Umami Finance is a decentralized finance (DeFi) protocol offering yield products on Arbitrum, Ethereum’s leading layer 2 scaling chain. By depositing into Umami’s vaults, users can earn a sustainable, risk-hedged yield on core crypto assets, including USDC, WBTC, ETH, LINK and UNI. Umami’s focus and commitment to full regulatory compliance with a transparent team is one of the many things that sets them apart from other crypto projects.
Umami originated as a fork of the well-known OlympusDAO codebase. Like other emerging OHM forks, the protocol boasted significant inflationary APRs for staking its native token. During this period, Umami bootstrapped its liquidity and acquired assets for its treasury. By late January 2022, its treasury had a value of $5M.
Although ultra-inflationary DAOs initially attracted investors, the model was not sustainable. As OHM fork projects plummeted in value, Umami made a pivotal switch. Through a DAO proposal, Umami’s community voted to continue forging onwards, only now with a slight twist.
The team opted for a complete restructure of its tokenomics. Umami abandoned its inflationary rebase emissions and began rewarding holders with dividends from treasury yields. The change catalyzed the #RealYield movement in DeFi, which continues to be the heart of Umami’s strategy today.
Umami’s overarching mission is to bridge the gap between decentralized and traditional finance, broadening DeFi’s audience and use cases beyond the isolated crypto ecosystem. In doing so, the team upholds its core values of integrity, advocacy, principled pragmatism, and tenacity to create sustainable yield products for the institutional market.
Instilling trust between DeFi protocols and institutions continues to be an ever-growing challenge. Umami will leverage ‘Umami Advisors,’ its U.S.-regulated crypto custodian, to bridge the gap. Umami's in-house digital asset custodian will utilize the creation of a private fund to manage digital assets for institutional clients. This fund will be a feeder into Umami’s on-chain vaults, but also guides funds into various ‘safe’ yield strategies across DeFi. Broadening its reach pushes Umami’s brand image beyond a crypto-twitter coin with a closed community. Umami intends to tap into this institutional audience to eventually achieve $1B+ in assets under management while operating under the standard 2-and-20 business model (2% management fee, 20% performance fee), therefore driving substantial value to UMAMI tokenholders.
Umami plans to pioneer institutional DeFi adoption with its expanding arsenal of products to generate passive income through sustainable, risk-hedged vaults.
The protocol's vaults enable users to source competitive yields on core crypto assets. Umami's vaults are trustless, non-custodial smart contracts built on Arbitrum. Umami does not custody or control depositors’ assets. Instead, users reserve the right to queue deposits or withdrawals anytime and track vault activity and performance by monitoring on-chain activity. In the interest of full transparency, users can view all contract addresses here.
Umami was audited by Zokyo for quality, security, and correctness. The audit deemed its smart contract codebase as Low Risk, citing no critical issues found. Umami’s vaults are carefully constructed with backtesting data models by Balance.
In addition, Umami holds its treasury assets in two 3/6 multisig Gnosis Safes. All multisig holders are doxed and have formal contracts with Umami Labs to only use multisig as instructed by Umami Labs in the interest of the DAO.
Protocol revenues are derived from a standard 2-and-20 fee structure built into its vaults’ smart contracts. Additionally, Umami uses its wholly owned treasury liquidity to generate revenue and issues monthly treasury update reports on Medium to ensure transparency and accountability.
Umami splits the generated revenue, paying out 50% to token stakers, with the remaining 50% going to the Umami treasury to fund operations.
Umami offers token holders two convenient options to earn and auto-compound a share of protocol revenues. The first, Marinate (mUMAMI), rewards stakers with regular payments in WETH taken from yields generated by Umami’s vault fees and protocol-owned treasury. The second, Compound (cmUMAMI), automatically reinvests these WETH rewards to accumulate more UMAMI.
Following rigorous backtesting, Umami’s initial USDC vault went live on July 27, 2022. The v1 vault aimed to generate close to delta-neutral yield by providing hedged liquidity to GMX’s leveraged perpetual exchange.
Users deposited USDC on the Umami platform and received a fungible receipt token. The majority of vault deposits were used to mint GLP on the GMX platform, with a small portion used to simultaneously hedge the GLP position with derivatives provided by Mycelium (formerly known as Tracer).
