Note: The Hydro team has been working on this draft for the past 4 months and already processed extensive feedback. We’re aiming to post it on-chain before mid-January so that, if approved, work on the new items may begin before the month of February.
Summary
We propose depositing 7M ATOM from the Cosmos Hub community pool into Hydro’s Inflow ATOM vault, where it will be deployed into low-risk DeFi strategies to earn yield.
A portion of the yield will fund development of a zero-fee, Hub-native ATOM LST focused on institutional users, its integration into Hydro’s ATOM Inflow vault and the ongoing expansion of the vault’s strategies, as well as the migration of Hydro’s existing contracts to the Hub. The excess yield will initially be directed toward ATOM burns, with the option to reallocate later if a higher‑impact mechanism is proposed by the tokenomics research firm hired by Cosmos Labs.
The proposal puts a large portion of the idle community pool funds to work. The ATOM “principal” will not be sold and the initial deposit can be reduced through total or partial clawbacks if better uses for the capital are identified. Hub governance retains the ability to independently initiate partial or total clawbacks, at any time, without requiring any cooperation from the Hydro committee or any other individual signers. Fund custody will be transferred to the ATOM-Aligned Apps DAO once it’s launched.
The LST
Hydro will build a hub-native, zero-fee ATOM LST with strong security and Hub governance compatibility, designed for institutional stakers but available to anyone. We’re exploring the option of bootstrapping the userbase of this new LST by taking over maintenance of dATOM from Drop and migrating it to the Hub, with a transition plan for existing dATOM holders. However, taking over dATOM isn’t a requirement, and Hydro will move forward with development of a new ATOM LST either way.
Until now, major ATOM LSTs like stATOM and dATOM have charged a 10 percent fee on staking yield. We aim to build a zero-fee LST that provides stakers with the highest possible return. These savings compound meaningfully over time. With the current ATOM staking APR of about 17 percent, staking ATOM with a zero-fee LST would earn about 1.7% more ATOM per year than with a 10 percent fee LST. After five years this grows to 8.87% more, and after ten years to 18.53% more. Zero fees create a strong incentive for users to start using the LST.
The LST will be designed with institutional stakers in mind. Cosmos Labs introduced a roadmap focused on onboarding institutions and incentivizing them to become major ATOM holders. LSTs appeal to institutions as they allow them to earn staking yield while participating in DeFi, and without locking capital. And unlike regular staking, where rewards are claimed and token balances increase, LSTs grow in value without increasing token count. In many tax jurisdictions, this enables automatic compounding without triggering ongoing taxable events, which this LST will also support.
Another focus will be peg stability. We intend to implement a minting cap as a function of the amount of liquidity available to defend the peg. A known attack vector for LSTs is the potential for large holders to mint large amounts of the LST and sell it quickly on the open-mark to trigger DeFi liquidations that would leave the protocol without enough liquid ATOM to provide redemptions in a timely manner. To prevent this, we would maintain a liquidity buffer as a percentage of circulating supply that will absorb redemptions and arbitrage during stress events, with tiered controls that progressively restrict or halt minting if this buffer becomes depleted. The Inflow ATOM vault would also be available to support the peg by supplying liquidity and executing automated redemption-rate arbitrage when deviations occur. The LST will support direct redemptions via the LSM, which will allow for better peg arbitrage.
Institutions will also need for the LST to have widespread compatibility across major DeFi protocols. We will expand the LST’s compatibility beyond Cosmos through integrations with lending markets, DEXs, yield platforms, and perps protocols in ecosystems where ATOM is not yet available. The Hydro team will leverage the “ATOM diaspora” (the teams that were previously building in the Cosmos ecosystem that have now launched projects elsewhere, such as Feather built on Sei by our friends at Shade Protocol, Ryze Protocol built on Base by the Elys team, etc.) to expand the LST’s acceptance across the EVM ecosystem.
