Right now I can purchase a three-month U.S. Treasury bill for $99.98, wait three months, and receive $100 in return — a profit of approximately $0.02 for the privilege of helping to finance the operations of the U.S. government.

But what if instead of paying $99.98, I would rather pay $5,000 for the exact same bond, and still receive only the same $100 back three months later?

OlympusDAO solves this.

OlympusDAO calls itself “a decentralized reserve currency protocol,” but you can think of it as a sort of crypto central bank and treasury rolled into one. It issues currency — OHM tokens — just as the U.S. Treasury issues dollars. And just as the U.S. dollar is backed by the full faith and credit of the United States government, OHM is backed by its pseudonymous founder, a suspected teenager who calls himself “Zeus.”1

The Olympus project has gotten a lot of attention lately, not all of it positive. Bloomberg’s Money Stuff columnist Matt Levine describes it as “crypto Ponzi economics,” and his colleague Joe Weisenthal is no more enthusiastic:

It was also cited last week under the subheading “Some in the Crypto Industry have Warned that Olympus DAO may be a Ponzi Scheme” by a witness before the Senate banking committee, which is almost never a sentence you want to hear about your project. Even the first line in a much-discussed and otherwise laudatory CoinDesk piece on Olympus from early December began: “Yes, it’s a Ponzi scheme. But who cares? So are the dollars in your pocket.” (Equating fiat currency to a scam is a common theme in the crypto world.)

And yet Olympus, whose self-reported “market cap”2 exceeds $3 billion, has its fans — and even converts. Nat Eliason, whose “DeFi Fridays” newsletter series is essential reading for anyone trying to understand the basic mechanics of the crypto ecosystem, penned a mea culpa in October titled “I Was Wrong About Olympus:”

It’s hard to admit when you’re wrong. But I was very wrong about Olympus. 

When a crypto project has a cult-like following and super high APRs, I usually take that as a sign it’s some kind of scam…

But I was wrong. After months of writing it off, I finally dug into what was going on, and god damn it is a brilliant product. It might be one of the most important DeFi protocols ever built.

And Andrew Thurman, who wrote that CoinDesk piece, concludes:

But my heart is with the frogs. [Olympus’] money isn’t very different from the shoddy, debasing stuff the state forces into our bank accounts (and it’s certainly not dumber).

The problem Olympus solves, according to its announcement post, is “that we still do not have an independently valued digital currency.” It describes the “perfect currency” as one that “holds the same purchasing power today as in 50 years.”

“In the long term,” its web site states, “we believe this system can be used to optimize for stability and consistency so that OHM can function as a global unit-of-account and medium-of-exchange currency.”

This is a lofty, dare-I-say Olympian goal. But what’s actually gotten crypto folks exercised about the promise of OlympusDAO is specifically its innovative approach to maintaining liquidity within the decentralized finance (DeFi) ecosystem. To understand how Olympus is new and different, you first have to dig into how liquidity generally works (or doesn’t) in DeFi today.

Say I’ve just generated a new cryptocurrency, JayCoin, and minted one million tokens of it. Following in the footsteps of previous cryptocurrency projects, I “airdrop”3 — or gift — a bunch of them to friends, family, and influencers in the hopes of incentivizing them to drum up publicity and convince other people to buy some, thereby driving up the price and making themselves a neat little profit.

But how can anyone actually buy, sell, and trade my new JayCoins for other cryptocurrencies? Well, before decentralized exchanges (DEXes) came along, this wouldn’t have been very easy:

Before DEXes, we would have had to email someone at a centralized exchange like Coinbase and ask them to list us. Then there’d probably be months of discussions, paperwork, debates, and we might not even get listed. It would heavily favor companies with huge bank accounts and money to burn. And it would have been slow.

Enter DEXes like Uniswap and SushiSwap. What’s new about these entities is that they’re fully decentralized and noncustodial. Unlike Coinbase, they never hold onto your token balance on your behalf, so you’re always in control of your private keys. You don’t need permission to list your new cryptocurrencies on them. And they also don’t use centralized order books to line up large institutional “market-making” buyers and sellers to settle on a market-clearing price.

So how do DEXes come up with a market-clearing price? They have an automated market maker (AMM), which utilizes a “constant product formula” to generate a currency exchange rate. At its most basic implementation, a constant product formula simply mandates that x*y=k (a constant).

x and y are references to a pair of tokens in a “liquidity pool,” or a currency trading pair. A real-world equivalent might be something like British pounds and U.S. dollars (GBP/USD). In a DEX, however, anyone can create a new liquidity pool from scratch by depositing pairs of tokens.

For example, if I wanted to allow the public to trade JayCoin against ether, I might deposit 1,000 JayCoin and 10 ether into a liquidity pool. 1,000 * 10 = 10,000, which is the “constant product.” Anyone who wants to buy JayCoin must deposit ether into the liquidity pool and withdraw the corresponding amount of JayCoin such that the product of the two tokens — 10,000 — remains constant. (Hence “constant product formula.”)

