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Umami Finance: Finding Value in the Depths of Arbitrum
An overview and analysis into an exciting DeFi protocol that aims to leverage the growing Arbitrum ecosystem
When we first started writing this post, only a mere 2 weeks ago, things were looking down across the board for crypto. It seemed as if we were on the verge of a bear market. But alas! Things change quickly in crypto, and many coins and tokens are approaching green on the year. The protocol we’re discussing today, Umami Finance, is no exception to this. When we decided to write this piece, UMAMI was trading at ~$8, which was more than 50% discount to treasury value. Since then, UMAMI has risen to a value of $15.25. The discount is still ~20%, but obviously not as substantial as it once was. The goal was to get this post out when discount was 50%, but obviously that did not happen as these things do take time to write. We talk about our future posts on Twitter before we post them, so make sure to give us a follow on there!
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Let’s get right into it!
Basic Investment Thesis
A funny thing about markets in crypto is that they’re pretty inefficient. If you look in the right places, you can find some pretty interesting mispricing opportunities. For example, some DeFi protocols drop over 50% in price yet have increased revenues, many assets trade below treasury value, or some projects launch to almost no attention or fanfare. Since our recent post on Arbitrum and its ecosystem, we have been searching for such opportunities on Arbitrum. We believe that Umami Finance may be one of them.
Before diving into and explaining what Umami Finance is, we first want to go over our basic investment thesis and how Umami fits in to it. By starting with this, we want to make our thinking surrounding Umami abundantly clear. After you get the general gist of why we’re investing in Umami, we’ll break it down by discussing Umami’s overview and background followed by a deeper analysis of the DeFi protocol. The first aspect of our investment thesis involves the chain Umami Finance resides on, Arbitrum. It goes as follows:
Layer 2 scaling solutions should continue to grow in popularity throughout 2022 as they provide the ability to interact with Ethereum without paying high gas fees
Arbitrum, as the biggest Layer 2, should see increasing capital inflows which will lead to a higher Total Value Locked.
The challenge now is finding assets and protocols that will directly benefit from the increasing amount of capital that will reside on Arbitrum. We believe Umami Finance can be one such asset because:
At a market cap of ~$4.4 million, Umami trades at a significant ~24% discount to treasury value.
In short, buying UMAMI gives you discounted exposure to Arbitrum correlated assets. If you’re bullish on Arbitrum, this alone is a pretty decent value proposition. However, a discounted claim on treasury assets is not the only thing Umami Finance has going for it. It is additionally appealing because:
Umami Finance can leverage these partnerships to capitalize upon opportunities that would be otherwise unavailable for the individual investor
This 3-part investment thesis is fairly straightforward. As Arbitrum increases in usage, Arbitrum-native protocols should increase in value. This makes Umami attractive as it gives you discounted exposure to Arbitrum-native assets. And, as a cherry on top, Umami can utilize its partnerships to offer its investors unique opportunities.
Hold on, hold on… What even is Umami Finance? Glad you asked, time to break it down!
History & Overview of Umami
Umami Finance in its current iteration is a dividends protocol for Arbitrum. At its simplest form, Umami Finance owns a treasury which they deploy to earn yield. This yield is then distributed to UMAMI holders who stake their UMAMI in a product called Marinate v2 (Staked UMAMI is mUMAMI). The aim of Umami is two-fold: To grow its treasury and distribute proceeds gained from the treasury to mUMAMI holders. It is a simple, yet effective, DeFi protocol. Buy UMAMI, Stake UMAMI as mUMAMI, and receive dividends. Almost forgot, dividends are distributed in WETH by the way (Non-dilutive!). Before going any further into Umami, we want to take a look at Umami’s past.
Umami Finance has not always been Umami Finance. For those of you who have been around for a while, you may have heard of an old OHM fork known as ZeroTwOhm (Z20). ZeroTwOhm was the predecessor to Umami Finance. It launched in October of 2021 and became quite popular in some parts of twitter due to its “1,000,000%+ APR”. Z20 launched with the intention of being the prominent OlympusDao fork on Arbitrum, a rebase currency. If you don’t know what OlympusDao is nor what rebase currencies are, we recommend checking this post we made awhile back briefly discussing them. What happened to Z20? Well, it rebranded to Umami Finance in November of 2021.
