The cross-chain capabilities and boundaries of the Cosmos ecosystem: A detailed analysis of the leading project Osmosis

Author: echo_z, Chain Teahouse

As an early cross-chain ecosystem, Cosmos once fell into silence, but in the past year, with the richness of ecological projects, the Cosmos ecosystem has rapidly risen, becoming a strong contender in cross-chain solutions.

Osmosis is the leading DEX within the Cosmos ecosystem, with its TVL continuously growing over the past year, currently stabilizing at over $1 billion, and its FDV reaching approximately $5.5 billion, ranking 211 on Coinmarket Cap.

Cross-chain is an unavoidable theme in the blockchain world, and the future landscape of public chains largely depends on their cross-chain capabilities. Chain Teahouse attempts to analyze Osmosis to understand the cross-chain operation within the Cosmos ecosystem, thereby gaining a better understanding of the challenges faced by current cross-chain solutions.

Table of Contents:

1. Product Mechanism: Bridge + DEX 1.1 As a Bridge: Cross-chain Transfers via IBC 1.2 As a DEX: AMM Protocol with Adjustable Parameters 1.3 Other Functions and the Future of Interoperability

2. Token Economics: Tiered + Multi-staking Leading to High APR 2.1 Token Functions 2.2 Token Distribution

3. Current Operations: Leading within the Ecosystem, Awaiting Bridging Outside

4. Team and Financing

5. Advantages and Risks

1. Product Mechanism: Bridge + DEX

Osmosis is an application chain that carries the complete application of Osmosis on an independent chain. Its application functions can be understood as a bridge + DEX within the Cosmos ecosystem, providing the two core functions of IBC cross-chain transfers and asset trading, making it a DeFi portal within the Cosmos ecosystem.

It is important to note that cross-chain transfers and asset trading are two sequential parts; users need to first transfer assets from other chains to the Osmosis chain via IBC, and then trade assets through the trading pools within the Osmosis chain, rather than being able to trade directly across chains. Therefore, Osmosis still remains at the stage of "bridge + DEX," rather than a "cross-chain DEX."

1.1 As a Bridge: Cross-chain Transfers via IBC

Osmosis's cross-chain transfer function is implemented in the "Asset" interface on the official website. The interface displays assets on various chains connected to Osmosis, and through Deposit/Withdraw, users can transfer assets from other chains into or out of the Osmosis chain. Deposit/Withdraw here describes a form of cross-chain operation.

The balance shown in the image below is actually the assets that have been transferred to Osmosis, such as the 0.000051 ATOM in the account's Osmosis chain address, rather than the Cosmos Hub chain address. If the funds are on other chains, the balance will not be displayed.

Here is some background on IBC cross-chain. Chains within the Cosmos ecosystem communicate through IBC, with each chain being a main chain responsible for its own security. During cross-chain operations, Chain A locks token a and passes this lock proof to Chain B, which then mints a mapped token a' on its own chain. Chain B can destroy the mapped token a', and after destruction, Chain A unlocks the originally locked token a. Therefore, the assets transferred to Osmosis are cross-chain assets and cannot be considered native assets.

A common scenario for cross-chain transfers is when users purchase Atom from an exchange and transfer it to a Cosmos Hub address (large exchanges like Binance may only support Atom transfers to Cosmos Hub addresses), then cross-chain transfer it to Osmosis, and finally purchase tokens of other projects within the Cosmos ecosystem on the Osmosis chain.

Readers may wonder why they can't directly exchange other tokens on the Cosmos Hub chain? It is possible, relying on the DEX applications on the Cosmos Hub chain, with the existing DEX being Gravity DEX. However, this exchange lacks native token incentives and has shallow trading depth, making it less widely used compared to Osmosis. Osmosis's advantages in token economics are a significant reason for its status as the main DEX in Cosmos, which will be elaborated in Section 2.

1.2 As a DEX: AMM Protocol with Adjustable Parameters

As an AMM, Osmosis's biggest feature is the ability to freely adjust parameters, creating customizable liquidity pools.

Adjustable parameters include: the value ratio of the two assets, transaction fees, LP exit fees, etc. The following image shows the input parameters for asset value ratio and transaction fees in the creation interface.

