Osmosis (OSMO): A DEX for the Cosmos Ecosystem

The Cosmos Ecosystem

Osmosis is a decentralized exchange (DEX) and automated market maker (AMM) protocol for the Cosmos ecosystem. To understand the specifics of Osmosis, it’s helpful for you to know the context of the Cosmos ecosystem upon which and for which it is built. Cosmos is an overarching ecosystem of blockchain networks that can connect with one another as part of Cosmos’ mission to build an “internet of blockchains.” Interoperable decentralized applications (dApps) on these various networks communicate with each other and send tokens and data back and forth via Cosmos’ Inter-Blockchain Communication (IBC) Protocol.

The Cosmos Hub is the mainchain that serves as the central ledger and primary blockchain protocol to connect with other blockchains in the Cosmos Network. It is a Proof-of-Stake (PoS) blockchain built by the Ignite team and uses ATOM as the native token for voting, staking, and transactions. Cosmos also provides a software development kit (SDK) to enable projects and teams to build on its network. Now that we have a surface-level understanding of Cosmos and how it operates, we can dive deeper into Osmosis.

The Osmosis AMM

Osmosis is a DEX protocol, which means it uses smart contracts to determine the price of digital assets, to produce liquidity via a peer-to-peer (P2P) methodology, and to exact trades between users. This approach to an exchange platform is known as an AMM — a DEX protocol that prices crypto assets in liquidity pools. Contributing tokens to these pools helps foster decentralized liquidity, which is then used to facilitate trades on the exchange. Participating as a liquidity provider (LP) can earn you both trading fees and newly minted LP tokens as incentives for participation.

The Osmosis AMM is unique in that it affords users the ability to create their own liquidity pools, or to duplicate existing ones with their own unique parameters. Because Osmosis is built on the Cosmos ecosystem, users are able to natively trade assets from more than 47 different chains within Cosmos.

While most AMMs today are fairly efficient at providing liquidity in a decentralized manner, they still operate as service-based products: the platform creates pools that are free to join. In the dynamic landscape of decentralized finance (DeFi), this can arguably compromise the efficiency of the liquidity pools available for use. To help solve these issues, the Osmosis AMM was conceived as a “serviced infrastructure” that provides users the ability to tweak the values of tokens and the supply, therefore lowering the barrier to creating custom-built AMMs.

Two primary concepts that drive the Osmosis protocol are sovereignty and heterogeneity. To that end, Osmosis makes use of self-governing liquidity pools. These liquidity pools that exist in Osmosis are not hard-coded and users can use the native Osmosis token (OSMO) to vote on pool parameters and protocols, provide liquidity, and stake. Essentially, it allows holders of the token to decide the make-up of specific liquidity pools, in addition to playing a central role in wider Osmosis protocol governance.

OSMO Token and Superfluid Staking

OSMO is the native token of the Osmosis network. Primarily, OSMO is used for staking to secure the Osmosis chain. As a PoS token, OSMO is inflationary. Over time, new tokens will be minted and entered into circulation. The maximum number of OSMO tokens has been set at 1 billion. As of May 2022, there are 282 million OSMO in circulation.

A key innovation within the Osmosis protocol structure is superfluid staking, which allows users to both stake tokens while simultaneously using them to provide assets to a liquidity pool. This means Osmosis users are rewarded for helping secure the blockchain while staking, and receive reward fees associated with liquidity pool transactions. The first Osmosis token pool to allow for superfluid staking is the ATOM/OSMO pool, which is the top Osmosis crypto staking pool by volume and includes both OSMO and the Cosmos token ATOM.

Osmosis’ use of superfluid staking is designed to not only increase users' capital but also contribute to the security of other blockchains in the Cosmos ecosystem. Prior to the innovation of superfluid staking, if a user brought their assets to Osmosis to earn block rewards in one of the liquidity pools, the blockchain that provided those assets would not be able to use them to secure the chain. With superfluid staking, users supply the liquidity pool while still staking the underlying asset in the blockchain from which it came. To that end, Osmosis and its OSMO crypto staking feature strengthen the security of all Cosmos blockchains, in addition to providing a core DEX for the Cosmos ecosystem.