Despite earning substantial ETH yield from its GLP position, the USDC vault generated a net loss during its operating period. Furthering its commitment to transparency, trust, and accountability, the team decided to pause the vault and reimburse depositors for the losses, accounting for less than 2% of net asset value.
The underperformance of Umami’s initial USDC vault was primarily attributed to shifts in skew on its hedging positions. Although the target leverage on Umami’s short positions was 3x, Mycelium’s perpetual pools exhibit a shifting effective leverage on both the long and short side depending on current long/short positioning. In other words, with more longs than shorts, effective leverage for gains on the longs would reduce to a value below 3x (while still maintaining leverage for losses on longs of 3x); the opposite holds true with more shorts than longs - effective leverage for gains on the shorts would reduce to a value below 3x (while still maintaining leverage for losses on shorts of 3x). This incentivizes participants to keep the pool in approximate balance of shorts and longs, similar to dynamic funding rates on futures exchanges.
Mycelium’s perpetual pools also exhibit an 8-hour simple moving average of the underlying’s price feed to reduce the impact of volatility decay. Umami knew Mycelium’s 8-hour SMA perpetual pools would demand careful management in a delta-hedged strategy. Although the team outlined the risks in its documentation, the actual cost of hedging was higher than anticipated in its models. In addition, a swift change in the effective leverage on Mycelium’s perpetual pools initiated Umami’s failsafe keeper bot. Although triggered, the bot was not equipped to handle the sharp GLP price drop and failed to execute for six hours of the rebalancing cycle. As a result, the vault was paused, and depositors were reimbursed for net losses at the treasury’s own expense to restore the value of 1 glpUSDC to its original value of 1 USDC.
Developments are currently underway for Umami’s v2 vault strategy. The imminent launch of a new and improved suite of trustless DeFi vaults will innovatively address its prior shortcomings to better serve delta-minimized yields.
The team is building isolated vaults for each asset in the GLP liquidity pool instead of its prior use of a singular USDC vault. The upcoming product suite will have five vaults that pay yield on USDC, WBTC, ETH, LINK and UNI. The vaults will independently track its underlying asset at a 1:1 ratio (e.g., 1 share of the ETH vault will track 1:1 with the price movement of ETH).
Although numerous options are available to ETH and WBTC holders to earn yield throughout DeFi, there is currently lack of opportunities for LINK and UNI holders to benefit from the token other than governance. Thus, there likely will be some demand from holders of these assets to earn yield through Umami vaults.
Umami’s vaults will employ a capital-efficient hedging strategy that passes GLP's yield onto depositors while hedging out unwanted market delta. Umami’s documentation states:
A crucial element of Umami’s hedging strategy is internal netting. Each of its Vaults acts as a hedging counterparty to the others. Instead of costly external hedges, Umami’s Vaults swap delta among themselves while keeping the vast majority of their TVL deployed to GLP to generate yield. When required, Umami’s Vaults take external long or short hedging positions on GMX or similar exchanges. Umami’s modelling shows that GMX’s leveraged perpetuals are an exceedingly cost-effective tool for hedging out unwanted delta for its Vaults.
To ensure the robustness of the v2 vaults, the Umami team built a detailed simulation of the finalized vault strategy and backtested it against approximately eight months of real-world market data. The team pulled all available GMX and GLP data directly from the blockchain — with one-second interval time granularity. For a more conservative assessment of performance, the team decided to omit data from May and June 2022 from its final annualized return figures where extreme crypto market drawdowns contributed to elevated trader liquidations on GMX.
During the backtesting period, the vaults were able to generate returns at an annualized rate of 26.67% while keeping the maximum delta exposure between rebalances at a relatively low level of approximately -1.29%, with a standard deviation of 2.10%. Additionally, the strategy exhibited a worst-case drawdown of -4.55%. On average, the internal netting strategy reduced hedging costs by 65%-95% (as compared to hedging directly on GMX), depending on the distribution of vault TVL and GLP composition. These results show that the strategies used in the GLP vaults were effective in generating high returns while managing risk, as indicated by the low delta exposure and drawdown.
