The Swapping Solvent: Everything You Need to Know About the Osmosis DEX

The Swapping Solvent: Everything You Need to Know About the Osmosis DEX

Decentralized exchanges revolutionized how tokens are swapped, but a new Cosmos-based blockchain called Osmosis is pushing the boundaries of what a DEX can do.

The Swapping Solvent: Everything You Need to Know About the Osmosis DEX
Guy Ovadia

Published May 10, 2022Updated May 10, 2022

Crypto

Crypto

DeFi

DeFi

Technology

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Decentralized exchanges (DEX) have become so cookie-cutter that you can barely tell them apart. I mean, can you even tell the difference between Quickswap and Sushiswap? The truth is that most DEXs are just copies of the Uniswap automated market maker (AMM) protocol—just slightly altered versions of the same liquidity formula. Liquidity providers on Ethereum have a lot of choice in terms of which DEX to stake their cryptos, but not as much when it comes to how their cryptos are utilized once they're in a liquidity pool.

Selecting a longer unbonding period will yield a higher reward rate compared to shorter unbonding periods, but longer unbonding periods mean you'll have to wait longer to remove your liquidity.

Osmosis is a decentralized exchange that wants to change that by enabling the creation of iterative self-governing liquidity pools where there's no one-size-fits-all solution to liquidity. Osmosis is not only a DEX, but is a standalone blockchain made to host a protocol for creating liquidity pools with unique AMM parameters. Customizable liquidity pools, low fees, and interoperability are what make Osmosis such a competitive crypto exchange. Here's how it all works.

What is Osmosis?

Osmosis is a DEX blockchain that's a zone of the Cosmos Hub ecosystem, thus making it compatible with networks using the Inter-Blockchain Communication (IBC) protocol, like Terra. Osmosis has a customizable AMM that's different from ones like Uniswap and Curve because it allows users to deploy sovereign liquidity pools. This means that each Osmosis liquidity pool is like an independent decentralized autonomous organization (DAO), where liquidity providers can vote to change the parameters of the AMM formula for their pool.

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Governance

The goals of governance on Osmosis are to give stakeholders a say in how their liquidity is used and for the deployment of liquidity pools with custom parameters that can adjust according to the market and compete with each other. While OSMO token holders get to vote on proposals for the Osmosis protocol as a whole, it's up to the liquidity providers of each self-governing liquidity pool to collectively decide the rules of their pool. This allows liquidity pools to experiment as a way of formulating a balance between liquidity and swapping fees.  

OSMO token

The OSMO token is the main governance token of the Osmosis Protocol as well as the native currency of the Osmosis blockchain. Osmosis is a proof of stake blockchain, which means validator nodes must have a certain amount of OSMO staked to confirm transaction blocks. Being a validator means taking responsibility for the network's security, so those who don't have the resources to do that can also delegate their OSMO to another validator and earn part of their rewards.

How to use Osmosis

Osmosis is the biggest IBC blockchain by transfer volume because it's both a standalone blockchain and the biggest DEX in the Cosmos Hub ecosystem. To use Osmosis, you'll first need to install a Web3 wallet that's compatible with Cosmos—The Keplr browser wallet for Chrome is highly recommended. Then, since OSMO is not currently available to buy on centralized exchanges like Kraken, you'll need to transfer some ATOM crypto into your Keplr Cosmos wallet.

Using IBC

Using the IBC protocol, you can transfer assets from Cosmos to other zones in the ecosystem. However, configuring your IBC transfer by finding the correct channel can be complicated for some users. That's why the 'Assets' section of the Osmosis interface has 'IBC deposit' and 'IBC withdrawal' features that simplify IBC transfers to and from the Osmosis blockchain. This makes it so much easier to transfer ATOM from the Cosmos blockchain to the Osmosis blockchain.

