Introduction

Osmosis is an application-specific blockchain (appchain) in the Cosmos ecosystem. The Osmosis DEX, which is built on the Osmosis appchain, is the most popular exchange in the Cosmos universe. Serving as the main liquidity hub for Cosmos and handling millions in daily trading volume, the Osmosis network holds over $650 million in TVL with $175 million of that on the Osmosis DEX.

Osmosis’s investors include Paradigm, Figment, Nascent, Ethereal, and others. As its own chain, Osmosis offers tons of unique features like staking LPed $OSMO, MEV-resistance, and interoperability with all other Cosmos appchains. Osmosis continues to develop and build up its native ecosystem, which is particularly focused around the Osmosis DEX.

The Problem

Even though decentralized exchanges are a huge improvement over centralized exchanges, they still have plenty of their own issues. DEXes on general purpose blockchains (like Ethereum) compete against all other apps on the network for blockspace. This means higher gas fees and slower transactions, especially as time goes on and the network bloats.

While developers have more flexibility at the application level, they cannot customize at the network level. They are limited by the security, governance, and general infrastructure of the chain they build their app on. Apps are only composable with and accessible to other apps/users on the same chain.

The Goal

Osmosis is its own app-specific Cosmos blockchain, rather than existing as an app on a general purpose L1. The Osmosis DEX has its own custom underlying network and validator set which is completely sovereign from any other chain. The Osmosis network is specifically designed to accommodate the Osmosis DEX.

With Cosmos IBC, Osmosis is interoperable and composable with all other IBC chains. Rather than a single chain with a bunch of apps, Cosmos is a network of individual blockchains each designed for a specific app(s) or purpose. Osmosis can operate on its own accord while still staying connected to the rest of the IBC ecosystem.

How Does it Work? The Chain

The Osmosis network is built using the Cosmos SDK, a toolkit for building custom appchains that run with the Tendermint consensus engine. Appchains are layer 1 blockchains built with infrastructure that’s tailored specifically to some application. Simply put, appchain developers can customize network-level features to meet their dApp’s needs. In Osmosis’s case, the chain is built to host the Osmosis DEX, plus any other smart contracts built in conjunction (e.g. Mars Protocol Outposts).

When analogizing Cosmos to a standard L1 chain, appchains are like the apps on an L1. Except, appchains are each their own L1 chain. So rather than a bunch of apps connected on a single blockchain, Cosmos is a bunch of L1 appchains connected via the Cosmos Inter-Blockchain Communication protocol (IBC).

Osmosis is one of the 50+ Cosmos chains that has enabled IBC. IBC is a messaging protocol that lets blockchains send data and tokens to each other without using any kind of token bridges. This means users on any other IBC-enabled chain can swiftly transfer their assets to Osmosis with zero bridge risk. Features like interchain accounts combined with IBC can enable interchain swaps on Osmosis, among other cool things.

While Osmosis is a layer 1 blockchain, not everyone can deploy dApps on it. All smart contracts deployed on the network must be approved by Osmosis governance first, which differs from chains like Ethereum that offer permissionless smart contract deployment. This is a feature though, not a bug, since Osmosis is designed as a custom appchain network for the Osmosis DEX (not a general purpose network).

$OSMO is the de facto gas token on the network, but users can pay gas with any whitelisted asset. As a proof-of-stake (PoS) chain, nodes can stake $OSMO to validate transactions and earn rewards, or regular holders can delegate their $OSMO to validators and earn a share of their rewards. Osmosis also integrates Skip Protocol into its infrastructure to capture MEV as revenue. This integration is expected to generate “$10,000 - $35,000 of revenue per $100 million in DEX volume” which could partially go to stakers in the future.

How Does it Work? The AMM

The Osmosis DEX (similarly known as “Osmosis”) is the dApp that the Osmosis appchain is designed for. For Cosmonauts, Osmosis is the go-to platform for making swaps and providing liquidity.