Going further, the Umami team is planning future improvements to the vaults including optimizing strategy hyperparameters for increased performance, testing the effects of hedging GLP's counterparty exposure, ensuring protection in edge cases, developing solutions for adapting to dynamic open interest caps on GMX, and exploring the impacts of different fee structures.
Umami has deployed a managed strategy through Kromatika Finance for maintaining DEX trading liquidity for UMAMI on Uniswap v3, using its protocol-owned liquidity from the Umami treasury. Uniswap v3 introduced concentrated liquidity providing (LP), allowing users to select a price range to provide liquidity. Umami’s Uni v3 LPs provide deeper trading liquidity and capital efficiency for buyers and sellers of the UMAMI token. It offers multiple levers for value accrual, including increasing Umami’s treasury value and generating incremental revenue, therefore benefiting long-term UMAMI holders. See below “Kromatika Finance” in the partnerships section for additional information.
The Umami project is comprised of several distinct entities:
Umami DAO is a decentralized autonomous organization (DAO) governed by its community of UMAMI token holders. Major protocol decisions are voted on the governance platform Snapshot. The DAO controls the protocol, including its smart contracts and custody of its assets.
Umami Labs LLC
The protocol's daily operations are sourced to Umami Labs LLC, a U.S.-based end-to-end professional services company. Umami Labs enables DAOs to refine their strategy, streamline their operations, and rapidly scale their user base. It does not control Umami DAO or have custody over its on-chain assets or smart contracts.
Umami DAO Foundation
Umami DAO is represented off-chain by Umami DAO Foundation, a Cayman Islands-based legal entity. Incorporating as a "DAO Foundation" gives the DAO real-world legal representation, including the ability to enter into contracts. The Foundation has a contract with Umami Labs LLC for professional services including engineering, product strategy and business development.
Soon Umami Labs will be creating a Registered Investment Advisor (RIA) and Money Services Business (MSB) to on-ramp fiat to Arbitrum and deposit into Umami's vaults on behalf of its institutional clients, all in compliance with U.S. regulations.
Umami’s team has grown considerably over the past 12 months. Rare in the crypto ecosystem, most of the team members’ public identities are known, lending further credibility and accountability to the project.
The Umami team has remained active throughout the 2022 bear market, pushing for continued innovation as they drive towards building a DeFi powerhouse. The team happily upholds its commitment to full transparency with regular treasury updates and community newsletters. In a recent announcement, Umami addressed the FTX fallout, reassuring that its treasury has/had zero exposure to FTX, FTX US, and Alameda Research. Additionally, all its on-chain assets are viewable at any time, and as it stands, the Umami treasury has not held any assets on any CEX or with any CeFi entity.
Alongside its global team of blockchain engineers and DeFi strategists, the protocol seeks strategic partnerships to provide additional value to the platform and grow TVL.
Umami's expanding partnerships and network of resources include:
Umami operates on the Arbitrum network, a layer 2 optimistic rollup designed to utilize the strong security guarantees of Ethereum while speeding up transaction times and cutting fees. Arbitrum was launched in May 2021 and has become Ethereum’s most dominant layer 2 network, holding about $1 billion in total value locked as of December 2022, impressively generated completely organically without any token incentives.
GMX is a decentralized perpetual and spot exchange that permits trading assets on-chain with up to 50x leverage. It works through a shared liquidity pool (GLP). The multi-asset pool supports trading, allowing users to take long or short positions and conveniently perform swaps on both Arbitrum and Avalanche. As discussed above, the GLP token provides the foundation for Umami’s initial core vaults. Umami will also utilize GMX for hedging activities, to minimize delta exposure. Additionally, Umami's treasury holds GLP.
Vendor Finance provides permissionless, non-liquidatable, fixed-rate, and fixed-term loan pools customized by lenders. The platform allows users to borrow against their cmUMAMI to leverage up their UMAMI position and further compound yield.