Getting OSMO

After you've transferred your assets onto the Osmosis blockchain, you can now use the Osmosis DEX to swap your crypto for OSMO. To do this, you must navigate to the 'trade' section of the Osmosis interface and select the token you wish to exchange for OSMO. It's recommended to trade using ATOM since it's easy to obtain and holds the largest share of liquidity with OSMO. Once you type in the amount you wish to trade, you will see the exchange rate, the fee percentage, and a slippage estimate.

Then, once you click swap you will be directed to the Keplr wallet where you'll have to accept the transaction fee and sign the transaction. After you sign the transaction and the swap is processed, you can navigate back to the assets section to see your new OSMO balance as well as the new balance of whatever asset you traded it for. Be sure to always leave a small amount of ATOM in your Cosmos wallet and OSMO in your Osmosis wallet to pay fees for future IBC transfers.

Staking

Once you have OSMO in your Osmosis wallet, one thing you can do is stake or "bond" it to help secure the Osmosis protocol. To do this you'll need to head over to Keplr, but hold your horses because the Osmosis interface has got you covered. Just click on 'stake' and you'll be automatically redirected to the Osmosis staking page in the Keplr app. There you'll see a list of active validators to whom you can delegate your OSMO as well as their 'voting power' (amount of OSMO that's staked with them) and commission rate (the percentage they charge from your staking rewards). 

Bonding and unbonding

Staking on Osmosis is a great way to earn rewards on your OSMO that would otherwise be idle, but making sure you delegate to a validator that has a high 'uptime' is important because there are fewer rewards for validators that aren't always active. It's also good to do your research before choosing a validator because bonding and unbonding are irreversible processes that take 14 days each. This means that delegating and undelegating OSMO requires locking your OSMO for at least 28 days and no rewards are accrued during unbonding.

Providing liquidity

Bonding is also the term used for providing crypto into liquidity pools and this is done in the 'pool' section of Osmosis. Liquidity providers must stake two crypto assets into a liquidity pool to earn the fees traders pay for utilizing that liquidity as a reward. While most pools require an equal dollar amount of each crypto, the value ratio can vary according to the parameters of the pool. 

Gamma

Once you decide on a pair of cryptos that you'd like to bond, you just need to select an appropriate pool and stake that amount of those cryptos from your wallet. Staking is denominated in gamma, which is the name for liquidity pool (LP) tokens on Osmosis. LP tokens represent one's proportional share of the liquidity pool as well as their voting power for proposed changes to the pool's parameters. Rewards from fees generated by the liquidity pool are calculated based on how much of that pool's gamma is in one's wallet.

Liquidity unbonding periods

After you select how much to stake into your liquidity pool of choice, you will be asked to select an unbonding period. Selecting a longer unbonding period will yield a higher reward rate compared to shorter unbonding periods, but longer unbonding periods mean you'll have to wait longer to remove your liquidity. Selecting a longer unbonding period earns a higher APY rate because it illustrates a greater commitment to the pool, while a shorter unbonding period offers a conveniently brief unlocking period in exchange for a lesser reward rate.

Superfluid staking

Osmosis recently introduced Superfluid staking to some of its liquidity pools. Rather than having to choose to bond OSMO either with a validator or into a liquidity pool, Superfluid staking allows you to do both simultaneously. This can be done automatically on select ATOM/OSMO liquidity pools as well as those of a few other assets. Superfluid staking works by taking the gamma LP tokens of liquidity providers who choose to Superfluid stake and delegating an equal value of OSMO to validators. 

No amount of experimentation can ever prove me right; a single experiment can prove me wrong.

Strictly speaking, DeFi is more of a shared ambition than a reality. Full crypto adoption is sowly progressing as investors begin holding their own keys and developers invent creative ways to utilize blockchain. The crypto world is like a Macy's department store where you've got all the brands in one place, but now you're in the fitting room trying everything on for size. The question is, what will most investors have in their blockchain basket when it's time to check out?

No amount of experimentation can ever prove me right; a single experiment can prove me wrong.

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