OHM, meaning we’re about halfway to the next reduction which would reduce APY for staking to 500% - 1000% from ~8,000% currently. The current estimate for this reduction to take place is late December 2021 or early January 2022. Any change would require a governance vote to take effect.
OHM’s supply increase is primarily driven by staking rewards. As such, reducing the reward rate slows down the rate of supply expansion of OHM. Put another way, that means OHM needs to be absorbed by the market at a slower rate to maintain price. If demand for OHM stays the same or decreases less than the reduction in supply expansion, the price of OHM would increase. If the decrease in rewards results in a substantial decrease in demand, OHM would decline in price.
The million OHM question is: how will the change in rewards affect demand?
We analyze this question based on opportunity cost and break out alternatives into two:
1. Yield farming
2. OHM Forks
Yield Farming: Let’s say you are a large OHM holder (more than 1,000 OHM, or $1.0 million) and the APY goes from ~8,000% to 800% APY. You will be hard pressed to find a yield farm with high liquidity for a token with similar fundamentals to OHM (strong, in our opinion) where you are unlikely to get rugged that will allow you to earn 800% APY over an extended period. In addition, yield farming will involve more time and effort, as compared to staking and chilling (3, 3). As such, we believe that even at the reduced rate, OHM provides a better risk/reward than comparable yield farming alternatives.
OHM Forks: While there are OHM forks out there that will continue to provide APYs well in excess of 10,000%, we consider OHM as having a unique value proposition (unpegged reserve currency) and being the furthest along in having a real use in the future. Due to its relative strength fundamentally, we do not believe most people with large amounts of OHM are going to rotate all or even most of their OHM into coins with a more questionable future and less proven track record.
So far, the only credible OHM forks we have seen that have achieved scale are Klima DAO (KLIMA) and Wonderland Money (TIME). Both forks provide APY significantly higher than OHM, with Klima offering 37,600% and Wonderland offering 84,000%.
Klima has a different value proposition (as a bet on carbon credits) and TIME is focused on gaming. That said, we think some migration from OHM to one of these forks is likely as people chase high yields.
Overall, we believe large holders of OHM have a strong incentive to continue to 3,3 (stake and chill) even at the reduced reward rates, which mitigates some of the risk of massive dumping from the reward rate reduction.
The reward rate reduction may reduce demand for OHM, but the rate at which OHM supply inflates (and thus needs to be absorbed by the market) also decreases. If the reduction in supply inflation is greater than the reduction in demand, OHM will continue to grow.
The supply and demand dynamics are one part of the equation. We think a reduction in the rate of supply expansion is a net positive for the protocol and a necessary step - OHM cannot become the reserve currency trying to sustain such high inflation.
The second part of the equation is value - what does 1 OHM really get you?
The Value of OlympusDAO
OlympusDAO created a new asset class within cryptocurrencies – named by one of the founders as Decentralized Backed Digital Currencies (“DBDCs”).
DBDC refers to the class of cryptoassets that are rebasing currencies backed by assets. These currencies use the fundraising model pioneered by Olympus to bootstrap a treasury of assets. Olympus aims to build a treasury backed by a wide variety of cryptoassets, Klima aims to build a treasury backed by carbon credit tokens, and so on.
The end goal for OHM is to become the reserve currency of crypto, achieving a stable price in the future while not being pegged to any other currencies thereby creating a truly crypto native decentralized currency.
In our view, due to the lack of price stability during the bootstrapping phase, whether Olympus can achieve the end goal of becoming a currency continues to have a high degree of uncertainty. As such, we do not put much stock in the currency aspect of the protocol *today*. Currently, the value of DBDCs is in their treasury, their ability to grow that treasury and how much of a premium the treasury deserves in the context of rewards paid to stakers. Rewards are paid in the native currency, meaning sustaining price is a function of a protocol’s perceived ability to grow their assets.
To illustrate our thought process on analyzing value for DBDCs, we compare OHM with its largest fork, TIME.
As of November 14, 2021, OHM trades at 5.0x Price to Treasury Market Value (“P/TMV”). In other words, anyone buying OHM is paying $5 for every $1 in the treasury. OHM stakers earn 8,000% APY.
TIME trades at 4.2x P/TMV and rewards stakers at 84,000% APY. By comparing these metrics, we can deduce that the market is putting a substantial premium on OHM relative to TIME as they are paying more per dollar in the treasury as well as accepting lower rewards (although they are incurring less dilution).