Kromatika Finance is a decentralized exchange (DEX) powered by Uniswap and Chainlink. The DEX functions as an aggregator, comparing swap prices across various platforms while also providing the ability to execute limit orders. Kromatika’s limit order feature, FELO (Fees Earning Limit Orders), provides the following benefits: no front-running bots, automated limit orders, no price slippage, no swap fees and traders earn fees on their filled limit orders. The Umami team uses Kromatika to actively manage its reserve of Umami tokens. By providing liquidity on Uniswap in specific ranges, not only do they deepen liquidity for the UMAMI token, but the treasury accrues capital when the token is trading at the high end of its anticipated range, while simultaneously returning UMAMI to the treasury and reducing circulating supply when it’s trading at the lower end of its trading range. Adopting this LP strategy helps increase the treasury's profitability and improve the efficiency of its protocol-owned liquidity.
Camelot is a decentralized exchange built to support the Arbitrum ecosystem. Umami plans to migrate their cmUMAMI/UMAMI liquidity pair to Camelot, in return for receiving an ownership allocation in the Camelot protocol and incentives for an UMAMI/WETH pair.
Umami has been approved to open a Circle Account. This reduces the friction in connecting Umami with institutional capital since they’re now able to bridge from traditional to digital currency with a best-in-class single portal for payments, treasury and custody. Umami is also working with the Circle team to explore other potential opportunities for collaboration.
The Socket API enables users to seamlessly bridge tokens into Umami products from most major chains in a single transaction.
The Umami and Banxa partnership allows users to instantly on-ramp currencies from fiat accounts directly to the Arbitrum network.
Umami launched as an OlympusDAO (OHM) fork, affording the protocol to own its liquidity and build a treasury. Given this model, the project has evaded the need for private funding from venture capital firms.
Umami's philosophy for sustainable yield in DeFi catalyzed the #RealYield movement. The mantra is embodied in the protocol's straightforward, no nonsense tokenomics and strategy:
The UMAMI token has a maximum supply of 1,000,000. If excluding “dead” tokens permanently locked in defunct contracts, its adjusted max supply reduces to 895,865 UMAMI.
The protocol still maintains a portion of non-circulating UMAMI tokens in its reserve, which could be sold in future fundraises. The team has received multiple inbounds from interested Venture Capital firms. In 2023, Umami may consider potentially selling some of the ~100,000 dormant UMAMI in its treasury for a modest OTC capital raise. The team has said that OTC investors would not receive any special governance rights beyond those of existing holders. Moreover, any OTC raise would only take place after its v2 vault launch at a valuation considerably higher than UMAMI's current price. Proceeds would be used to extend runway to 24 months and potentially hire additional engineers and financial analysts to support its product development team.
The protocol has allocated 20% of its total token supply to support its current and future team members. Tokens not in circulation are held within the Umami treasury.
Token holders can stake UMAMI to receive a share of the protocol revenues, denominated in WETH. Umami offers two staking options, Marinate and Compound. Both require users to keep UMAMI staked until the end of its monthly epoch, and deposits can be withdrawn on the 1st of each month. Users can further maximize earnings with Umami’s autocompounder staking option, Compound.
To date, Umami’s revenues are derived from Umami’s wholly-owned, productive treasury. The value of treasury assets, excluding native UMAMI tokens was $4.7M as of November 30, 2022. This represents a risk-free value of $5.20 per token, assuming a max supply (excluding “dead tokens”) of 896k total tokens.
As of November 30, 2022 gross treasury yields comprised of staked GLP, Uniswap v3 LP positions, esGMX, hedged short positions, stablecoins and other small positions in volatile tokens. Umami started reporting its treasury metrics via monthly treasury reports in April 2022. Since then, the value of treasury assets declined 16% compared to 52% and 54% declines in Ethereum and Bitcoin, respectively.
With its prudent treasury management strategy, Umami has consistently generated between $78k and $200k monthly gross yields, implying $939k-$2.4M on an annual run rate basis, since the broader crypto market drawdown in June. This has yielded APRs in the mid-to-high 20% range. In June, Umami generated $78k of gross yield and experienced a 22% drawdown in the value of its treasury. Following the June drawdown, Umami adjusted its hedging strategy to hedge 75% of its notional treasury value via short perpetual positions on GMX. Prior to this change, Umami was hedging 50% of the treasury value.