Another major advantage for institutional users is that Hydro’s new LST will let holders vote on Hub proposals even while their tokens are deployed in DeFi. Cosmos Labs is exploring ways to get major institutions invested in ATOM by using it to govern parts of the tech stack they’re building on. With the Hydro LST, institutions will be able to govern while still earning yield from ATOM DeFi. They will be able to submit their votes through Hydro, the protocol will tally them, and a single weighted vote will be cast from the LST contract (in order to achieve this without impacting quorum, the Hydro team will submit a PR to add a new “NoVote” option, which would allow for a portion of voting power in a weighted vote to not be represented at all).
On the security front, we will use Informal Systems’ Quint specification language to harden the LST’s design. Quint encodes operational rules such as one-to-one backing and redemption logic, and verifies them through automated model checking. This reduces the risk of design flaws and makes audits more efficient. Informal Systems has already created a Quint specification for parts of the Drop codebase, which we will expand. The LST’s validator set will strictly follow the framework set by Cosmos Labs for its delegation program.
We will make it possible for CEX users to access the LST without having to create a wallet. Our integration with WAVS will allow people that buy ATOM and stake it on a centralized exchange to transfer it and access a higher yield immediately. This will result in a larger amount of ATOM being staked with community validators and participating in governance, as exchanges often run their own validator and don’t vote on proposals. We will also make the LST accessible to users who have never owned any cryptocurrency before, through simple fiat on-ramp options like a bank transfer or credit card. Appealing to this untapped audience will unlock a far larger addressable market for ATOM.
As a side note for dATOM holders, if we do take over maintenance of dATOM and use it as the base for the new LST, we’ll provide a seamless migration experience. We’ll also recognize early participation in the Drop protocol by offering two different options for redeeming Droplet points. One will be to mint a new type of Hydro lockup NFT and convert their Droplets into a score that will determine the percentage of yield distributed. The second option will be to receive a one-time distribution of the remaining revenue that Drop generated since its launch.
The Inflow integration
The new LST will be a product gateway for Hydro’s ATOM Inflow vault and help to funnel users so they can start earning DeFi yield with their ATOM. We believe that creating and delivering more non-inflationary returns for ATOM holders is going to become critically important if ATOM inflation gets reduced, as has been suggested by Cosmos Labs in the recent discussion around updating ATOM’s tokenomics to be more sustainable. Inflow depositors benefit from stable, risk-adjusted yield while Hydro manages the complexities of managing DeFi strategies, risk and security assessments, and deploying assets across various protocols and chains. All vault strategies are designed to be delta-neutral or low-volatility and prioritized based on risk profile, expected return, and operational complexity. Staking rewards will provide a base level of yield for all ATOM deposited, and more strategies will progressively be layered in over time. Examples of strategies include LST redemption rate arbitrage, liquidations on lending protocols, leveraged staking, perp arbitrage, and borrowing and lending arbitrage. Beyond the vault strategies, Hydro uses its Riptide feature to enable deployments into higher yield, market-exposed strategies, while insuring depositor’s capital against potential losses. Some ATOM may also be used as collateral to borrow BTC and stablecoins, enabling a broader set of yield strategies. And as institutions enter the ecosystem with tokenized real-world assets (stocks, bonds, treasuries, commodities etc.), the building blocks available will expand significantly. New protocols will be launched to trade, lend, hedge, and leverage these assets, creating many more ways of generating yield.
The Inflow integration will enable LST holders to seamlessly access DeFi yield by depositing their LST into Hydro’s ATOM Inflow vault, and will give users multiple options suited for different liquidity and risk preferences. They’ll initially be able to choose from three different lock durations: 1 day, 24 days, and 90 days. The longer the lock, the higher the yield, as Hydro will be able to deploy the LST into more advanced DeFi strategies. After choosing the lock duration, the user will receive a vault share receipt token, and will be able to track the progress of their deposit on a transparency dashboard, showing how their funds are performing and exactly which DeFi strategies are being used. At any time, users will be able to convert their vault shares into a different lock duration, or back to the native LST if they’re ready to exit the vault. Conversion options for vault shares will be provided directly in the app for a fee. This will provide users a chance to earn more yield while also keeping the option on the table to instantly exit if they decide they need liquidity. And just like the LST, we’ll work to get the Inflow vault share tokens supported on DeFi protocols so they can be used as collateral.
