How to Profit from the New Liquidity Bootstrapping Pools (LBP) on Osmosis

Osmosis is the implementation of Balancer protocols within the Cosmos network. The mathematics of Balancer is far more flexible and powerful than the standard fixed-product uniswap-style binary swap pool - once the implementations become more widespread, they will make uniswap look like a horse and cart.

The first innovation that comes as standard when creating a pool on Osmosis is the ability to add multiple tokens. The second innovation is the Liquidity Bootstrapping Pool (LBP) - this is my focus today.

You can read about the basics of LBP in the Osmosis docs, with more details in the Balancer docs and their dev docs. You can dig as deeply into the mathematics as you please.

I do not wish to repeat what can be read in those documents, so I shall focus on how an LBP works from the point of view of the user. There are 3 categories of users here: the token creators; token buyers; and liquidity providers.

Launching a New Token

For a team launching a new token, these Bootstrapping pools are an excellent way to lower initial costs and to quickly establish a market price for their token. Let's work with some numerical examples to clarify the issue.

Imagine you have your new token (TOKEN) and you think it should be priced at $0.10. You think about creating a swap pool with ATOM which, let's assume, is priced at $30. Now a 50%/50% pool means that the values of the two coin pools are equal. So if you wish to add 1 million new TOKEN, thus adding $100,000 liquidity on that side of the swap, you need to match it with the same value in ATOM. That's expensive, when your aim is to actually raise money!

You also have no real idea of whether you have over-priced or even under-priced your new token. You could instead have your pool with weightings of 90%/10%. That means your $100k worth of TOKEN need only be matched by about $11k of ATOM - that's an easier cost to swallow.

However, this can lead to liquidity issues further down the road. Looks great at the start when investors are swapping into your TOKEN, but may lead to large slippage unless the liquidity remains high.

What the Liquidity Bootstrapping Pool does is automatically change the token weights so that you can start with the 2nd scenario and then morph into the 1st one! As the pool morphs from a 90/10 start into a 50/50 end, tokens are being swapped behind the scenes. If nobody added any extra liquidity and nobody ever swapped (sad, I know) then the pool would end up with equal values on both sides - note this does not mean equal tokens.

Live Examples

A visual may help. Copperlaunch has the same Balancer LBP; here is one about to start, PATH LBP, and here is one in the middle of the auction, HDAO LBP. These links are live and may well look different in the future.

Notice firstly the theoretical price change during the auction for PATH as it goes from 93/7 to 50/50 weights. Although not absolutely accurate, one can make a rough estimate that 7/93=0.075 and multiply this by the starting price of $0.4 to get the ending price of about $0.03.

Note how the HDAO auction is tracking the theoretical curve downwards. There have been quite a few wobbles, showing large buys and sales. These swaps will affect the weight-balancing algorithm, but it will always calculate the smooth transition towards the final destination of a 50-50 pool (in this case) from whatever is the current price and token distribution.

In the extreme case of a popular auction, look at this recent FLEX LBP. The initial price was $2, but with only 3 hours left it is still up at about $1.40 and predicted to close at about $1.36.

I have used the word auction because, from the point of view of the issuing team and prospective investors these LBPs work like a Dutch or reverse auction. The buyer knows that, in theory, the price will drop, so they could wait until near the end but, as can be seen with FLEX, if there is a lot of interest that price can even rise above the starting price.

So, for token investors and the admin team, these LBPs use a swap pool mechanism with a smoothly changing weight so as to behave like a price-discovery mechanism so that both sides of the trade are satisfied.

Liquidity Providers

So what about the liquidity providers? An LBP is still a swap pool and one can add liquidity. The first LBP on Osmosis is the ATOM/CMDX pool. Sadly, it doesn't as yet have the same visuals as Copperlaunch (hence why I gave those examples) but one can see the same data.

With no further incentives, the LPer is really playing on the popularity of the LBP, both in terms of the final price of the new token and the swap fees accumulated. In the case of CMDX, there was a huge surge of interest within the first 12 hours, with liquidity going to over $26m; this has since come down, as has the CMDX token price. The numbers have been impacted by the sudden drop in BTC, so a lesson that nothing in crypto can be isolated from external factors to any given contract.

Summary

In summing up, LBPs are a cost-effective way to launch new tokens using a variable weight swap pool as a price discovery mechanism. For liquidity providers, it can be a way to make some profits from both swap fees and price movements. Understanding how the token price changes due both to swaps and the underlying rebalancing algorithm is key for both investors and liquidity providers.

At the end of the Liquidity Bootstrapping Pool period that pool reverts to standard swap pool protocols. It could revert to something more interesting but that's for the future.