The DEX can be accessed from either the standard frontend or “Osmosis Frontier”, the only difference being pool creation is permissionless on Frontier. Users can swap, provide liquidity, view their assets, stake $OSMO, participate in governance, and view up-to-date Osmosis analytics all in one place.

Inspired by Balancer, virtually everything is customizable when creating a pool: swap fees, token weights, and even the pool’s bonding curve. As such, Osmosis can be viewed more like “AMM infrastructure” since pool creators have so much flexibility they can basically deploy custom AMMs. Expected in the next update (v16), LPs and traders alike can start enjoying the benefits of concentrated liquidity on Osmosis.

Liquidity pool parameters on Osmosis are dynamic. Pools are self-governing, so liquidity providers have a say in their pool’s parameters using their LP tokens as votes. LPs may want to adjust parameters based on the broader market, the pool’s volume, factors in the asset(s) being traded, etc. No matter the reason, liquidity providers can react to new market conditions and vote on parameters they think make most sense for their pool. By default, Osmosis uses TWAP pricing for each liquidity pool.

Providing liquidity on Osmosis is straightforward and just like any other DEX. Users can choose a pool from the Pools page to provide liquidity to, which they earn swap fees from by default and can earn $OSMO rewards by bonding their LP tokens. Bonded LP tokens can be unbonded at any point after bonding, but LPs must wait the duration of the unbonding period before they can actually withdraw their liquidity.

Select $OSMO pairs qualify for “superfluid staking” which is like backwards liquid staking. LPs in superfluid pools can stake some of their LPed $OSMO and earn staking rewards on top of their swap fees/bonding rewards. In short, Osmosis can secure the network with some of the liquidity on the DEX. With interchain accounts, Osmosis can take this one step further with “interfluid staking”, which is just superfluid staking but for other IBC assets like $ATOM, $JUNO, $STARS, etc.

Osmosis offers custom AMM designs for pool creators to work with, like Liquidity Bootstrapping Pools (LBPs). LBPs are a way for new projects to conduct public token sales in a sort of Dutch auction-style approach, where a pool’s token weights are slowly adjusted down to 50/50 over time. This slow adjustment to 50/50 from an initial 90/10 ratio facilitates the fairest price discovery for new asset sales.

Another AMM design Osmosis offers is the Stableswap AMM. Stableswap pool parameters are tuned specifically for low-slippage stable asset swaps like Curve Finance. Pools with liquid staking derivatives (ATOM/stkATOM) can also leverage the Stableswap design as they maintain a 1:1 peg. On top of this, Osmosis offers multi-asset pools where more than two assets can trade in one pool. Combined, creators can compose things like multi-asset Stableswap pools.

The Keplr interchain wallet is needed to interact with most Cosmos appchains including Osmosis. Before users can use the DEX, they must bridge funds to the Osmosis network via the Assets page. Deposits of IBC-native assets (ATOM, JUNO, STARS, etc.) will prompt users with a Keplr popup to sign a transaction from whatever chain the asset is coming from. Deposits of non-native assets (USDT, wETH, BNB, etc.) are facilitated by Axelar bridges which connect Osmosis to Ethereum, Moonbeam, Polygon, Avalanche, and Fantom.

Osmosis has handled over $21 billion in total trading volume with $1 billion in this quarter alone. Over 125 million transactions have been made on the network, and there are around 35,000 daily active users today. These numbers are expected to grow in parallel with the rest of the Cosmos ecosystem.

This is where Osmosis ultimately benefits as the liquidity backbone of Cosmos’s appchain ecosystem. Most appchains don’t have their own DEX and rely on Osmosis for IBC-native token liquidity. As new appchains launch and the broader IBC userbase grows, this just means more volume for the Osmosis DEX and more fees paid to LPs/stakers. Simply put, users on other IBC appchains are Osmosis’s userbase.

Osmosis Outposts are another exciting innovation that should bring more volume to the appchain. In short, using the Osmosis DEX with IBC should be as easy as swapping from any chain without having to move assets to Osmosis beforehand.