In addition to building the LST on the Hub, we will migrate Hydro’s existing contracts to the Hub. This will position us to help foster a new Hub-native ecosystem where new products will be built on the Hub to complement Cosmos Labs institutional efforts. As their partners bring new assets on-chain (stocks, bonds, treasuries, commodities), they will need DeFi protocols capable of generating yield for these assets, and these protocols will need liquidity. Our system will deploy ATOM, BTC and stablecoins against the new institutional assets. We want Hydro to operate from the Hub and incentivize other protocols to build there as well and leverage the cross-chain primitives we’ve already built.
The Ask
We propose depositing 7M ATOM from the Cosmos Hub community pool into Hydro’s Inflow ATOM vault. The vault will deploy the ATOM into DeFi strategies to generate yield, which will be used to (1) fund the development of the new ATOM LST and its integration with Inflow, and (2) perform regular ATOM burns that will reduce supply and provide positive market pressure. A portion of the 7M ATOM deposit will likely be allocated to seed liquidity for the new LST and ensure low-slippage swaps with ATOM (the liquidity will be provided in stable ATOM/LST pools and would not be subject to impermanent loss).
The DeFi deployments will happen gradually and conservatively, based on clearly defined safeguards and following progress on the Inflow vault’s automation and monitoring systems. In the early stages, a portion of the ATOM may simply be liquid staked, with a progressive rollout into DeFi to ensure that risk is minimized at every step, and that the system never scales faster than our ability to monitor it safely. An audit of the ATOM Inflow vault has started, expected to complete before the end of the month. No significant amount of funds will be deposited into the vault until then.
We see the burn mechanism as the simplest way to direct excess yield toward ATOM value-accrual, but if a higher-impact alternative is proposed in the future by Cosmos Labs, a tokenomics research team that they hire, or Hub governance, we will submit a new separate proposal to reallocate the yield. See annex 3 for more on potential alternatives.
Custody
If the proposal passes, the funds will be sent to the Hydro committee. The committee is structured as a multi-sig DAO on the DAODAO platform. The committee will deposit funds from this multi-sig wallet to the ATOM Inflow vault, which is currently semi-automated (some DeFi strategies are implemented automatically, while others require manual transactions by the Hydro team). For manual strategies, approval and signing of these is required by a sub-DAO involving members of the Hydro Committee.
The current committee members are RoboMcGobo (Cosmos Labs), Phil RX (PRO Indicators), Trix (The Membrane), Johnny Wiles (Osmosis), Andres (Range Security), Carter Woetzel (Shade Protocol/Feather), Luisqa (Neutron), and Arlai (Moonkitt). Members can be voted in and out by Hydro governance. If the proposal passes, we plan on adding several more members to this DAO to ensure even stronger operational oversight for the community pool funds. The Hydro committee has a solid track record of deploying community pool liquidity, as that’s exactly what it was originally built to do. Since its launch in late 2024, Hydro has deployed over 3.5m ATOM across 20+ Cosmos DeFi protocols. Throughout all of these deployments, Hydro has successfully navigated risk and preserved 100% of the amount of ATOM originally provided to it by the community pool. Over the past several months we’ve also begun operating our Inflow vaults in beta, deploying private capital across both Cosmos and EVM ecosystems, which has proven to be very successful in bringing in consistent yield.
Once the ATOM-Aligned Apps (AAA) organization is set up, the Hydro committee will be able to transfer the custody of the funds. In the meantime, Hub governance will be able to clawback the funds at any time as enabled by Hydro governance proposal A6. Through a nested DAODAO structure, Hub governance ultimately controls all of Hydro’s DAOs, including the Hydro committee.
