Bootstrapping of ERC-20 Markets using Protocol Liquidity

This proposal would allocate up to 400k AXL and 25 ETH from the Osmosis Community Pool to be Dollar-Cost Averaged (DCA) into alternative Axelar bridged assets to establish liquidity of prominent ERC20 token pairings on Osmosis.

Each pairing will create a $80k 0.05% Supercharged pool paired with ETH.axl as protocol liquidity.

Acquiring this liquidity supports increased asset breadth and availability for users and further cements the usage of the Axelar bridge on Osmosis as more bridge providers deploy.

It represents establishing liquidity concentration for these assets on the Axelar bridge, which should add mutual value, especially as more bridge providers come in and there is a first-mover advantage to bridge stickiness.

Background

Trading functionality for popular assets is a crucial value for Osmosis to pursue. As a true interchain decentralized exchange, it is vital to ensure that users can trade as many assets as possible by providing basic liquidity to list these and redirecting traders to limit-style orders.

Users should feel like they can hold all their favorite ERC-20s on Osmosis and buy/sell them here without being forced to bridge to Ethereum. Some volume/liquidity will eventually spawn more due to market demand, spread fee generation, and increased liquidity concentration.

There are two significant hurdles:

  • A cold start with low amounts of traders for these assets, resulting in low volume.
  • Low liquidity on Osmosis is giving those few traders bad price execution.

Incentives are unlikely to be effective as they currently stand. The community pool would be paying for temporary liquidity on the platform, likely to leave at the end of the incentives period. This temporary nature of liquidity rental can be seen with the previous attempts to establish LINK liquidity before the incentives system was reduced to quote asset pairs only. These incentives resulted in very little LINK liquidity arriving on Osmosis due to high bridging fees and low demand for trading LINK on Osmosis, leading to an isolated market with minimal cross-chain arbitrage occurring to stabilize the price. Since these incentives ended, liquidity for LINK has fallen to around $6k.

With the low-fee transfers provided by General Message Passing (GMP) across the Axelar bridge, utilizing Squid as a provider, the time is now right to bootstrap the trading of these popular assets through a more durable method of spending that benefits both Osmosis and the Axelar bridge.

By swapping assets in the Osmosis community pool for these ERC-20 pairings, we can acquire protocol liquidity, which will lead to functional trading of these tokens and increase the breadth of assets available on Osmosis.

As an example of how this could work, a Liquidity Provider created a MKR/USDC pool with $30k liquidity 70 days ago. Since then, $87k in trading volume has taken place because this single liquidity provider bootstrapped the pool in this way.

This pool went out of range recently and has not been rebalanced, which is why these positions are set on a more correlated pairing and significantly wider.

Targeted Markets

The top ERC-20s by volume that can be bridged from Axelar, without significant liquidity already on Osmosis, are:

  • PEPE
  • LINK
  • ARB
  • SHIB
  • OP

These liquidity pairings will be with ETH.axl to reduce their volatility, decrease the liquidity range needing to be set, and increase this liquidity’s capital efficiency.

Liquidity Settings

Liquidity levels are targetted to have <1% slippage on $500 trades; this enables basic trading to occur, resulting in increased liquidity concentration by liquidity providers and lower slippage levels. It is expected that larger swaps would take the form of limit orders through the upcoming limit order system, or pseudo-limit orders through single-sided liquidity provision into Supercharged pools.

The liquidity will be added to Supercharged liquidity pools with a low spread factor of 0.05% to maximize the frequency of arbitrage transactions, ensuring that the price of these assets on Osmosis is as close to the currently dominant marketplaces as possible. The taker fees for these pairs will also be heavily reduced to 0.01% during the onboarding period to encourage onboarding and arbitrage. This period is set at 60 days or the doubling of liquidity present of the ERC-20 token in Osmosis pools.

Liquidity positions will be set at approximately -50% to +100% of the spot price at the time of liquidity addition. This may vary due to the ratios of assets obtained by the acquisition, but the position should aim to be approximately this breadth of liquidity.

Users may use these pools for further liquidity provision or establish higher fee pairings, where providers attempt to be more concentrated to compete for trading volume.

Acquisition

Osmosis owns 647k liquid AXL worth approximately $650k, obtained from the original loanswap at launch. The protocol liquidity provided to the Astroport pool in Proposal 756 also gives the community pool exposure to an additional 510k of AXL.

To meet the settings in all five proposed pools this proposal targets $80k liquidity per pool, split evenly between ETH.axl and the ERC-20 asset. To compensate for market volatility, $45k of each asset will be initially acquired.

To obtain the ERC-20 Assets, $225k of USDC.axl will be obtained through a 14-day DCA sale of AXL via Calculated Finance. The USDC.axl will then be transferred to a Gnosis multisig on Ethereum controlled by the same multisig and swapped to the desired ERC-20s before returning to Osmosis across the Axelar bridge.