Monthly expenses have ranged between $175k and $256k. There have been several one-time expenditures over the last several months including product and technology audits, fees related to Umami Labs’ legal incorporation, severance related to a reduction in headcount in June and the one-time reimbursement for depositors in the initial USDC vault in August. Umami has recently hired a few new team members to support the development and launch of the v2 vaults in addition to supporting the future roadmap. Monthly run rate expenses are expected to be $250k on a go-forward basis.
With a robust treasury, Umami is well positioned to weather an extended “crypto winter”. As of November 30, 2022, Umami had an implied cash runway of 16 months. This assumes no revenue, monthly run rate operating expenses of $250k, or $3M annually, and starting treasury balance of $4.7M.
Umami generates revenues and cash flow from its protocol-owned productive treasury today. With the imminent v2 vault products, Umami will generate revenue and cash flows through annual management and performance fees of 2% and 20%, respectively.
Umami expects a maximum capacity of at least $200M of TVL for its v2 vaults. The section below analyzes a range of TVL, APR and token price scenarios to provide a valuation framework for Umami.
Using an illustrative example of $40M TVL and an aggregate vault APR of 22.5%, Umami would generate $2.6M of gross annual fees, with a 50% split, or $1.3M, between Umami’s treasury and Umami stakers. As shown in the example below, this implies a 8.6x price / sales multiple and 8.7% staking APR at today’s UMAMI price (December 2022) of $25.
The exhibit below sensitizes the $40M of TVL and $25 token price used in the previous example. As TVL increases, the price / sales multiple declines linearly assuming a constant token price. As the previous example illustrates, a token price of $25 and $40M of TVL implies 8.6x price / sales. At $60M in TVL, price would need to increase to $37 to maintain a constant 8.6x multiple. Alternatively, if you assume a $25 token price and the vaults blended APR increases from 22.5% to 27.5%, the price / sales multiple declines from 8.6x to 7.5x.
The $25 token price / $40M TVL case implies a 8.7% APR for UMAMI stakers, assuming 80% of tokens are staked. If TVL increases to $80M, but the token price only increases to $45, the staked UMAMI APR increases to 9.6%. Alternatively, if you assume a $25 token price and that the vault APR increases from 22.5% to 27.5%, the staked APR increases from 8.7% to 10.0%.
The inverse of the table above is to imply the token price based on a range of normalized stake APRs and TVL. As revenues to UMAMI stakers increase, APR increases which should lead to increased buy demand for the token. As the token price increases, the staked APR declines. In the exhibit below, a range of UMAMI staking APRs and TVLs are sensitized. Looking at normalized staking APRs of 7.5% and 12.5%, $100M of TVL implies an UMAMI token price of $72.12 and $43.27, respectively. If TVL increases to $160M, the implied token prices are $115.40 and $69.24 assuming the same APRs, respectively.
Umami directly competes with vault providers who deploy managed, delta-neutral strategies. Competition is fierce, particularly on Arbitrum with multiple protocols building atop GMX using GLP as a base yield layer.
Despite the below-mentioned competitors who exhibit similarities to Umami’s product designs, Umami aspires to differentiate itself through its strategy of compliant institutional onramping. Although this approach presents an extra set of challenges, especially in regards to legal and regulatory considerations, it opens the door to a much larger addressable market and therefore potential for much higher implied valuation.
Selected Umami competitors with managed vault strategies include:
Jones Dao builds vaults with managed option strategies. They recently announced new GLP and USDC vaults. These two vaults will work in tandem. The GLP vault will borrow from the USDC vault and loop GLP. jGLP achieves high leverage by borrowing undercollateralized from jUSDC which amplifies the GLP yield, managing it safely with algorithmic liquidation protection.
Rage Trade is an omnichain ETH perpetuals platform. They use “recycled liquidity”, LP tokens they recycle and use for liquidity on their perpetuals exchange. They are launching delta-neutral risk-on and risk-off GLP vaults. The risk-on vault earns yield on GLP while shorting the ETH and BTC exposure in the liquidity pool. It takes a flash loan from Balancer in ETH and BTC and sells for USDC to establish a short position. It then loops the USDC and borrows additional ETH and BTC to increase the size of the short position as needed. The risk-off vault provides the collateral for the AAVE borrows and earns yield from AAVE in addition to a portion of the GLP yield.