Funding
Hydro’s team currently has 6 full-time members (5 on Product, 1 on Growth) and 4 part-time members (technical reviews, design, finance, operations). In Q3 2025, expenses were $107k per month (72K from the team, 35K for grants), which was funded by yield generated from Hydro’s liquidity deployments. The yield accrues to the Hydro Treasury and is primarily held in ATOM. As ATOM’s price has declined over the past few months, the dollar value of the treasury has fallen, reducing Hydro’s ability to operate from profits.
In order to take on the development & integration of the new LST, we estimate that we’d need to onboard 3 new full-time developers to the team. In the first 12 months, we also estimate that we will need to pay for 4-5 audits ($250K for the first year), price oracle integrations, and data indexing. In total, we project the expenses to be around $150,000 per month. Starting for the month of January 2026, and at the end of each following month, the Hydro committee will withdraw the yield generated by the community pool deposit from the vault:
- If the yield is above $150,000, it will send the equivalent of $150,000 to the Hydro team and the rest to a burn address (see section below)
- If the yield is below $150,000, the outstanding amount will be taken out of the yield collected in the following months (and nothing will be burned)
If the Hydro team has any excess budget at the end of a quarter as a result of using less than $150k each month, the excess amount will be burned. The Hydro team will continue to post detailed quarterly reports on the forum (see Q1 2025, Q2 2025 and Q3 2025) so that the community can easily see exactly how much yield is being generated, used for funding, and burned.
ATOM burns
Any yield generated above that amount will be put towards ATOM burns.
The ATOM Inflow vault will take the ATOM deposited by this proposal and deploy it into DeFi strategies. We’ll use the LST redemption rate arbitrage strategy as an example. This particular strategy works by swapping ATOM for an ATOM LST when it is trading for lower than its redemption rate. Let’s say the redemption rate is 1.25 ATOM, but it’s trading at 1.20 ATOM on Osmosis. If the vault swaps 100k ATOM for this ATOM LST, it will receive around 83k ATOM LST, which will also help restore the peg. The vault can then begin the redemption process, converting this ATOM LST back into ATOM. After this redemption period is complete, the vault will have 104k ATOM. The profit is 4k ATOM, and is entirely non-inflationary since it isn’t generated by ATOM inflation but rather arbitraging a temporary mismatch between the LST’s market price and the amount of ATOM it can be redeemed for. At the end of the month, this 4k ATOM will be withdrawn from the vault by the Hydro Committee, and then sent to a burn address. ATOM burns directly reduce the circulating supply of ATOM, creating long-term upward pressure on its price.
While a portion of the vault’s yield will still come from ATOM staking rewards, this percentage will decrease over time as Hydro’s ATOM Inflow vault’s capabilities increase and as ATOM inflation gets reduced. Implementation of additional strategies like borrowing/lending and perp arbitrage, improved automation, and new DeFi opportunities emerging for ATOM and this new LST will allow for more and more non-inflationary yield to be generated. Some of the vault strategies are already using ATOM to generate BTC and USD denominated-yield, which is then used to buy ATOM and compounded into the vault. See the Annex sections at the end of this proposal for our yield projections and a more detailed list of the strategies that will be used.
Parting thoughts
The Hydro team has been eager to build DeFi products on the Hub for some time. Although we did not initially plan to launch an LST, we now see an exciting opportunity here in developing & integrating a zero-fee, Hub-native LST which will bring more funds on-chain, and we believe we are the right team to build it. Many of our engineers maintained the Cosmos Hub for years and have built an in-depth knowledge of the liquid staking, staking, and governance modules, as well as the other systems involved in an LST. We understand the role that LSTs play as they’ve been an essential part of Hydro’s deployments in 2025. The Hydro LST will be a key building block of a Hub-native DeFi ecosystem which serves institutional and retail users.
Voting options
Yes: I approve depositing 7M ATOM from the community pool into Hydro’s ATOM Inflow vault, using a portion of the yield to fund the developments mentioned above, and burning the rest.
No: I oppose depositing 7M ATOM into the ATOM Inflow vault as outlined above.
