Osmosis DEX Explained
DeFi has been experiencing tremendous growth since 2020, thanks to the juicy opportunities it brought to crypto in terms of yield farming, decentralizing lending and borrowing, stablecoins, synthetic assets, and much more.
Decentralized exchanges (DEXs) are among the most promising segments of DeFi, but their utility has until now been limited by their underlying blockchain.
In this article, we’ll explore the unique contribution Osmosis is making to the DeFi space.
Defining Osmosis DEX
Osmosis is a decentralized exchange (DEX) that uses the Cosmos SDK for optimized functionality with other blockchains. Its automated market makers set it apart, allowing enhanced market responsiveness for liquidity providers.
Osmosis is a multi-chain DEX specifically built to function with other blockchains in the Cosmos ecosystem. Communication with these other blockchains is achieved via its Inter-Blockchain Communication protocol (IBC). Because Osmosis is linked to other Tendermint blockchains, providing smooth, fast trades.
Furthermore, IBC enables customizable automated market makers, or AMMs. Uniquely, Osmosis liquidity providers can set their own parameters based on current market conditions. This customization provides increased responsiveness to changing market conditions for optimized results. In addition, token holders can earn staking rewards, participatory rewards, liquidity mining rewards and transaction fees when they delegate tokens to validators.
How Does Osmosis Work?
Since Osmosis was built using Cosmos SDK, it’s interoperable with other blockchains in the Cosmos ecosystem. As noted, its unique multi-chain blockchain uses Cosmos’ IBC for communication. Because of this unique design, OSMO token holders can complete swaps and trades with non-native token pairs. By staking tokens and being a liquidity provider, token holders can earn transactions and staking rewards. In addition, holding OSMO tokens comes with governance voting rights and the ability to help steer upgrades and new developments.\
Features of Osmosis
The Osmosis DEX’s innovative features give it key advantages over some of the other DEXs that are currently available. Let’s look at some of them.
Customizable Liquidity Pools
The customization capabilities of Osmosis’ liquidity pools provides a more flexible fee structure than those of other platforms, who exclusively take token pair rarity into account. Liquidity providers can optimize earnings from fees and staking rewards by compensating for market volatility and other factors.
Self-Governing Liquidity Pools
Osmosis liquidity pools are also self-governing, meaning users can vote on changes to a pool’s protocol. In doing so, they can adjust TWAP calculations, swap fees, curve algorithms, rewards and incentive models. The platform’s liquidity pool governance feature supports diversity in the pools, so that users’ strategies and risk tolerance can more fully be represented.
To encourage longer-term commitments to the pools, those who make such commitments gain more liquidity mining rewards and have greater voting power. And those who have a greater financial investment in the platform have more say in the direction their pools take.
Osmosis is the first platform to offer enhanced staking rewards, which it calls Superfluid Staking. When users stake OSMO tokens, they can also contribute to a liquidity pool. This allows them to receive two types of rewards at the same time, including earning a proportional amount of transaction fees from the liquidity pool and earning staking rewards. Other platforms that offer liquidity mining incentives only allow one of these earning options at a time.
Currently, token distribution is weighted heavily on liquidity mining incentives and staking rewards to promote the growth of the platform.
MEV (maximal extractable value) resistance is assured through Osmosis’ use of threshold encryption. Thus, pools are private and cannot be manipulated by bots and other malicious forces. Often, bots and other forces use a sandwiching technique to profit while causing other users to suffer a loss.
Sandwiching involves bots raising the price through large buy orders and quickly selling their holdings. MEV resistance makes it impossible for malicious forces to identify such trading opportunities, which protects users against losses from nefarious actions.
Osmosis thirdening is a model adopted to create scarcity for the OSMO token and increase its price. Every year, Osmosis will release a set number of tokens. However, the amount of tokens released will decrease by a third with every “thirdening.”
Osmosis thirdening occurs in June. While it may increase the token’s price, it also results in a decrease in staking and liquidity pool rewards.
What Does Osmosis Want to Achieve?
While decentralized exchanges have dramatically expanded the opportunities available with DeFi, popular DEXs like Curve, PancakeSwap, Uniswap and others have specific shortcomings that Osmosis aims to overcome. The functionality of these single-blockchain exchanges is limited to the tokens native to their networks. The Osmosis DEX, however, is a multi-chain exchange that allows the staking of many tokens on other blockchains. Its AMM is linked to numerous other Tendermint blockchains, so Osmosis can support its users’ cross-chain trades.
Osmosis also aims to support customization in liquidity pools via the platform’s governance processes. OSMO, the native Osmosis token, is used to pay transaction fees and to support governance.