Ribbon Finance offers a variety of structured options and borrow/lend strategies. For example, they recently launched an undercollateralized institutional lending protocol and developed a USDC vault strategy built on top of their lending protocol. The USDC vault provides market makers with undercollateralized USDC loans. A portion of the yield generated is kept in the vault as the base yield; the remaining yield is used to purchase weekly at the money knock-out barrier options.
GMD Protocol is a yield optimizing and aggregating platform built atop Arbitrum protocols. Their first products are single-sided, delta neutral ETH, USDC and BTC staking pools built on top of GLP.
Friktion offers a variety of option vault strategies. Their vaults utilize covered calls, cash-secured puts, short power perpetual and delta neutral. The delta neutral strategy uses a delta hedging strategy on Mango Perpetual exchange.
Smart Contract Risk: Smart contracts carry a level of risk surrounding complex business, financial, and legal arrangements. To mitigate the associated risk, Umami is both audited and insured. However, exploits on other protocols could potentially impact the protocol.
Regulatory Risk: Umami faces an external element of risk in the form of regulation. Traditional funds are subject to complex, arduous regulatory practices and know-your-customer (KYC) laws. Since Umami is launching an innovative on-chain, managed vault structure, it is conceivable that regulatory bodies may require Umami’s team and/or investors to comply with some or all regulations imposed on traditional funds. In addition, the UMAMI token could encounter further inspection if constituted as a security. While future implications from regulations remain unknown, Umami’s legal strategy and multi-entity structures may aid in triumph.
Vault Risks: Umami’s v1 USDC vault faced notable shortcomings in performance, including:
Execution Risk: The Umami team could face scrutiny if it fails to launch its suite of DeFi vaults, and/or its vaults don’t generate sustainable yields that are as high as competitors’ yield-bearing vault products.
Vault Performance Inconsistent with Backtests: Although the Umami team performs rigorous backtesting of its vault strategies prior to launch, backtesting has its challenges due to limited datasets, potential over-fitting, over-optimization, and accurately reflecting trading costs. Seemingly innocent discrepancies or nearly invisible issues in backtests can often get amplified in a live-trading environment. For example, the Umami team may find that a thoroughly researched strategy with excellent backtest results could exhibit poor performance when deployed live with real capital.
Adoption: The success of Umami’s roadmap relies heavily on institutional investors adopting its products and advisory services. As with any early-stage project, widespread adoption poses a potential threat, and crypto is likely to be met with increased skepticism by outside audiences after the many notable 2022 blowups of industry titans including 3AC, Luna, FTX, and Genesis.
The lack of trusted pathways has hindered institutional investors from sourcing yield in DeFi. Marketplaces warrant a new layer in the blockchain ecosystem that connects institutional capital with DeFi protocols. Umami Finance is a hybrid Decentralized Finance (DeFi) protocol and digital asset custodian that synthesizes the best of both DeFi and CeFi.
The team’s transparent nature and commitment to regulatory compliance, combined with its well-designed legal structure of multiple entities, will hopefully attract non-crypto natives to earn DeFi yields.
Umami’s fundamentals are refreshingly straightforward and attractive: relatively low fully diluted market cap, no-nonsense tokenomics with little remaining token emissions, a simple yet sensible revenue model, and 50% fee distribution to UMAMI stakers.
While this report and accompanying valuation analyses focus primarily on Umami’s upcoming v2 vaults, it’s worth noting that Umami will very likely be launching additional vaults / product lines not yet announced. The Umami team has publicly stated they intend to launch an offering related to ETH staking, however at this point no details have been provided. Not only would new vaults bring incremental revenue and earnings streams to UMAMI stakers, but the addition of product lines in different verticals would likely usher in new narratives for the Umami brand, fostering multiples expansion and therefore increased token valuation.
In summary, Umami's expanding array of DeFi products and strategy vaults source sustainable yield from reliable on-chain revenue streams. The DeFi protocol bridges the gap among markets and paves the way for institutional adoption.
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