This proposal is to bring $500k in liquidity (less than 1% of Olympus’ total POL) during a trial period to GammaSwap. This will provide a higher yield on the OHM/WETH Balancer Liquidity as well as enable the protocol to fully hedge the IL (with as little as 5-10% of the total yield).
GammaSwap is the modular DeFi scaling layer enabling traders to borrow liquidity from AMMs like Uniswap, Sushiswap, Balancer, etc. Essentially we provide higher risk adjusted yields to LPs (they earn borrow fees from those longing gamma) while enabling traders leveraged exposure to any token and the ability to hedge any LP pool. The LPs in GammaSwap will always earn a higher yield than the vanilla LP position excluding token incentives.
If the model works, it should enable LPs to remain passive and expect to be positive EV. If you look at TradFi, IV has overstated HV 83% of the days since 1990. That means 83% of the days the edge has been to volatility sellers. Given crypto is even more volatile, we believe this model will help retail LPs come out ahead on average.
Why is this important? Well the current AMM model is broken. LPs are selling volatility and being compensated in volume. Most LP pools are not profitable to provide liquidity into and rely on token emissions to attract liquidity. This is not sustainable. GammaSwap is building a two sided volatility marketplace to make LPing profitable again without renting liquidity.
Olympus DAO is in the privileged position to own most of its liquidity and is not reliant on renting it; however, it is actively losing money in the OHM/WETH pool. Unlike the OHM/DAI pool or most stable pools, OHM/WETH operates similarly to USDC/WETH ie the two tokens have little to no correlation. Although OHM experiences some volatility, Olympus has put in place a mechanism to maintain range bound stability (RBS) and has designed an operation to stabilize OHM against DAI.
Therefore, since OHM is built to be pegged as a semi-stable token and WETH is quite volatile, the OHM/WETH pool is potentially susceptible to high degrees of Impermanent Loss.
Let’s do some simple calculations. The OHM/WETH pool has been around since Nov 23, 2022. At the time, the price of OHM was $8.53 and ETH was $1,163. At the time of writing (Feb 4 2023), OHM is $10.15 and ETH is $1664. Using this calculator to determine the IL of the 50/50 pool, we get an Impermanent Loss calculation of 0.42% - https://dailydefi.org/tools/impermanent-loss-calculator/.
There are 73 days between Nov 23 and Feb 4. Dividing that by the whole year, we get 5. That means that the yearly IL for this pool is 2.1%. Given the current APR of the pool is 0.75% from swap fees, that means the OHM/WETH pool is producing an annual loss of 1.35% or ~$500k a year based on current TVL.
The proposal would be to put 500k of the POL in GammaSwap as a way to earn a higher yield (now the LP position will earn the swap fees + the borrow fees for hedgers and speculators) which is almost a way of pseudo hedging. In the sense that in periods of higher IL the borrow fees should be higher from the increased demand for volatility. Given that the long straddle is the exact opposite position of the IL curve with leverage, Olympus can also hedge their POL with as little as 5-10% of their liquidity.
1. Smart Contract Risk
Smart Contract Risk is the only risk on the LPing side. Since the LPs in our platform are not counterparties to the borrowers (the AMM and the total liquidity is), then they should always be better off than the vanilla LP. There is also no type of liquidation risk as an LP. However, this is a completely novel type of product, not a fork so there is risk there. We will mitigate this risk by receiving an audit from a top firm, Halborn, for our core smart contract code and Zellic for our balancer integration.
2. Liquidation Risk (If Actively Hedging)
To open a Gamma Long position to speculate on volatility or to hedge an LP position, one must put up collateral in either or both of the underlying tokens. That’s how GammaSwap ensures the positions are overcollateralized.
Then the LP tokens are redeemed for the underlying tokens and if there is any volatility the underlying tokens can be used to redeem more LP tokens later. That’s how GammaSwap turns Impermanent Loss into Impermanent Gains. Those positions also accrue an interest rate(representing utilization) and if there is low volatility then that interest rate can eat up the collateral.
You can pick the LTV Ratio when opening up the position from 90%-97%. Picking a lower LTV will ensure that it will take more time to get to liquidation. Given the current APY of the OHM/WETH pool, Olympus could open a position for three-four weeks easily without worrying about liquidation.
GammaSwap is also happy to advise the Olympus DAO team on optimal hedging strategies.
The implementation is quite simple. GammaSwap will already support 50/50 and weighted pools in Balancer upon Mainnet launch with the support of Balancer DAO in the form of a grant. Olympus can simply deposit the OHM/WETH or the BAL LP tokens into the GammaSwap wrapped pool to earn a higher risk adjusted yield. That requires little to no extra work.
To hedge, Olympus would simply use a small percentage of the yield to short the liquidity and monitor the position semi-actively to make sure it has significant collateral.
The proposal is contingent on the successful audit of the core smart contracts by Halborn and the balancer integration by Zellic.
GammaSwap Protocol: https://medium.com/gammaswap-labs/gammaswap-protocol-6a4430e4b0ad
Balancer Grant: https://medium.com/@BalancerGrants/gammaswaps-will-support-volatility-hedging-options-for-balancer-s-weighted-pools-313993059f45
Seed Round: https://twitter.com/GammaSwapLabs/status/1622609745763762180