Among the dozens of liquidity pools currently established, most still follow the general rules of a 5:5 asset value ratio and a 0.3% transaction fee, but some liquidity pools have special parameters, such as the NGM/ATOM asset ratio of 6:4 and the AKT/OSMO transaction fee of 0.2%.

In addition to adjustable parameters, "customization" is also reflected in that the incentive distribution for each liquidity pool will be decided by community voting. All users who stake OSMO to Osmosis validator nodes can vote. This part will be detailed in Section 2.

Osmosis's vision is to replace centralized exchanges and become a testing ground for AMMs. In the ETH ecosystem, high transaction fees may not support the existence of various AMMs, leading to a monopoly situation among early players like Uniswap and stablecoin players like Curve. In the Cosmos ecosystem, transaction fees are very low, approximately $0 to $0.05 per transaction, allowing for experiments with different liquidity pools, which may give rise to a different liquidity ecology.

1.3 Other Functions and the Future of Interoperability

Osmosis also has three notable functional characteristics: 1) zero-fee transactions; 2) interoperability with other apps within the ecosystem; 3) prevention of MEV. The latter two have not yet been fully realized and need to wait for implementation.

Zero-fee Transactions

In Osmosis, whether for transfers, exchanges, or staking liquidity, if users choose the low-speed option, they can complete transactions with zero fees, and in fact, the speed is not low; I have personally tested it to complete in a few seconds. For users accustomed to paying transaction fees, this is undoubtedly a highlight, and it also facilitates users to perform necessary operations without a platform token $OSMO balance.

Interoperability

In March of this year, Osmosis announced the integration of the CosmWasm module. CosmWasm provides developers with rich development tools, and smart contracts built using CosmWasm can be compatible with the Osmosis chain. It can be expected that in the future, there will be a batch of yield aggregators, lending platforms, automatic LP management tools, etc., that can easily interact with Osmosis.

On April 13, Cosmos announced the completion of the Theta upgrade, adding inter-chain account functionality, which is also a boon for Osmosis. Inter-chain accounts may allow necessary operations on other chains to be completed within the Osmosis interface. For example, users can withdraw $UST from Osmosis and then directly stake it to Anchor for yield, all steps can be completed without leaving the Osmosis official front end.

Prevention of MEV

Osmosis's future roadmap also includes the function of preventing MEV (sandwich attacks). This function will encrypt transaction information, making it invisible to validators during the transaction process, and only open after the transaction is completed, preventing validators from profiting by adjusting the transaction order.

Token Economics: Tiered + Multi-staking Leading to High APR

2.1 Token Functions

The platform's native token $OSMO has the following functions: 1) In terms of public chain usage, staking $OSMO ensures network security, and $OSMO is also the transaction fee for public chain usage, distributed to node stakers; 2) At the application level, $OSMO serves as the transaction fee for the DEX, along with newly released $OSMO used to incentivize liquidity providers; 3) At the governance level, node stakers can obtain voting power proportionally.

Public Chain Usage

Since chains within the Cosmos ecosystem do not share consensus, each chain must be responsible for its own security, so Osmosis also has its own validator nodes. Retail investors can delegate $OSMO to node operators while paying a certain commission to earn staking rewards and also gain voting rights.

If one wants to unstake, they need to wait for 14 days, during which no staking rewards will be generated.

Application Level

The platform offers high APR to attract users through tiered staking and superfluid staking, which is also the most distinctive part of its token economic model.

Taking the ATOM/OSMO trading pair as an example, users can stake in three different tiers: 1-day unlock, 7-day unlock, and 14-day unlock. The longer the unlock duration, the higher the yield. The unlock duration refers to the minimum number of days that the principal must be held in order to withdraw upon unstaking, but the rewards can be withdrawn immediately. This means that liquidity has a longer staking time guarantee, and if withdrawn early, the user must bear the time cost.

This is somewhat similar to Curve's staking time weight, where the longer the staking time, the higher the rewards and voting weight, incentivizing users to stake for longer periods.

