Olympus DAO, according to their website, is a "Decentralized Reserve Currency". They are trying to build a "community-owned decentralized financial infrastructure to bring more stability and transparency for the world." In this post, I'll try to break down what that actually means in the context of Olympus DAO and how they can afford to provide an unreal APY of ~500% at the time of writing this article. It used to be as high as 7,000%!
As humans developed and evolved, so did our needs. In order to fulfil those needs, often times you'd need to "buy" it from another person. Methods like the barter system, gift economy and debt handled these exchanges. Eventually, many cultures developed commodity money. Shells were a popular form of currency for a long time and then, rare metals like Gold and Silver came into play. With growing trade, it became extremely inconvinient to handle Gold. Say you want to buy a pack of chewing gum worth $1. If we were still trading with Gold, you'd have to shell out 1/60th of a gram. You can probably see this getting tedious extremely quickly and that is essentially what happened. With time, representative money gained popularity.
Representative money, (often paper money) is a medium of exchange that represents value but does not have any intrinsic value. For a long time, the US dollar was backed by gold meaning that for each dollar you own, you could get it exchanged for gold at a fixed rate on demand. Dollars could only be issued/printed if the country had the equivalent amount of Gold in its reserves. Today, US Dollar is a fiat currency meaning that it isn't backed by anything other than the trust in the US Government. Often times govenments print cash whenever a quick infusion is needed. This often leads to inflation and in some cases, hyperinflation like what happened in Zimbabwe and Venezuela.
DAO stands for Decentralized Autonomous Organization. You can think of DAOs as a community with a shared bank account. All the decisions are made by the community from the bottom up, unlike traditional organizations where all the decisions come from the top down.
You might have heard about the ConstitutionDAO, which set out to buy a rare copy of the US constitution. They ended up raising $47 million within days. While they ultimately were outbid, it was nonetheless a very interesting experiment to see what a community can accomplish together with the help of the blockchain. A DAO is governed by a smart contract which removes the trust involved within participating entities. It begins with a team developing a protocol and issuing tokens to the community in exchange of funding in form of ETH, SOL, etc. The tokens provide voting rights. Once the contract is deployed, the original developers have the same authority on the organization as other token holders. I plan to write more specifically about DAOs in the future but for now, all we need to proceed here is that Olympus is a DAO.
A ~7000% APY certainly sounds sketchy and unsustainable. How is that even possible? To answer this question, we need to first understand the problem. Within crypto, ETH, BTC, etc. are extremely speculative investments (to be fair, they do show promise) and cannot be relied upon to be a stable store for value just yet. On the other hand, stable coins like USDC, USDT, etc. aren't any better since their peg to the fiat currency puts their value at the whims of a government. Olympus is addressing this issue by creating 'Ohm', a "free-floating reserve currency".
Wikipedia describes reserve currency as:
a foreign currency that is held in significant quantities by central banks or other monetary authorities as part of their foreign exchange reserves.
While this definition doesn't completely apply to DeFi protocols, it provides a good benchmark. My comprehension of economics is limited to ECON 103 but from what I understand -- a "stable" and developed country (the United States) becomes a de facto provider of a currency (the US dollar) to facilitate international trade. A large number of commodities like oil and gold are priced in this currency on account of its stability and this facilitates trading without exchange rate risks. In the world of Crypto, BTC and ETH come close to this status and are often used as such but they are still pretty volatile.
There is still the "free-floating" part that needs to be addressed in order to understand 'Ohm'. Stable coins are pegged to traditional fiat currencies so their value is tied. Unlike stable coins, 'Ohm' is backed by crypto assets. For each 'Ohm' issued, the treasury contains one DAI. DAI is a stable-coin pegged to the USD. Since 'Ohm' is not pegged, its value is decided by the market and protected by the Olympus protocol. If at any point, the value of Ohm falls below $1, the protocol buys back Ohm and burns it thus reducing the supply. On the other side, if Ohm trades above the value of the backed assets, the protocol mints and sells new tokens thus increasing the supply.
The Olympus treasury issues bonds and to incentivize buyers, the protocol provides the Ohm token at a discounted price. Let's say that the current market price for Ohm is $10. If you want to buy one Ohm through a bond, the protocol will sell it at a discounted price of $9 but the bond will require the buyer to provide $9 worth of assets in tokens such as wETH, DAI, etc and then wait 5 days to receive the Ohm.
During that period, if the price of Ohm stays the same or shoots up, the buyer of the bond has turned a profit. There is certainly the risk of the Ohm price going down. To combat that a bit, staking comes into play.
You may remember that the Ohm token is supposed to be backed by 1 DAI (~$1) so when the bond for 1 Ohm was sold for $9 in our above example, $8 of that is technically a profit from the treasury's perspective. This will allow the treasury to mint 8 more Ohm tokens without the value falling below the backed assets and also provide them as staking rewards. To add to that, when Ohm is staked, it reduces the supply in the market and thus even with the increased number of Ohm tokens, the price is maintained.
There is a lot more stuff to discuss when it comes to Olympus -- LP Rewards, (3, 3), Inverse Bonds, etc. and they would require separate posts.
With the concepts discussed in this one, there are still a lot of questions about the legitimacy of the project. Does Olympus actually solves the problems it claims to solve or is it just an elaborate scam?
Olympus is a novel idea and the scale it has accomplished in such a short period of time is truly commendable. However, there are obvious concerns. For eg. the Ohm token has no utility and the demand is fueled by buyers wanting to get in on the insane APY. Essentially, the protocol is selling a token with no value so that the buyer can keep accumulating more of that token hoping that someone in the future will be willing to pay a higher price on it. That seems like a classic pyramid scheme model. To be fair, a lot of crypto works that way. People only buy crypto because they believe it has value. The same thing goes for the US dollar as well. If people suddenly stop believing that the dollar has no value, it won't!
In conclusion, the Olympus DAO is complicated, interesting and controversial. It could be a pivotal instrument in building a resilient decentralized currency or it could fizzle out like so many other promising DeFi protocols. Only time will tell but it is certainly worth keeping an eye on.