Abstain: I wish to contribute to quorum without expressing a preference
Annex 1: ATOM vault burn projections
Our projections account for variables such as inflation reduction, ATOM price increase, LST adoption and Inflow vault APR. Because we strongly believe that Cosmos Labs’ institutional strategy will succeed, we do make optimistic assumptions about the price of ATOM. Note while it is possible for a fee to be built into the LST in the future, the Hydro team has no plans to do so at this stage. The projections assume partial clawbacks over time, since community funds may be reallocated if higher‑priority needs arise.
Annex 2: Vault strategies
This is a non-exhaustive list of strategies that the ATOM Inflow vault will utilize. More strategies will be added over time as new opportunities are identified. All strategies will be market-neutral and comply with the risk management rules established by the Hydro Committee.
| Strategy | Description |
|---|---|
| LST arbitrage | Buying LSTs below the redemption value & redeem to capture spread |
| Liquidity provision | Providing concentrated liquidity on DEX pools using stable pairs |
| Funding arbitrage | Taking opposite perp positions across markets to collect funding rate |
| Leveraged staking | Looping b/w a staked asset and its base asset to amplify staking yield |
| Fixed yield arbitrage | Locking in fixed yields (yield tokenization or fixed-rate lending) |
| Borrow-lend arbitrage | Borrowing assets and redeposit into other higher yield protocols |
| Liquidations | Acting as a liquidator on DeFi protocols (money-markets, perps etc.) |
Annex 3: FAQ
Q: ATOM DeFi has shrunk considerably, how will the vault be able to produce yield?
First, several opportunities still exist. A number of strategies (providing liquidity in tight ranges on Osmosis and Astroport, liquidations on lending protocols, leveraged staking etc.) are delivering APRs above the staking rate. The Hydro vault has also had great success with the LST redemption arbitrage which is regularly generating APYs between 28 and 35%. The vault monitors the price of dATOM and stATOM and automatically swaps ATOM for dATOM or stATOM when the tokens are trading below their redemption value.
Second, Hydro will soon be able to tap into market-exposed strategies like leveraged lending and DEX LPing with non-stable pairs via our Riptide feature. Riptide allows Hydro’s voters to put up their Hydro-locked ATOM as collateral to insure Hydro’s deployments against losses. If a deployment is profitable, they earn a share of the yield, but if it results in a loss, their ATOM is slashed to make up the difference. Market-exposed strategies often provide even higher yields than the delta-neutral strategies the vault typically utilizes, but are obviously riskier. Riptide allows Hydro to take advantage of these opportunities without putting depositors (like the Hub community pool) funds at risk.
Third, the vault is able to use ATOM LSTs as collateral to borrow BTC and stablecoins and access a much wider range of strategies on a much wider set of venues. For example, the Hydro vault lends USDC on Morpho and reallocates between markets & chains based on how the rates change. Since September 20th, the vault has also used stATOM as collateral to borrow BTC on Mars’ Osmosis outpost at a borrow rate of 1% and deposited that BTC into Amber Finance’s maxBTC to earn around 6% APY. We are now working on a new perps funding rate arbitrage where the vault uses dATOM or stATOM to borrow USDC and uses it to take opposing positions on two different perps protocols (Mars & dYdX) and profit from the funding rate differences.
Fourth, we will expand ATOM’s yield opportunities by integrating our LST into DeFi protocols outside of Cosmos by leveraging the relationship with the “ATOM diaspora” (the teams that once built in the Cosmos but are now focusing on projects elsewhere). With the help of the Feather team (developers of the Shade Protocol) will get our new ATOM LST accepted as collateral on EVM lending platforms like Morpho. This would give us access to cheaper liquidity for borrowing BTC and stablecoins with our ATOM and allow us to scale the strategies described in the above paragraph. As an example, at the time of writing Hydro could borrow USDC at 0.2% APR and lend it for 8.2% APY on Morpho on Sei. Liquidity pools will be necessary to perform liquidations so we’re already talking to EVM DEXs like DragonSwap on Sei to set them up.