So if someone wanted to buy 700 JayCoin, thereby leaving 300 JayCoin remaining in the liquidity pool, they would need to deposit about 23.3 ether in exchange, such that the liquidity pool would now consist of 300 JayCoin and 33.3 ether in total, for an unchanged constant product of 10,000. This comes out to an approximate ETH/JayCoin exchange rate of 700 / 23.3 = 30.

One of the key differences from centralized exchanges is that the liquidity, or currency pair, in DEX liquidity pools can be provided by regular crypto users, not just large, institutional market-makers. In order to incentivize those users to lock up, or “stake,” their cryptocurrencies for this purpose and thereby increase liquidity in the crypto ecosystem, the DEX protocol automatically gives these users a cut — usually 0.3% or less — of the value of all trades occurring in that currency pair (proportionate to their share of the total liquidity pool). They do this by issuing liquidity provider (LP) tokens that represent the liquidity provider’s share of profits from trading on the DEX. Additionally, token issuers themselves often incentivize liquidity providers as well, by rewarding them with additional tokens.

This is a genuine innovation. But it has a major vulnerability: the only thing liquidity providers care about is yield, the rate at which their staked tokens earn additional revenue. If and when another opportunity arises to earn higher yield, they’ll redeem their LP tokens for the underlying currency pair and decamp immediately to another exchange or protocol, leaving the original liquidity pool less…liquid.

The net effect of this is that, for any given token such as JayCoin, the amount of liquidity — and thus the ability of users to buy and sell the token easily — is highly fickle and unpredictable. Imagine if tomorrow you tried to exchange your dollars for euros but there were no one around to make you an offer. This is similar to the position many tokens find themselves in today: the market isn’t “liquid” enough for buyers and sellers to easily enter and exit at will.

This problem is exacerbated by the absurd levels of volatility in the crypto ecosystem: since LP tokens are effectively claims on an underlying currency pair, their “profits” are relative to those currencies. That is, if I provide liquidity for an ETH/SHIB currency pair and my LP tokens earn a 10% profit, I may still end up losing real-world money if ETH and SHIB themselves have depreciated against the U.S. dollar in that time.

Olympus believes it’s solved these problems by owning its own liquidity. Before we get into how it works, though…

A brief digression

Olympus claims both that A) “1 OHM is backed by 1 USD” and B) “each OHM is backed by 1 DAI.” In reality, however, Olympus’ “treasury” contains DAI, not U.S. dollars. DAI is a crypto “stablecoin” theoretically backed by U.S. dollars such that 1 DAI = $1, so Olympus is effectively claiming that each OHM token will always be worth a minimum of $1, because every new OHM it mints will have 1 or more DAI corresponding to it in the Olympus treasury.

It is tempting to condense all of the above into a simpler sentence: “1 OHM token is backed by $1.” But that is not strictly true. DAI is itself comprised of a lot of ether and other cryptocurrencies which, in combination, attempt to maintain approximately $1 of backing per DAI token. DAI’s whitepaper calls itself (emphasis mine) “a decentralized, unbiased, collateral-backed cryptocurrency soft-pegged to the US Dollar.”

This complex reality is widely transformed into the less accurate shorthand claim that 1 DAI is equivalent to $1. And that settled conventional wisdom is largely the result of DAI’s parent organization, MakerDAO, repeating it in prominent places like its home page:

And its Twitter feed:

But the reliability of that principle is extremely doubtful in the case of a significant crypto downturn.

It is so doubtful, in fact, that MakerDAO contradicts itself in its own public-facing documents as to DAI’s interchangeability with U.S. dollars:

On the Maker Protocol page: “In extreme events, 1 Dai can be redeemed for $1 worth of collateral through a process known as Emergency Shutdown.”

On the Emergency Shutdown page: “It is, therefore, possible that Dai holders will receive less or more than 1 USD worth of Collateral for 1 Dai.”

🤷‍♂️

DAI’s effective equivalence with U.S. dollars is its most important feature — its raison d’être. So the fact that its parent organization isn’t sure if it’s strictly true is…concerning.4 If you visited your bank’s web site and discovered one page claiming you can withdraw your balance at any time and another page saying meh, actually, you might not be able to, this is presumably how fast you’d sprint to your closest local branch to demand all of your cash immediately:

And remember that DAI is the principal currency backing Olympus’ OHM token.

OK, back to our regularly scheduled programming

Right now 1 OHM token is trading at approximately $450. Since Olympus only needs 1 DAI’s worth of assets in its treasury for every new OHM it issues, it has spent most of its existence minting OHM tokens left and right and selling them into the market, currently at close to 450x its underlying “value.” This increases its treasury’s over-collateralization — or “runway,” as Olympus calls it.

OHM is so expensive right now that it’s not just selling at about