Deploy Contingency Liquidity for USDT Stability

Description

This proposal requests the allocation of 70,000 USDT and up to 140,000 USDC from the Osmosis community pool to establish a concentrated liquidity position on Osmosis to ensure liquidity exists to be arbitraged during abnormal ratios.

Problem

Stable tokens tend to depeg simultaneously in line with an increased or decreased demand for stable tokens overall. Therefore, when looking at available liquidity, we need to look at the pairing of these two assets rather than the peg of each vs their intended value.

While there are around 1.2 million dollars of liquidity in the USDC/USDT pool, this liquidity is heavily focused on the 1.001 - 0.999 range, which this pairing typically does occupy, to maximize the fee generation for liquidity providers.

When this pairing leaves this typical range, as it did recently, USDT on Osmosis can become far more volatile as the liquidity in use is then routed through multihop pairings. USDC has several non-stable pairings established as reserve liquidity, but USDT is almost entirely reliant on the USDC pairing to maintain its dollar peg on Osmosis.

With the USDT liquidity being concentrated in this pool, liquidity must be present in wider ranges, which are less profitable for the liquidity provider in normal circumstances but are valuable for the protocol to remain a functional trading venue.

Proposed Solution

Establish a protocol-owned liquidity range that covers 95% of highs and lows based on the previous year.

This is a liquidity range between 0.97 and 1.03 for the USDT/USDC pairing, as shown in orange below, compared to the yellow range, which is the typical range for liquidity provision.

This position would utilize the existing USDT and USDC holdings of the community pool:

67,918 USDT.kava to be added to the existing 1,333 Alloyed USDT, resulting in 69,251 USDT

67,385 USDC.axl will be swapped to USDC, along with another 73,000 USDC to ensure matching liquidity that uses all existing USDT.

This utilizes all USDT variants in the Osmosis Community Pool and allows a 2:1 ratio if the ratio rises to the highest liquidity point of 1.001 USDT/USDC during deployment.

Therefore, the resulting position size will range between 105k and 210k, depending on the ratio at the time of addition.

Any excess assets and the position will be returned to the community pool.

This liquidity would be placed in a higher spread factor, 0.05% pool compared to the standard 0.01% pool, to act as liquidity of last resort.

Rationale

Increased USDT liquidity reliability during volatility of peg

This liquidity ensures that USDT retains some depth against USDC in more situations, which can be arbitraged during the more excessive variation in the USDT/USDC ratio.

Increased Alloyed Usage

The deployment of existing USDT.kava assets to the main USDT alloy will increase the baseline depth of the Alloy USDT and allow greater movement through USDT variants. This also supports the uses of Alloyed assets on Osmosis by allocating risk associated with this mechanism to the community pool directly. In case of a corruption event, the community pool would be able to directly absorb the corrupted asset to make Alloyed USDT users whole from existing holdings.

Increased depth for USDT/USDC in normal range.

Traders experience lower slippage when swapping between USDT and USDC during the normal range. This is a minor benefit as the liquidity will be stretched over a wider position at a greater spread than most USDT/USDC liquidity on Osmosis.

Increased Revenue for Osmosis Community Pool

This deployment would earn spread fees on liquidity that is currently unutilized in the community pool. This is likely a very small revenue but is still a net gain compared to assets held individually in the community pool.

Risks

Community pool exposure to USDT increases

If USDT loses its peg permanently, the community pool has an increased exposure due to being slow-responding liquidity that agrees to purchase this under peg USDT for USDC.

Community pool exposure to USDC increases

If USDC loses its peg permanently, the community pool has an increased exposure due to being slow-responding liquidity that agrees to purchase this under peg USDC for USDT.

Community pool exposure to Alloyed USDT

There is an increased risk from holding the IBC-natively issued USDT.kava due to increased exposure to multiple sources of USDT within the Alloy. This is mitigated through both inter-chain and intra-alloy rate limits. If a security issue involves the USDT Alloy, the Community Pool should include this position’s USDT holding in any resolution proposal to make users whole.

Community Pool asset exposure within liquidity pools

While adding liquidity to pools adds an additional layer of risk compared to native asset deployment, the Osmosis Concentrated Liquidity pools have been live with no security events for over a year.

Use of Multisig for execution

This 4/6 multisig has previously been used to deploy liquidity in other proposals, acting as an intermediary to perform multi-stage or time-dependant transactions, such as adding liquidity to a pool with a ratio of assets that will vary before a five-day Osmosis governance proposal is completed.

Implementation

If approved, the funds will be allocated from the community pool to the Liquidity SubDAO, which will deploy the concentrated liquidity position and transfer the position, along with any remaining assets, back to the community pool.

Conclusion

Deploying baseline USDT liquidity addresses the need to stabilize trading activity and enhance the robustness of the USDT/USDC pairing on Osmosis outside of the most profitable liquidity ranges.

By leveraging the community pool to establish a protocol-owned liquidity position within a broader range, this proposal ensures the availability of liquidity during volatile periods while also reducing slippage for traders and providing minor revenue benefits to the community pool.

Forum Thread: https://forum.osmosis.zone/t/deploy-contingency-liquidity-for-usdt-stability/3297