These two proposals ask for the deployment of 50k ATOM (~$415k) and 18,900 TIA (~$125k) into Margined Protocol Redemption Rate Arbitrage Strategies.
Redemption Rate Arbitrage Theory
Liquid Staked Tokens (LSTs) have the advantage over standard-staked assets in that they can be disposed of rapidly in response to user needs rather than being delayed by an unbonding period, typically 14 to 21 days.
This disposal requires another entity to either purchase the Liquid Staked asset for their own use or to trigger the unbonding themselves to access the underlying staked asset. As no staking rewards are received during unbonding, this makes the usual maximum price of a Liquid Staked asset a discount based on the staking rewards that are sacrificed during the unbonding period and the fee paid by acquiring the asset.
This results in a typical maximum price that we refer to as the Optimal Discount.
LSTs normally trade under this value, depending on
- Exit demand
- Often a function of token volatility - Prices increase leading to exiting to a capital asset, and price decreases leading to liquidation of collateral assets or derisking.
- Available liquidity for the underlying pair.
- Holding demand
- An entity that is willing to hold the underlying token for the unbonding period when the exiting entity is not. This entity has differing prices that it is willing to pay, with arbitrageurs charging a premium over the Optimal Discount and other holders content with acquiring the underlying asset at a small discount.
As the community pool already holds the underlying tokens, collected from protocol fees, it is an ideal provider of Holding demand, as long as the community wishes to continue holding these tokens.
These proposals would deploy around 2/3 of the community pool ATOM and all of the community pool TIA into this role, aiming to increase protocol revenue in asset terms as well as supporting Osmosis as a primary venue for LST usage.
The OSMO LST arbitrage strategy contains the bulk of current deployments ($442k) and has been reliably returning above OSMO staking APR returns for the two months while supporting both stOSMO and qOSMO pegs so far. The impact of this can be seen in the constant up and right correlation of stOSMO and OSMO compared to the more stagnant pegs of stATOM/ATOM and milkTIA/TIA.
Proposal Texts
Deploy ATOM to Margined Redemption Rate Arbitrage Strategy
This proposal asks for the deployment of 50k ATOM (~$415k) to the Margined Protocol Redemption Rate Arbitrage Strategy.
About the Strategy
The Margined Redemption Rate Arbitrage Strategy (RRArb) strategy takes advantage of the tendency of Liquid Staked Tokens (LSTs) to trade for less than the equivalent of the underlying staked assets and automates the arbitrage process for participants.
This consists of:
- Buying the LST below a known optimal discount rate which is based on the opportunity cost of unbonding and trading fees.
- Performing a cross-chain redemption transaction to redeem the LST for an instant, but pending unbonding, profit.
- Looping this activity when the redeemed assets become available.
RRArb strategies are based on a single staking asset, but multiple LSTs derived from that asset are arbitraged.
In this case, ATOM is held by the strategy and used to purchase stATOM, dATOM and qATOM on Osmosis when it can redeem these LSTs for more ATOM than the number of ATOM used to purchase them.
This strategy, funded by the Osmosis Grants Program, has been live for three months and has consistently been above or similar to ATOM staking APR while supporting both the peg of ATOM LSTs for use cases on Osmosis as well as contributing to volume through these pools, which in turn attracts liquidity around the market rate and generates protocol fees.
Margined charges a 15% performance fee for this strategy. This is paid on profits accrued by the deposit so the initial deposit quantity of tokens is not impacted.
There is a 0.5% withdrawal penalty for withdrawals within 21 days. Osmosis governance commits to retaining liquidity in the vault for this period to make this obsolete, barring any security related need for withdrawal.
Risk Analysis
Asset Risk
As this deployment does not change the composition of the Community Pool holdings, there is no change in Asset risk.
Contract Risk
Margined contracts have recently completed an audit, and this strategy has been in operation for three months with no incidents.
Three RRArb contracts are running, securing around $667k in liquidity, mostly in OSMO, before this deployment.
LST Risk
The strategy is exposed to the LST asset for a very brief period before unbonding occurs. The risk of exposure is increased due to the unbonding and distribution mechanism requiring 14 days. All three assets have been operational for at least three months with no incidents.
As this contract is purchasing LSTs below a set price, it may purchase a compromised LST that has no backing, resulting in a loss of funds.
This would only occur if the deposit were liquid and awaiting an arbitrage opportunity. As most assets will be in the process of unbonding or not intended for arbitrage as a withdrawal float, this risk can be mitigated by Margined pausing the arbitrage strategy contract.
Lack of Returns
As purchases are only performed when there is an available opportunity, the return may eventually be less than ATOM inflation. This still will outperform the current return of holding unstaked assets in the Osmosis Community Pool and only be the case when the peg of LSTs is very close to the redemption rate, improving their utility on Osmosis.
Use of Multisig for execution
This 4/6 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.
Technical Implementation
50,000 ATOM will be sent to the Osmosis Liquidity SubDAO.
