Compounding, and the Mechanics of Staking
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“Understanding the power of compound interest and the difficulty of getting it is at the heart and soul of a lot of things.”
- Charlie Munger
You may have seen the staking APY’s on OHM and thought, “there is no way this is possible.” It’s a natural reaction, and it stems from the fact that most of DeFi misunderstands and mislabels APY.
APY, or Annual Percentage Yield, is a measurement of compound interest. This is different from APR, or Annual Percentage Return, which is a measurement of simple interest (this is what you usually get). So, how do they differ?
Imagine you have $1,000, and you have two opportunities: you can earn 2% per day in simple interest or 1.5% per day in compound interest. Your first thought might be, the 2% per day of course. Obviously I’ll earn more because the number is higher, right?
The answer is it depends. Over the course of a week, the simple interest will net 14% (0.02 * 7) while the compound interest will net 11% (1.015⁷-1). Over the course of a month, the simple interest will net 60% while the compound interest nets 56%. But over the course of a year, the simple interest will net 730% while the compound interest nets 22,814%. This is the power of compounding.
The Olympus staking system allows us to provide compounding returns automatically. We do this with sOHM, a secondary token that represents staked OHM. sOHM can always be exchanged 1:1 for OHM, but it rebases to reflect profits. This means we can compound; for example, every day of our first week we rebased ~0.45% per epoch. If you held 100 OHM, your first rebase of the week was 0.45 OHM and your last rebase of the week was 0.49 OHM. This is a 10% increase in yield! If we had simple interest, every epoch would be 0.45 OHM.
Almost everything you will find in DeFi uses APR, or simple interest, and not APY. It is a pervasive mislabeling that has created a lot of confusion as people learn about Olympus. Any yield that pays a consistent amount is simple interest. If you have to harvest it, it is simple interest. With OHM you get compound interest; we give an actual APY.
This is how we can offer tens of thousands of percent APY that is actually quite sustainable. On our current path, we need to take in ~$12m in assets over the course of the next year to sustain the current 67,000% APY (given the current 94% of supply remains staked. If that number goes down, APY goes up). We do not believe that this a particularly absurd premise. Bonds are now live and bringing new assets into the treasury. In a few weeks we will launch sales, which should rapidly increase our pace of asset growth. Together, we believe we can quickly lock in our next years worth of yield and far more.
This is, of course, not guaranteed in the least. But the ohmies are united, the 3,3 game is strong, and the system is working.
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