BUT, this first version of Umami Finance was also a rebase currency. Umami Finance was not much different than Z20, and the goal was still the same: To become the premier rebase currency of the Arbitrum network. Umami Finance did try to innovate the rebase model, as it did introduce some cool mechanics such as Marinate v1. This version of Marinate basically made it so that you could time-lock your UMAMI tokens for boosted rewards. The longer you time-locked, the more rewards you earned.
However, as you may know, December was not a good month for rebase currencies and OHM forks. At the end of 2021, essentially every single rebase currency blew up in valuations, dropping drastically from all-time highs. What was once DeFi’s hottest innovation was now nothing more than an afterthought. Although rebase currencies such as OHM still exist, this marked the end of Umami’s existence as a rebase currency. In a Snapshot vote on January 22nd, the community voted to shift away from the rebase model and tasked the team with figuring out a new vision for Umami Finance.
The current iteration of Umami Finance is what came out of this Snapshot vote. Although Umami’s time as a rebase fork was disastrous in terms of price action (It fell 92% from its all-time high), one benefit of this model was that Umami Finance was able to create a sizeable treasury worth millions of dollars.
One thing we particularly like about Umami is its simplicity. In an industry where every newly launched DeFi protocol is becoming more and more complex, it is nice to see a protocol that is easy to grasp. Umami Finance is a protocol that we believe anyone can easily understand, regardless of their crypto experience.
Umami Finance utilizes its $5.5 million treasury to enter into yield-producing opportunities. These can range from managing the liquidity pools of other projects, stablecoin deposits, or token farming. With the yield gained from these positions, 50% of it is distributed to UMAMI holders who stake their UMAMI using Marinate v2 as mUMAMI (Also time-locked for 1 month once staked). The other 50% is put back into the treasury and used for future yield opportunities. Currently, not every UMAMI can be staked as mUMAMI. Marinate v2 is partially filled to capacity, but members of the team have stated to us that the plan is to eventually lift the mUMAMI limit so that every single UMAMI could be staked (Remember: No stake, no rewards).
Additionally, Umami’s treasury brings yield in a variety of different tokens. To simplify it for stakers, all yield distributed to stakers is done in the form of WETH. This is a much better alternative to distributing rewards in UMAMI. Why? Because if rewards were distributed in UMAMI, then rewards would be dilutive. If you had UMAMI that wasn’t staked, not only would you be missing out on rewards, but your claim on the treasury would also be diluted. Also, we don’t think anyone would complain about earning a little extra ETH.
Let’s take a look at how these dividends payments are going. Marinate v2 was launched on February 27th, 2022. To date, ~19 WETH has been distributed to UMAMI stakers. With 152,037.37 mUMAMI staked, each mUMAMI has received approximately .000125 WETH ($.42 at an ETH Price of $3350) in a month. If we extrapolate this out to an annual basis, each mUMAMI would receive 0.00161 WETH ($5.39 at an ETH Price of $3350). At a price of $15.25 for UMAMI, mUMAMI holders are currently receiving an APR of ~35.37%. Again, allow us to reiterate two important points:
This APR is purely from yields, in the form of WETH, and not dilutive UMAMI emissions.
Only half of the yield generated by the treasury is distributed to mUMAMI holders. The other half is retained by the treasury for future yield opportunities.
However, what if you want to use your WETH rewards to continue adding to your mUMAMI position? Umami Finance has a solution to that issue: The mUMAMI Autocompounder. This is a new product which allows investors to turn their WETH dividends into mUMAMI, increase their mUMAMI position, and therefore increase their claim over future WETH dividends. It may sound complex, but it is actually quite simple:
Stake UMAMI as mUMAMI, and deposit the mUMAMI into the autocompounder at a 1 month time-lock.
When WETH rewards are distributed, the autocompounder will automatically take the WETH rewards and swap them for UMAMI using the UMAMI/WETH Uniswap v3 pool. Oh, by the way, that pool is predominantly owned by Umami Finance.
The autocompounder then takes this UMAMI, stakes it as mUMAMI, and increases your mUMAMI position.
This repeats every time WETH is distributed, and you will continually increase your claim over WETH rewards.
We think this autocompounder is a great feature as it is also non-dilutive. The UMAMI gained from this autocompounder comes from already existing UMAMI in the UMAMI/WETH LP, not from new minting. More on this later!