To obtain the ETH pairings beyond the 25 ETH already present in the Osmosis community pool, $130k of ETH.axl will be obtained through a 14-day DCA sale of AXL via Calculated Finance.

All ERC20 assets transferred will take the form of Alloyed Assets before pooling.
These are established here:
To be Instantiated before chain

This proposal posits that the short-term sale of these assets will result in increased revenue collection for both protocols through fee generation and the establishment of popular markets.

This spend will also provide the multisig with 100 USDC as pool creation fees which is returned to the community pool by the pool creation mechanism.

Any ERC-20s remaining after the liquidity has been provided at the target ratios will be swapped back to ETH through these new pools.

After executing the swaps and pool bootstrapping, the positions and any remaining funds, consisting of AXL and ETH, will be returned to the community pool.

Multisig

The Liquidity subDAO is a 4/6 multisig comprised of contributors to Osmosis and the wider Cosmos and can be viewed here.

This multisig has previously been used to deploy liquidity in other proposals, acting as an intermediary to perform multi-stage or time-dependant transactions, such as adding liquidity to a pool with a ratio of assets that will vary before a five-day Osmosis governance proposal is completed.

4 Likes

I really like this. Four things I think are worth re-emphasizing more:

  • Asset breadth matters a lot to users, even with decent slippage at first (e.g. 1%)
  • Incentives are a bad way to get long-lasting liquidity here, its far more efficient for the community pool to just buy assets.
  • Given Top of Block auctions, the community pool does not actually need to be that concerned with LP protection/efficiency. An efficient top of block auction should drive cross-DEX and CEX<>DEX loss to be ~80% going back to the community pool.
  • This is value positive with Axelar, as it helps first-mover cement Axelar as the bridge in use here.

@JohnnyWyles Great idea and definitely a step in the right direction for Osmosis/Cosmos. But instead of using Axelar why not leverage the Ethereum IBC connection that Picasso developed?

IBC has a ton of advantages (that I am sure I don’t need to cover here) and is really the standard we should stick to, especially when dealing with new ecosystems.
Just a thought to maybe align better with our interchain vision and long-term goals.

2 Likes

In this instance, because I am proposing selling some of the AXL in the community pool to cover this.
While there is nothing directly preventing the community pool from then bootstrapping via Picasso’s IBC implementation, it seems like a net negative to Axelar, of which we will still hold a sizable amount.

Since these will be deployed as Alloyed assets, as Picasso rolls out, with Frax assets first from the recent community spend proposal, then the equivalent assets could be voted to be added into these assets and automatically become just as liquid for deposits.

I am normally against Protocol-Owned-Liquidity, since there is always a basic question which has to be asked first; namely, why is the liquidity not building up naturally?
In a lot of cases I think it is safe to conclude that there is a lack of interest to trade or pool those specific assets causing liquidity to fall behind.

In this specific case I see that there is no OSMO used to provide this POL, which might make it a nice experiment.

However, one thing worries me (and also why I can understand the question from @Kontra) is why this is a one-sided action? What is the action taken by Axelar to contribute to this initiative? I would expect that it would need to be two-sided, especially since it will offset the balance between different bridges big time.

I feel it is rather like a Chicken and Egg question.
“Why would I provide liquidity to X on Osmosis when there is no volume?”

“Why would I trade X on Osmosis when there is high slippage?”

For example, If I want to buy $500 of LINK on a decentralized exchange then I would likely go to Arbitrum to use Uniswap v3 where there is practically no slippage according to swap aggregators - I get 31.29 LINK
If I want to do the same on Osmosis then I only get 29.54 LINK - about a 6% loss at current liquidity levels.
There may well be some traders who absorb this, particularly at lower trade sizes, but not enough to generate high swap fees.

What this proposal does is drop that slippage to only 1% (~31 LINK) which still makes Arbitrum a better trading location in theory, but 1% is a far more acceptable convenience fee for doing all your trading in one location without having to juggle different DEXs.

I used to find this with CEXs, where I would only trade on the 2/3 that I signed up to that had a range of assets rather than go to register with specific exchanges that held niche liquidity. This is often a contributor to the listing spikes that are often seen on listings on Binance/Coinbase.

Axelar’s liquidity initiative has been the addition of wstETH incentives recently. There is a large budget for building that route, this is a smaller initiative that diversifies the Osmosis community pool Axelar holdings into other Axelar bridged assets rather than anything prompted by the Axelar team.

Is Osmosis as a trading location already integrated on a lot of aggregators who also service DEXxes like Arbitrum, Uniswap and the likes?

Because only having the liquidity simply doesn’t make sense if no-one uses it. And people who are now already using a DEX as their trusted home for swaps won’t probably switch very easily, so the major gain would be on the back-ends of aggregators imo.