Another feature of Osmosis's liquidity incentives is "superfluid staking," which allows users to earn staking rewards from the staking nodes without incurring additional costs while staking LP. In the 14-day unlock tier shown in the image above, in addition to the regular 52.03% incentive, there is also an additional 15% node staking incentive.

The source of this incentive is that the platform mints a corresponding amount of $OSMO based on the LP staked by users and delegates it to node operators. In the above case, staking approximately 60 $OSMO corresponds to the minting of approximately 30 $OSMO, yielding approximately 67% APR. Users can choose their node operators.

The newly minted $OSMO will be destroyed and minted on a daily basis to correspond with the user's actual staking amount. Additionally, superfluid staking is only available to users who choose the 14-day unlock period.

Furthermore, liquidity pools on Osmosis can add third-party incentives. In the liquidity pool shown in the image below, in addition to receiving incentives from $OSMO itself, users can also be allocated corresponding third-party token incentives, facilitating third-party projects to guide users in adding liquidity.

Governance Level

The voting governance scope of Osmosis mainly includes incentive distribution for liquidity pools, the number of stakers, and other parameters.

Currently, a total of 122 million OSMO are staked, with a minimum vote count of 20% required for proposals to pass, which is approximately 24 million votes. Retail investors' delegated validator nodes will vote on behalf of retail investors, but retail investors can also vote themselves, overriding the votes of validator nodes.

It is important to note that the 122 million votes should include the $OSMO from superfluid staking, as superfluid staking also grants users voting rights; however, when calculating the total $OSMO, the $OSMO from superfluid staking has already been counted in the LP, so it will not be double-counted.

2.2 Token Distribution

Osmosis adopts a limited inflation model for its tokens, with a total supply of approximately 1 billion. The genesis generated 100 million tokens, with 300 million newly released in the first year, and thereafter reducing by one-third each year, meaning 200 million will be released in the second year, 133 million in the third year, and so on. Following this rate, the total amount released will approach 1 billion, with the majority released after 8 years.

In the genesis phase, 100 million tokens were generated, half of which were airdropped to ATOM holders, and the other half retained as strategic funds. Of the newly released tokens each year, 25% are allocated as staking rewards, 25% as development phase allocations, 45% as liquidity mining incentives, and 5% as community assets.

It is estimated that in the overall supply, liquidity mining incentives account for approximately 40%, staking incentives for approximately 22.5%, and funds for the development team's phased allocation also account for 22.5%, with the remaining approximately 14.5% allocated to early airdrops, strategic funds, and community assets.

The total amount of liquidity mining incentives is fixed, but the distribution for each pool is determined by the community. Each pool will have a "distribution score," and the incentive amount for the pool is determined based on the ratio of its distribution score to the total score, with the distribution score decided by community voting.

3. Current Operations: Leading within the Ecosystem, Awaiting Bridging Outside

As the leading project within the Cosmos ecosystem, Osmosis has achieved high TVL and cross-chain transfer volumes.

Osmosis currently has a TVL of $1.35 billion, which is quite an achievement. Among this, $OSMO accounts for the highest proportion, approximately 40%; $ATOM follows with about 20%; $UST and $LUNA rank third and fourth, respectively.

The high TVL is primarily attributed to Osmosis's high APR. As mentioned earlier, Osmosis does have competitors like Gravity Dex, but the latter lacks native tokens as liquidity incentives, making its TVL almost negligible, with the TVL of the leading liquidity pool ATOM/OSMO only around $1 million, while Osmosis's ATOM/OSMO liquidity reaches around $400 million.

In terms of IBC cross-chain functionality, Osmosis also leads, with approximately $4 billion in IBC transfer volume over the past 30 days, exceeding the combined total of the second-place Terra and third-place Cosmos.

The high IBC transfer volume is due not only to the zero-fee transfer experience but also to the most comprehensive cross-chain channels. In terms of cross-chain capabilities, Osmosis is connected to 38 chains, covering most of the active chains in the Cosmos ecosystem. Except for a blockage with the Evmos channel, others are generally smooth. In contrast, Terra and Cosmos are connected to 14 and 34 chains, respectively.

