Osmosis Incentives have always been a controversial but constantly evolving subject. With many changes over the last year, I am posting some thoughts on where I believe we should aim.
At launch 28 months ago, we had a total of 12 pools, which were allocated incentives equally, and new batches of incentives were added with each weekly proposal at the proposer’s discretion.
We soon moved to following the format of a signaling proposal for each pool to be added being needed and switched to a Fee Subsidy model that aimed to provide a percentage bonus to all pools based on their fee generation.
Since then, there have been many tweaks to the incentives model, from adding and refining an external matching program to encourage third-party incentives, adopting a category model to focus incentives on the most strategically important pools for Osmosis, continually cutting the incentive levels in the wake of the Terra collapse and reducing Osmosis inflation to a more sustainable level.
The most recent changes have stripped the incentives program back to a core set of pools, and I think it is important to talk about the next steps that I hope governance chooses to approve.
The journey so far is best pictured by the Fee Subsidy rate Osmosis has given LPs over time. This shows that Osmosis is finally in the established phase where the fee subsidy is less than one, marking a shift in OSMO usage for incentive farming to that of a primarily governance token with deliberate spending thanks to constant inflation reduction over time.
Implementing Supercharged liquidity and the Taker Fee triggered a migration from OSMO being the base pair for the ecosystem to OSMO being a governance token with value capture from volume.
The original base pair usage was mostly driven by only incentivizing OSMO paired assets and the OSMO multihop discount, which was removed with the taker fee implementation. This became less feasible with Supercharged liquidity, where Stablecoin Quote assets give a far better experience for setting positions.
This migration has not been a clean one as it requires new pools and routes to form whilst also ironing out issues that cause difficulty for integrations to interact with the new pool types. While this is the case, there is a destination in mind and I wanted to share where I hope that Osmosis incentives will be heading over the next few months.
Incentivize pairings rather than pools
- Mentioned in proposals around implementing USDT pool incentives and being implemented for some pools during the V20 software upgrade proposal. Volume Splitting Gauges allow Pairings to be incentivized rather than specific pools.
- This allows liquidity to move between multiple spread factor pools in order to find the optimal pool parameters for each swap route.
- This action takes the form of proposals asking that 0.05% or lower spread factor pools be added to the incentive groups that 0.2/0.05% pools currently occupy.
- Also expect to eventually see proposals that aggregate similar assets within a group, i.e. All OSMO/Stable pairings grouped rather than OSMO/USDC and OSMO/USDT
Continue to only incentivize Core pairings long term
- While Osmosis governance has strongly preferred to incentivize OSMO pools in the past, this has led to all ecosystem projects adopting OSMO pools as their main pairing to obtain incentives.
- Removal or rejection of these incentives in the past has caused complaints that Osmosis is not supporting certain projects, contributing to hostility in the ecosystem. I believe that we should continue to only incentivize Core Quote assets long-term and allow the capital efficiency of Supercharged pools, opportunities for ecosystem usage and wider integrations of Osmosis tooling to be the reason that existing projects want to maintain liquidity on Osmosis.
- This action takes the form of governance rejecting adding new pools not composed of Quote assets only to the ongoing incentive system and carefully consider if a new Quote asset should be added.
Optimise volume by including non-OSMO pairings in the incentives structure
- Optimising volume occurs by minimizing the fee per transaction. Therefore, Osmosis should be trying to acquire liquidity in direct swap routes such as ETH/WBTC.
- As these routes now yield protocol revenue from Taker fees and the fee subsidy rate is overall below one, then we should be able to fully offset the cost of incentives in these pools by promoting their use.
- This action takes the form of proposals to add non-OSMO pairings to the incentives structure as Native WBTC liquidity and Alloyed assets roll out.
Change how incentives are received
- What OSMO incentives we do issue should require interaction with the Goverance process itself to increase the friction for mercenary liquidity treating it just as a bonus yield, and encourage them to participate in governance to request changes that make Osmosis more attractive to liquidity providers in other ways.
- This proposal was raised before Supercharged liquidity was out and did not make it to chain as there was still a bonding period in place for liquidity, which made the double bonding period unpopular. With the new lack of unbonding period in supercharged pools and above proposed movement to non-OSMO pairing incentives this should be revisited.
Target specific markets to establish through limited time Community pool spends
- Over the last year, many OSMO incentives have been redirected to the community pool. These should be spent for specific promotions with a fixed end point to ensure that we gain market share of trading in specific assets, which can then self-sustain as the fee subsidy for that specific pool drops below one.
- Ideally these should open new markets, or be targetted at large assets which can then be used in dapps such as Mars, Calc, Membrane and Levana.
- This was touched on as part of dropping several major assets previously - each large onboarding needs to have a focused push to attract participants from other ecosystems to Osmosis rather than just sourcing liquidity with no use case.
Establish Protocol Owned Liquidity using the community pool
- Osmosis is now accumulating yield as Quote assets from Taker Fees and Protocol Revenue arbitrage.
- Osmosis should use these assets to create additional yield bearing Protocol owned liquidity that auto-compounds through the use of Vaults by pairing with the existing OSMO in the community pool.
- Further pools should be established with established projects through community swaps such as the Manta Token Swap.
OSMO incentives potentially go to a large number of pools, but only composed of a few core assets. There are 10 Assets currently allowed to receive incentives, which should be divided into groups of Stable, ETH, WBTC, (st)ATOM , (st)OSMO and (st)IBCX.
Incentive distribution would naturally distribute mostly to the few most popular routes through these thanks to volume splitting gauges.
OSMO base pair liquidity becomes increasingly community-owned, be that by projects who launched via Streamswap, community swap proposals or the use of taker fee revenue.
OSMO usage becomes predominantly for staking through the multiple protocol revenue sharing strategies such as Taker fees, Protocol Arbitrage, Fee abstraction, Protocol Owned Vaults/App liquidity review, Block SDK and Fee Market.
Trading fees on Osmosis become mostly 0.15% for popular volatile routes and ~0.3% for less common ones, with 0.03% Stable pairing fees and free composability conversion. Trading on Osmosis becomes highly competitive due to capital efficient pools, low gas fees, convenience of use within the ecosystem and as the crossroads of interchain defi through connections to other ecosystems.