This is what Osmosis Outposts enable, allowing IBC users to make interchain swaps directly from their native chain while IBC relayers handle the routing in the background. Furthermore, Outposts can facilitate swaps from one chain to another using Osmosis as a sort of “swap middleware”. Outposts aren’t limited to IBC chains either, as solutions like Landslide and Axelar can facilitate cross-chain Osmosis swaps from non-IBC chains like Avalanche or Etheruem.

Partnerships

Osmosis is connected to over 50+ other blockchains via Cosmos IBC, and has a budding ecosystem that is heads-down in development.

Osmosis is partnered with Axelar and uses the Axelar token bridge to connect to chains outside of the IBC realm like Ethereum, Avalanche, Fantom, and more. Axelar is also its own Cosmos appchain, offering its cross-chain interoperability solution for both IBC and non-IBC blockchains.

The partnership between Osmosis and Kado Money establishes one of many major fiat onramps to the appchain. The Kado onramp is directly integrated on the Osmosis frontend, making it seamless for users to buy crypto with fiat without needing something like a centralized exchange.

Mars Protocol is another Cosmos appchain that just launched earlier this year. The Mars and Osmosis communities have formed close ties, and as a result Mars will be leading the first major dApp deployment on the Osmosis network. At launch, Osmosis users can borrow/lend with ATOM, OSMO, and USDC via the newly deployed Red Bank Outpost. Since Mars can freely deploy code on Osmosis, planned features like Farm (leveraged yield farming) and Rover (credit accounts) are expected in the future. Rover would allow users to take out undercollateralized loans with certain assets, but only use the liquidity for trading select asset pairs on Osmosis (similar to CEX margin).

Osmosis governance recently voted to integrate Babylon, which adds extra protection layers to the network using Bitcoin security. Babylon is infrastructure for Proof-of-Stake (PoS) chains, offering features like safeguards against “long-range” blockchain attacks. Also with Babylon, $OSMO unstaking periods can drop from 14 days to as low as 15-30 hours without compromising network security.

Tokenomics

$OSMO Price: $0.87

Market Capitalization: $477,641,238

Circulating Supply: 549,739,286

Maximum Supply: 1,000,000,000

Fully Diluted Valuation: $869,977,751

Read more about token distribution here.

The $OSMO token is native utility token of the network and the protocol. It is staked to become an Osmosis validator, can be used to pay gas fees, used for governance, and is the most popular base pair on the DEX. In select $OSMO pools on the DEX, users can stake a portion of their LPed $OSMO to earn staking rewards on top of their LP rewards. Staked $OSMO can be unstaked at any time but comes with an unstaking period (14 days) before the user gets their $OSMO back. $OSMO can be liquid staked on LSD appchains like Stride (and soon Quicksilver).

$OSMO inflation is used to pay both validators and liquidity providers on the DEX. 25% of daily $OSMO emissions is used to pay stakers, 25% is vested to pay developers, 45% is used to pay LPs, and 5% goes to the community pool. Every year $OSMO undergoes a “thirdening” (issuance cut by 1/3), and the second $OSMO thirdening will be this year near the end of June. Today, $OSMO takes on around 36% annual inflation.

The distribution of $OSMO pool rewards is ultimately determined by pool volume. Osmosis governance tends to divide $OSMO emissions relative to how much volume each pool is generating. This incentivizes liquidity providers where demand for liquidity is highest, making the most efficient use of $OSMO inflation for LPs.

Conclusion

Osmosis is a first-of-a-kind innovation as a DEX-specific appchain. While it continues to evolve with the broader IBC tech stack, it’s almost certain that Osmosis will keep delivering unique features for the DEX. As the go-to DEX choice of the average IBC user, and given the continued rapid growth of the Cosmos ecosystem, the future of Osmosis undoubtedly looks bright.

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DISCLOSURE: I hold a small amount of $OSMO (<1% of my portfolio). I was not asked to write this article and have not been compensated in any way. The information provided in this article is solely for educational purposes and should not be considered as financial advice. The views expressed in this article are my own and do not necessarily reflect the official policy or position of any company or organization. Readers should always conduct their own research before making any financial decisions.