The last important aspect of Umami Finance we must cover is Bonding v2. This will be a mechanism used by Umami Finance to strategically increase their treasury holdings. The plan is to launch it once price of UMAMI returns to Net Asset Value (NAV). This version of bonding aims to maximize treasury value while minimizing dilution to current holders. As such, Bonding v2 will begin once UMAMI trades at treasury value.
Once it is live, you can bond assets to Umami Finance’s treasury (What assets will be accepted are still undisclosed) and receive discounted mUMAMI in return. The discount will be in the range of 5-10% and will also be deposited into the mUMAMI autocompounder. This bonding mechanism will be the only way new UMAMI is minted. In theory, the max supply of UMAMI is infinite due to this. However, the team behind Umami Finance will be strategic with this bonding mechanism. If yield opportunities are robust and the team thinks more capital can be used to benefit from this, the bonding discount will be greater. And vice versa, if there are few yielding opportunities and the treasury would not benefit from capital inflows, then the bonding discount will be decreased.
Through the combination of Marinate v2, the mUMAMI Autocompounder, and the forthcoming Bonding v2, Umami Finance offers a core suite of products that will help bring the price of UMAMI to treasury backing, and hopefully beyond.
Why Umami Provides an Attractive Opportunity
As we’ve mentioned previuosly, UMAMI is not just a simply play on the treasury discount. While this discount to treasury does give us investors a great entry, the bull case for UMAMI is much, much more than this. We will expand upon our theses laid out in the beginning of this post, starting with the short term.
A major short-term catalyst for Umami Finance is the aforementioned mUMAMI autocompounder. The successful launch of this product will introduce steady buy pressure to UMAMI with no real drawbacks. First off, the autocompounder introduces no new UMAMI to circulation. This is key. All mUMAMI from the autocompounder is bought from the UMAMI/WETH Uniswap v3 pool. When Marinate rewards are distributed, the autocompounder takes these rewards, buys UMAMI, and stakes as mUMAMI. WETH enters the pool, UMAMI leaves the pool, UMAMI reprices upwards against WETH. This is constant buy pressure that will occur every time rewards are distributed.
The second part of this is that Umami Finance is not losing value from this. Why? Because the UMAMI/WETH LP is Protocol-Owned-Liquidity (POL)! Whatever fees the autocompounder has to pay to the LPs to exchange WETH for UMAMI will be redistributed back to treasury since they are the LP. This whole process is actually value accretive to Umami Finance, as the WETH (That otherwise would’ve been distributed to mUMAMI stakers) is now back in the treasury and can be redeployed to earn yield.
We can even project out the amount of buy pressure this autocompounder will translate to once released. At current run rates, Umami treasury is distributing just above 19 WETH to mUMAMI stakers monthly. Starting with this number, we can begin to conceptualize how much buy pressure the autocompounder can introduce:
The mUMAMI Utilization Rate is just simply the amount of mUMAMI tokens that get deposited into the autocompounder. If all mUMAMI is deposited, then the utilization rate is 100%. If we make some modest assumptions and start with 19 WETH rewards and a utilization rate of 50%, that is still $31,895 of monthly buy pressure for UMAMI. Since the pool only has liquidity of ~$870K, that is a pretty significant amount. Over time, these buys will add up and steadily push UMAMI towards treasury backing in the short term. One final note on this, we expect this mUMAMI autocompounder utilization rate to rise in the coming weeks as it will also be incentivized with ARBIS token rewards. You can read more about that here.
Moving to the long term, Umami Finance is interesting as it essentially a bet on the success of the Arbitrum ecosystem. Let’s take a look at their partners:
And no, these aren’t just “partnerships”. Umami Finance is working with these protocols in real and meaningful ways. The most exciting partnership, in our opinion, is a stablecoin vault that Umami is working on in conjunction with GMX and Tracer. This stablecoin vault will allow anyone to deposit USDC, USDT, DAI, MIM & FRAX and earn rewards in the form of TCR, ETH, and GMX. Estimated rate on this stablecoin vault? 35%!