This will be deposited into the Margined Redemption Rate Arbitrage Strategy - ATOM
The representative tokens for this position will be returned to the Osmosis community pool.
Success Metrics
- Revenue earned in ATOM terms based on existing deposit (50,000)
- Improved peg for ATOM LSTs (Current 3.5% discount to Redemption Rate)
- Increased volume through LST pools (Current 7D, $4.1M in stATOM, 1283, 38k in dATOM, 2371)
Conclusion
Deploying 50,000 ATOM to the Margined Redemption Rate Arbitrage Strategy (RRArb) offers a promising opportunity for existing unutilized assets within Osmosis Community Pool. This strategy has already demonstrated consistent returns comparable to ATOM staking APR on the currently unutilized community pool ATOM while generating volume on Osmosis to attract LPs, supporting the peg of ATOM-derived LSTs, and generating additional protocol fees.
Overall, this deployment aligns with Osmosis’ goals to enhance ecosystem utility and generate sustainable value for the protocol from existing holdings.
Deploy TIA to Margined Redemption Rate Arbitrage Strategy
This proposal asks for the deployment of 19,200 TIA (~$125k) to the Margined Protocol Redemption Rate Arbitrage Strategy.
About the Strategy
The Margined Redemption Rate Arbitrage Strategy (RRArb) strategy takes advantage of the tendency of Liquid Staked Tokens (LSTs) to trade for less than the equivalent of the underlying staked assets and automates the arbitrage process for participants.
This consists of:
- Buying the LST below a known optimal discount rate which is based on the opportunity cost of unbonding and trading fees.
- Performing a cross-chain redemption transaction to redeem the LST for an instant, but pending unbonding, profit.
- Looping this activity when the redeemed assets become available.
RRArb strategies are based on a single staking asset, but multiple LSTs derived from that asset are arbitraged.
In this case, TIA is held by the strategy and used to purchase milkTIA and stTIA on Osmosis when it can redeem these LSTs for more TIA than the number of TIA used to purchase them.
This strategy, funded by the Osmosis Grants Program, has been live for three months and has consistently outperformed the TIA staking APR while supporting both the peg of TIA LSTs for use cases on Osmosis as well as contributing to volume through these pools, which in turn attracts liquidity around the market rate and generates protocol fees.
Margined charges a 15% performance fee for this strategy. This is paid on profits accrued by the deposit so the initial deposit quantity of tokens is not impacted.
There is a 0.5% withdrawal penalty for withdrawals within 21 days. Osmosis governance commits to retaining liquidity in the vault for this period to make this obsolete, barring any security related need for withdrawal.
Risk Analysis
Asset Risk
As this deployment does not change the composition of the Community Pool holdings, there is no change in Asset risk.
Contract Risk
Margined contracts have recently completed an audit, and this strategy has been in operation for three months with no incidents.
Three RRArb contracts are running, securing around $667k in liquidity, mostly in OSMO, before this deployment.
LST Risk
The strategy is exposed to the LST asset for a very brief period before unbonding occurs. The risk of exposure is increased due to the unbonding and distribution mechanism requiring 14 days. All three assets have been operational for at least three months with no incidents.
As this contract is purchasing LSTs below a set price, it may purchase a compromised LST that has no backing, resulting in a loss of funds.
This would only occur if the deposit were liquid and awaiting an arbitrage opportunity. As most assets will be in the process of unbonding or not intended for arbitrage as a withdrawal float, this risk can be mitigated by Margined pausing the arbitrage strategy contract.
Lack of Returns
As purchases are only performed when there is an available opportunity, the return may eventually be less than TIA inflation. This still will outperform the current return of holding unstaked assets in the Osmosis Community Pool and only be the case when the peg of LSTs is very close to the redemption rate, improving their utility on Osmosis.
Use of Multisig for execution
This 4/6 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.
Technical Implementation
19,200 TIA will be sent to the Osmosis Liquidity SubDAO.
This will be deposited into the Margined Redemption Rate Arbitrage Strategy - TIA
The representative tokens for this position will be returned to the Osmosis community pool.
Success Metrics
- Revenue earned in TIA terms based on existing deposit (19,200)
- Improved peg for TIA LSTs (Current 1.7% discount to Redemption Rate)
- Increased volume through LST pools (Current 7D, 1.18m milkTIA, 1335 & 1475, $316k in stTIA, 1428 & 1476)
Conclusion
Deploying TIA to the Margined Redemption Rate Arbitrage Strategy (RRArb) offers a promising opportunity for existing unutilized assets within Osmosis Community Pool. This strategy has already demonstrated consistent returns comparable to TIA staking APR on the currently unutilized community pool TIA while generating volume on Osmosis to attract LPs, supporting the peg of TIA-derived LSTs, and generating additional protocol fees.
Overall, this deployment aligns with Osmosis’ goals to enhance ecosystem utility and generate sustainable value for the protocol from existing holdings.
Target Onchain Date: 10th December 2024