However, it is worth noting that the assets supported by Osmosis are all within the Cosmos ecosystem, meaning it does not support external assets like ETH or USDC. In contrast, products in the Terra ecosystem support cross-chain assets like ETH, so it is not difficult to understand why the overall TVL of the Terra ecosystem reaches $26 billion, with the TVL of the leading DEX Astroport being comparable to that of Osmosis.

The Osmosis team is likely working on this aspect, but their strategy is more restrained. In a blog post earlier this year, the team explained their thoughts on bridging ETH assets, pointing out a severe issue: assets from different bridges are different, which can cause confusion in user experience and fragmentation of liquidity.

In fact, this is also the problem with external assets like ETH/USDC in the Terra ecosystem. The following image shows the exchange interface of Astroport, where multiple versions of tokens for ETH/USDC can be seen.

Osmosis's vision is to replace centralized exchanges, so it hopes to avoid the emergence of different versions of the same asset, making the choice of bridge providers very cautious. It can be imagined that bridging assets outside the Cosmos ecosystem will eventually be on the agenda, but it still needs to wait.

4. Team and Financing

The core team of Osmosis has deep ties with Cosmos. Among the two co-founders, Sunny Aggarwal was the former chief researcher at Tendermint, and the other, Josh Lee, is the main developer of the Cosmos wallet Keplr Wallet. Their Twitter profiles indicate that Sunny Aggarwal currently resides in New Jersey, USA, while Josh Lee is based in Seoul, South Korea.

In October 2021, Osmosis raised $21 million through a token sale, led by Paradigm, with participation from Robot Ventures, Nascent, Ethereal, and Figment. This was also Paradigm's first investment in a DEX outside the ETH ecosystem.

5. Advantages and Risks

Chain Teahouse summarizes Osmosis's core advantages as follows:

1) With its comprehensive IBC cross-chain transfer capabilities and high ARP from multi-staking, Osmosis's excellent user experience has made it the leading cross-chain bridge + DEX within the Cosmos ecosystem, maintaining a TVL of over $1 billion, currently ranking 21st among all DeFi projects by TVL (data source: DeFi Llama). If bridging external assets like ETH/USDC is realized in the future, it is expected to bring another wave of capital influx.

2) Enjoying the dividends of the Cosmos ecosystem, potential future airdrops and upgrades in cross-chain operations brought by inter-chain accounts may lead to an increase in users and funds for Osmosis.

The main risks faced by Osmosis include: coexisting and prospering with the Cosmos ecosystem while facing competition from other cross-chain solutions like Polkadot and LayerZero. The Polkadot ecosystem has just begun, with TVL far less than that of the Cosmos ecosystem, giving Osmosis a first-mover advantage for now; however, LayerZero and its built Stargate have recently launched, achieving a TVL of approximately $2.6 billion, showing strong capital attraction.

After understanding how Osmosis operates, the most intriguing question remains: How will cross-chain operations work in the future? In Stargate's roadmap, it will soon be deployed on the Cosmos Hub and Osmosis chains. Given Osmosis's current lack of external assets from the Cosmos ecosystem, integrating Stargate may bring more influx of assets outside of IBC, but it may also lead to some asset outflow due to the convenience of cross-chain operations, preventing Osmosis from monopolizing funds.

Regardless, Osmosis has shown us a self-contained cross-chain ecological operation model, but the excellent experience currently remains within the relatively closed IBC ecosystem; the uncertainty of the future lies in what changes will occur when this independent ecosystem connects with external assets.

As the Osmosis team itself contemplates, bridging external assets can easily lead to issues of asset inconsistency and liquidity fragmentation. How will these be resolved in the future? If funds can flow seamlessly between all independent public chains and their ecosystems, what impact will that have on the existing players? We shall wait and see.

Appendix

Osmosis Official Medium:

https://medium.com/@Osmosis

Osmosis Official Docs:

https://docs.osmosis.zone/

Introduction to IBC Transfer Principles, from the Cosmos Hub Forum:

https://forum.cosmos.network/t/ibc-tcp-ip/4219

Messari Preliminary Research:

https://messari.io/article/osmosis-diffusing-liquidity-across-the-cosmos-ecosystem?referrer=category:all-research?utmsource=newslettertop&utmmedium=organicemail&utmcampaign=osmosisdiffusing_liquidity