Autonomous Monetary Policy

By Finn Anderson

In a confrontation that has dominated headlines over the past year, the efforts of the Federal Reserve (FED) to counteract inflation has forced many questions. With the recent collapse of the Silicon Valley Bank (SVB) many have wondered if central bank inflation targets should be raised to reduce the potential of a recession caused from overtight monetary policy.

The relatively placated nature of interest rates from 2008 to 2021 has caused recent movements to be particularly unnerving. SVB, however crude their risk management may be, fundamentally fell victim to an overdue tightening of monetary policy in response to unexpectedly high inflation. With sustained investor confidence this would not have mattered, but depositor panic, quick withdrawals, and a fire sale of devalued assets forced the SVB to clinch their own bankruptcy.

Widespread unrest is commonplace amongst contemporary investors, with many eagerly anticipating CPI reports, Federal Open Market Committee (FOMC) meeting minutes, and other new releases, all with the intention to gain foresight into the US dollar (USD) and its implications on their investments. This begs the question if there exists a reserve currency that is able to consistently grow in purchasing power despite market conditions.

The difficulty with excessive interest rate corrections is the mimetic exuberance from all investors that deviate them from their long-term investment strategies. A reserve currency immune to inflationary pressures or market conditions seems dream-like. However, a project with this undertaking can be found in Web 3.

In the event you are unfamiliar with crypto (synonymous with “Web 3”) please refer to my previous article!

The Olympus DAO is an organization with the intention of creating the first truly decentralized reserve currency. An anonymous developer, under the pseudonym Zeus, created Olympus DAO to address crypto’s over-reliance on fiat-backed stable coins. USDT, USDC, and DAI are all-pegged to the $1 mark and act as a ‘store-of-value’ for crypto traders, but they leave investors vulnerable to monetary policy actions and inflationary pressures. This has led investors to question the decentralized nature of stablecoins. Ethereum and Bitcoin, similarly, are claimed to retain their value relative to most crypto assets, but they are still subject to market manipulations and volatility. Olympus (OHM) is able to avoid these worries through protocol-owned liquidity (POL) and an income-generating treasury.

An investor can purchase OHM through the market or through a process called “bonding.” Olympus issues bonds to raise money, just as a government does, but when an investor purchases a bond they receive discounted OHM in exchange for DAI, FRAX, ETH, or liquidity-provider (LP) tokens. This accrues a large treasury of moderately stable assets that act as a backstop for the value of OHM. Think of it like the gold standard- it uses a reserve of valuable assets to back and issue new OHM tokens. Once receiving OHM, investors are heavily enticed to stake OHM for high APY’s. Although down from their heart-stopping four- figures, present-day APY’s rest at 7.3%- still promising higher returns than the Vanguard S&P 500 ETF (YTD).

Nevertheless, staking OHM “locks” the tokens for a period of time, increasing its overall scarcity. As more value enters the treasury through bonding, Olympus can mint more OHM tokens, increasing their already dominant control of the supply. This is the cardinal effect of the Olympus DAO protocol: it owns the vast majority of its liquidity. The protocol retains and supplies most of the OHM liquidity to automated market makers (AMM’s), like Sushiswap, Uniswap, and Balancer. Olympus DAO then retains its liquidity provider.

(LP) tokens, prompting them to receive subsequent fees. And this is the genius behind the project- the control of its own supply.

Many projects utilize staking rewards and liquidity pools to facilitate the same effect, but this attracts malevolent investors who farm rewards and just as quickly abandon projects. This is known as rented liquidity, and it results in many projects being left with an insufficient supply. Prior to November 2022, OHM was able to protect the value of its asset-backed reserve currency in a menial way: Olympus could reap rewards from its LP tokens, and when the discrepancy between the market OHM and backing per OHM was sufficiently large, the protocol would merely issue OHM to dilute supply and drop its price. Conversely, if the value of OHM would go below $1 the protocol would burn OHM to constrict supply and increase its price.

However, the intention of a monetary authority is to limit volatility and provide clarity for financial planning. Therefore, on November 12th Olympus launched a Range-Bound Stability (RBS) protocol. This concept may seem esoteric, but the analogies provided by Zeus in the RBS whitepaper are simple enough to conceptualize.

First, picture a car on a two-lane, one-way road. The driver is expected to stay on road and in one of the two lanes provided. Although able to veer off-road with sufficient intent, the driver is incentivized to stay on road by the guardrails along the side. Secondly, (I may have altered this analogy) envision a slinkie. One is able to pull the slinkie up or down, but with enough force and velocity one can break the slinkie. With sufficient momentum, this force will carry the user’s hand beyond the height of the now broken slinkie. In combining these two analogies we arrive at the purpose of RBS. The range (width of the road) of the allowable OHM price movement is contingent on a moving average of N epochs (8-hours) of the price of OHM versus some asset.

For example, this might be 15% above (one guard-rail) and below (the other guard-rail) a 30-day moving average of the OHM-WETH price. At the ends of this range, the Olympus treasury may permit users to buy newly minted OHM at a discounted price to increase supply, or, equally, create a swap market where they permit users to sell OHM back to the protocol at a premium. This is where the treasuries reserve of DAI is utilized. The purpose of the improvement is to mitigate inefficient single-direction price movement and instil confidence amongst investors.

One common inefficiency in crypto is the irrational exuberance that investors exhibit during price discoveries, allowing for markets to continue beyond rational highs and lows, and forcing massive overcorrections to occur. This causes the cushions (slinkies) of RBS to be employed: should price movements continue in such animated ways the protocol offers liquidity to halt the market and offer reasonable and attractive growth. This is not to say the upper and lower bounds limit growth- the range adjusts to the reality of the market given a sufficient passage of time- but they have been put in place to incur stable growth. This system is illustrated in the graph below. You may notice the red and green zones extend and are titled “cushion zone”; this is to demonstrate that these cushions serve to reduce the chance of range walls breaking. They act as “air-bags” for the protocol, mitigating the impact to the passenger during a collision- they reduce velocity prior to the full impact. As in, they reduce the speed at which major price movements occur.

Since its implementation RBS has reduced the standard deviation (risk) of OHM by 90%, as depicted in the chart below.

OHM has been hovering just over the lower price cushion, dipping into it over 50 days since the implementation of RBS. This is shown in the image below, wherein an RBS bond teller (an automatic operation) conducts a transaction whenever the cushion is breached.

In Olympus DAO’s Q4 report they also denote the tokens tendency to lay just above the lower cushion. At the end of Q4 the target price (centre of the road) was $10.41 and the OHM price was $9.59, just below the lower cushion of $9.63.

While the present lack of four-figure APY’s has dissuaded many investors from the project, its underlying purpose remains intriguing. Improvements such as the Range-Bound Stabilizer have caused Olympus to make immense strides in becoming a truly decentralized monetary authority. With central banks in constant uproar and fear over impending reductions to purchasing power, could an autonomously conducted monetary system seem viable?

The views expressed in this article are the author’s own, and may not reflect the opinions of The St Andrews Economist.

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