We believe OHM deserves to trade at a premium to TIME due to its first mover advantage, greater progress towards stability, expanded asset base / bonding program and “call option” value of Olympus Pro. Over time, we think the P/TMV will come down substantially as reward rates come down further (lower than the 500 – 1,000% range currently contemplated).
TIME benefits from being a part of the broader ecosystem of Abracadabra Money (SPELL) and Popsicle Finance (ICE) and compensates buyers with a significantly higher reward rate. TIME also has a first mover advantage on the Avalanche Network. Due to the lower P/TMV and high reward rate, we believe TIME buyers are well compensated for the higher risk. We would like to see a more clear value proposition and more integrations for TIME, particularly when reward rates decrease in the future.
The main questions we are asking in the value comparison are “who is stronger fundamentally and why” and “what is the risk and how well are we compensated for it?”
We view the impact of the reward rate reduction as being a function of the supply and demand dynamics outlined as well as the perceived value of Olympus’s ability to grow the treasury.
Okay, but how do we really get hurt here? Is every DBDC going to work?
Not every DBDC is made equal and not every DBDC is going to make it. The asset subclass as a whole is still quite new and remains highly speculative.
Many people are now familiar with the “bank run” scenario for OHM outlined by Asfi (@ishaheen10 on twitter).
The thread simulates an extreme bank run scenario. The degree of protection from a true bank run where vast majority of people unstake is in fact quite strong. As such, the real downside is not really a bank run.
The real downside for DBDCs is that revenue from bonding declines and a significant number of people *remain* staked. Bonds are either offered at a huge discount to incentivize bonding (thereby diluting stakers) or not bought at all thereby eliminating revenue.
In a scenario where people are no longer interested in buying the DBDC being issued, staking rewards are maintained through issuances backed by the treasury. For example, 1 OHM is backed by 1 unit of risk free value (“RFV”). The protocol would issue new OHM against existing assets to maintain the reward rate (paid in OHM).
As of November 15, 2021, OHM can pay the current reward rate for 316 days. While you would earn new OHM at this reward rate, the price of OHM could continue to fall and in certain setups, stakers would lose.
In this scenario, game theory works against DBDCs - while some stakers sell, other stakers realize that they will continue to earn rewards if they remain staked thereby diluting the rewards of every other staker. Meanwhile, the price of OHM may continue to decline as new rewards earned by stakers are sold.
The main point we would like to emphasize is that DBDCs are not a risk free trade.
Decision Time
The decision whether to hold onto your OHM or sell your OHM, as with any investment, is highly personal and depends on the individual’s risk tolerance, position size and cost basis.
Some options to consider:
1. Stay staked, sell none – Ignore volatility and continue to accumulate OHM from staking rewards at the new, reduced rate.
2. Sell OHM on the assumption that there will be a price drop – Sell then buy back later after the reward rate reduction to try and accumulate more OHM. Note: there is no reason there has to be a steep price drop – prices could fall slowly over time in which case you would lose rebases.
3. Take Profits – Some of you have made life changing money from being early to OHM and may not be able to stomach volatility, which could end up causing you to panic sell. Even if you believe in the thesis, you may be better off taking some profit. Remember, there is no shame in buying back later even if you buy back higher if that allows you to make rational decisions instead of emotional ones. Furthermore, some holders are primarily interested in ultra high yield farming. If that’s you, there are now other options available (TIME, KLIMA, etc.).
5. Sell all OHM – We do not plan to go to zero OHM as we have already derisked adequately (in our opinion) through rebases. In general, we do not like to go to zero on any investment in crypto especially when we are deeply in profit.
For those concerned that they are too late, we continue to believe a 2% portfolio allocation towards “degen” plays provides adequate downside protection provided you are otherwise properly allocated (see our post on risk management linked below for our framework).
From our perspective, the fundamentals for OHM have improved in the last few months with the launch of Olympus Pro, diversifying bonds / treasury assets and integrations with other protocols.
Some things that we will monitor for and could change our view (these are not current issues, but rather red flags we look out for):
Internal DAO/governance struggles: OHM has one of the most involved communities in crypto. We attended a recent community call that had over 600 attendees. Their DAO also has a separate Discord group which anyone can enter to discuss and learn more about the inner workings of the DAO. Their community remains one of their core strengths. The risk we monitor on this front is potential infighting, loss of trust/cooperation, etc. that slows projects down and make it difficult to operate cohesively towards a goal.