This will work through the use of a delta neutral strategy Umami designed which incorporates both GMX and Tracer. Essentially, users will deposit their stablecoin of choice to Umami on a time-lock of 1 month. With these deposits, Umami will mint a variety of Tracer pool tokens and GLP. Some examples of pool tokens will be 3SBTC/USD, 3SETH/USD, AND 3SLINK/USD (3S = 3x short). The goal of this strategy is to hold an appropriate ratio of tracer pool tokens and GLP such that the delta is 0. Regardless of which way the market moves, the value of the stablecoin vault will remain the same. From these positions, TCR, ETH, and GMX rewards will be accumulated. At the end of the time-lock, depositors can withdraw their stablecoins + rewards. Additionally, Umami Finance plans on adding a direct fiat on-ramp for this vault and allow deposits from other chains in a single transaction. This proposed stablecoin vault is ambitious and will certainly drive value to Umami if successful.
This is just one example of how Umami plans on leveraging its robust partnerships within the Arbitrum ecosystem. As Arbitrum continues to grow, Umami will alongside it. All these various partnerships will drive synergies within the Arbitrum ecosystem.
Before moving on, we want to highlight some interesting things Umami has planned for the future. One major goal of Umami is to become more DAO-like. What does this mean? Well, they want UMAMI investors to have more say over the future of the protocol. As Umami Finance grows and matures, UMAMI will also fill the role of a governance token. Some examples of governance they want to implement in the future is having the community vote on the % of distribution rewards. Currently, it is a 50/50 split between mUMAMI stakers and treasury, but that could be changed. In the future, UMAMI holders will vote to determine what the split on rewards should be. That is just one example of how governance in Umami could be done, and hopefully the team at Umami Finance continues down the path of “DAOfying”.
One other thing that Umami Finance will be introducing is community Umami NFTs. This has been a popular trend across the Arbitrum ecosystem, with examples being GMX Blueberry Club and Dopex NFTs. Umami NFTs will be coming soon, and they will have additional utility. They will be able to be staked for additional rewards. More importantly, it is another cost-effective way to raise capital for the treasury! In short, Umami Finance has a lot of upcoming catalysts which will help return it to treasury backing.
Risks & Downsides
Every investment comes with risks and downsides, and Umami Finance is unfortunately no exception. The first and most obvious risk is market risk. If the market tanks in price, Umami will go down alongside with it. However, Umami’s treasury is managed with the aim of achieving a beta of 0.5, so UMAMI should underperform on upwards moves and overperform on downwards moves. If you’re not quite familiar with beta, you can think of it like this: If the price of Bitcoin goes up 1%, the value of Umami’s treasury should go up 0.5%. And vice versa, if Bitcoin goes down 1%, Umami should go down 0.5%. In this example, we’re using Bitcoin as a proxy for market returns.
Umami Finance also has smart contract risk. As of writing, Umami Finance is not audited. This is a concern the Umami team is aware of, and it is one of their top concerns. To address this crucial need, they are in talks with Trail of Bits about an audit. In our opinion, this is the most significant risk associated with Umami Finance. With a successful audit, however, a large portion of that risk should dissipate. We agree with the Umami team that an audit of their code should be of utmost importance.
One thing we also noticed with Umami Finance is that it seems they have put the “cart before the horse”. What do we mean by this? Well, they have the big stuff figured out (An effective dividends strategy with proper treasury management) but are missing smaller things such as robust documentation. These aren’t serious issues, but it would be beneficial for Umami to put together an in-depth gitbook of the protocol. In addition, some aspects of the website are still a little buggy. For example, the Umami market cap and treasury holdings on the website do not update consistently, so they could be misleading at times. Again, these are not major issues, but they will hopefully be addressed in the coming weeks.
Umami Finance is an interesting protocol on Arbitrum that we are quite excited about (If you couldn’t tell by now)! They provide a great opportunity to gain exposure to the Arbitrum ecosystem and passively earn WETH rewards. To give you an idea of our exposure, our position in UMAMI currently represents ~2-3% of our total crypto portfolio. For a small cap crypto, this is not an insignificant amount of our portfolio. Once the code is audited, we plan on bumping up our allocation to about ~5% of our portfolio. In case you are unaware of our risk strategy, we very rarely ever recommend going more than 5% on small caps.
Before wrapping things up, we want to give a huge shoutout to @IntrinsicDeFi and @MrWinstonWolf_ for helping us on this post. They are two members of the Umami Finance team who were so kind to help answer any questions we had about Umami Finance. Go give them a follow!
That’s all we got for this post! A lot of work, research, and effort went into the making of this. If you found it helpful and would like to donate, you can do so at our Ethereum/Arbitrum Address:
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