Key figures leave project / retire / lose focus: This concern becomes more pronounced in crypto as the market continues to boom and projects do well. Some people become “financially set” and either leave or get distracted and take their foot off the gas. You see an increase in pet projects and less time and energy allocated to the main project. While the end goal of every project is to be decentralized, we still believe key man risk is present in crypto and should be monitored.
Standard risk of loss of funds, exploit, etc.: Smart contract risk becomes amplified as protocols become more interconnected. DAO to DAO relationships continue to expand, which we consider to be fantastic for innovation (and are highly supportive) but this creates added layers of complexity and code risk. Olympus is also considering farming with their treasury, which has an added layer of risk.
Closing Thoughts
Let’s remind ourselves, what is OlympusDAO’s goal? Their goal is to become a decentralized reserve currency backed by cryptoassets. At maturity, we believe that means 1) price stability 2) widespread adoption across DeFi and 3) being commonly available and used as a liquidity pair. OHM’s lack of price stability today makes it unusable as a currency. Whether or not the end goal will be achieved still has a high degree of uncertainty. At the same time, OHM’s incentive design represents a breakthrough in raising capital, community building and HODLing (3, 3).
Rebase rewards are likely to decrease significantly in the coming months. The impact of the reduction will be driven by two factors: the shift in supply and demand for OHM, and perceived growth potential of the treasury (and impact to P/TMV multiple) as rewards come down.
There is no doubt that fundamentals for OHM have improved since our first article. That said, we continue to view OHM as a speculative investment and analyze OHM from the perspective of downside protection gained through rebase rewards. It takes ~60 days to double your OHM stack at current rates, which means you can withstand a 50% drawdown after 60 days without taking a loss. OHM’s fundraising mechanic allows you to mitigate your downside quickly due to the high APY. Autist note: There is no reason a drawdown would be limited to 50%. We do not bet the house on any investment.
How are we playing it?
Owl is planning to stay staked and chill (most likely – will make final decision closer to year end). My ~2-3% allocation back in August discussed in our article has done a ~4x and I have added since. Given the magnitude of the reward rate cut, I do expect some rotation into other DBDCs. Some of that rotation has likely already occurred (I added to some forks instead of more OHM). However, I think many will continue to buy into OHM if Olympus can continue on their path of integrating and partnering with other protocols.
I also heard on the recent community call that Olympus may be working on an OHM-backed stablecoin, which I presume would allow OHM to capture value from people looking to borrow against their OHM (rather than that value leaking to lending protocols). I think that could create huge value for OHM.
Iguana stayed behind when the intrepid adventurers set out for Mt Olympus. While this was an error with the benefit of hindsight, here’s how I’d play if currently holding:
1) Rebalance! If you intended this to be a 2% degen play and it has grown to 7% of your stack (well done), sell back to your target allocation of 2%. This isn’t profit taking, it’s rebalancing and justified from a risk control perspective. More detail on this approach in our recent free post on volatility and risk management.
2) Market cap is $3.55b and liquidity on Sushiswap is $0.28-0.5b. Ohm is backed, so you can always exit (at par), but there is clearly not enough liquidity for the majority of the Ohmies to exit near current prices. If someone shouts fire, the door may be too narrow. A risk to be aware of.
3) Growth. To pay an 800% APY next year (in real not nominal terms), Ohm’s market cap would have to increase 8x, or $28.4b. (this would make Ohm bigger than each of Terra, Avalanche, Link, Litecoin; roughly the same cap as Doge). I’m not sure the DBDC asset class will grow this quickly. Growth depends on new investors paying a premium to treasury assets rather than on the protocols earning revenue for providing a service. If you don’t believe in such a high growth scenario (~$30b), then you must assume the toal return will be under 800%. Is the lower return worth the risk?
Note: OlympusDAO will be undergoing a contract migration as part of their Olympus v2 upgrade. Please refer to this medium article for the update:
https://olympusdao.medium.com/introducing-olympus-v2-c4ade14e9fe
Disclaimer: None of this is to be deemed legal or financial advice in any way shape or form. You are reading opinions from an anonymous group of Wall Street and Tech Engineers in Cartoon format.
It's a ponzi with extra steps
I recently sold 100% of a fairly large bag of OHM at $1,050 having made 5x. The price slide seemed obvious from a TA perspective and so many forks were clearly muddying the water. Right now I am well ahead with OHM at $715 and still tumbling. I don't believe you will see price improvement until the APY reduction is done, simply due to uncertainty about what's on the other side. I did not have confidence that rebases would outpace the falling price and so far it seems that I have been correct.