Fifth, the same expansion efforts will allow us to use the new ATOM LST to borrow LST’s for other popular proof-of-stake tokens (ETH, SOL, NEAR etc.) and perform the LST redemption arbitrage on them. Many of these tokens have several different LSTs to choose from and plenty of opportunities for arbitrage. To avoid liquidation of these borrowed positions, we will continue to use very conservative LTVs and monitor our positions programmatically, adding collateral or repaying debt as needed. Hydro experienced no losses on 10-October or during the Stream-triggered market crash.
In the longer term, we expect many new assets to be issued on-chain (stocks, bonds, treasuries, commodities, real estate) and many DeFi protocols to launch on Cosmos institutional chains ecosystem. For example, Circle recently launched Arc specifically to bring more global economic activity on-chain and focus on applications like lending, capital markets, foreign exchange, and global payments. Arc is built on Informal Systems’ Malachite consensus engine and Circle acquired Malachite in the process, leading to several of our ex-colleagues leaving to join Circle. We’ll be using this relationship to make sure Hydro can tap into the Arc ecosystem. More generally, if institutional adoption continues to grow on Cosmos rails, Hydro will be ideally positioned to take advantage of these opportunities.
Q: What is the motivation for the Hydro team to work on an LST? Are the right incentives in place?
We see the 0% Hub-native LST as an essential primitive for exporting ATOM and a gateway for onboarding new users into the Inflow ATOM vault.
Hydro’s goal is to become a component of ATOM’s tokenomics. Hydro doesn’t have its own token and hasn’t raised external capital. The team spun out of Informal Systems and received funding for Q1 & Q2 from the Hub community pool via proposal 986. In Q3 & Q4, Hydro has operated from the yield that it has been generating on ATOM liquidity deployments. Hydro’s incentives are aligned with the Hub on the upside and on the downside.
On the upside, if the LST gains traction and the ATOM Inflow vault generates a solid yield:
1- Hydro wins because Inflow earns additional revenue through performance fees on vault deposits and fees from converting the LST into vault shares. Higher yield leads to higher protocol revenue, so Hydro is incentivized to maximize vault performance. The protocol revenue is then shared with Hydro NFT holders, which represent ATOM lockups.
2- The Hub wins because the community pool is a depositor in the ATOM Inflow vault, similar to other depositors. While at first, the yield generated may only be sufficient to fund the development of the new LST, all the excess revenue will then be directed toward ATOM burns or distribution to long term stakers.
On the downside, if the Hydro team fails to deliver on the objectives in this proposal:
1- Hydro loses because the yield will not be sufficient to fund its operations, and the Hydro team would likely have to wind down. Note the Hub governance is also able to automatically clawback the entire deposit by passing a proposal.
2- The Hub loses the investment it made by funding Hydro via proposal 986 in Jan-2025. However, the Hub would not lose any of the funds it deploys via this new proposal since the “principal” would simply be returned back as ATOM to the community pool (only “the yield” is used to fund the new developments).
Q: Is burning ATOM the best way of using the revenue generated from the vault?
ATOM burns are the simplest option to provide a direct benefit to ATOM holders at this stage. However, our goal is to remain aligned with the efforts led by Cosmos Labs. Their Request for Proposals process will analyze the design space and make recommendations on how inflation and revenues should be used. If the research firms conclude that there are higher-impact uses for Hydro’s revenues, we intend to implement those mechanisms instead. Internally, we’ve already been discussing 3 other possibilities:
Staking duration incentivization: The vault revenue would be distributed as extra rewards for specific commitment durations. For example, users who stake ATOM for longer periods (such as 1, 3 or 5 years) would receive additional yield on top of the base staking rewards. It creates a clear incentive to hold and encourages long-term alignment. The mechanism would be implemented as a reward multiplier that scales with lockup length and make the trade-offs easy for users to understand.
Treasury management: The vault revenue would be used to buy BTC and USD when market conditions are favorable. Once acquired, these assets could be deposited into Hydro’s Inflow BTC and USD vaults, and deployed into delta-neutral DeFi strategies for these high-demand assets and provide the community pool with more diverse holdings (exposure to BTC for upside and USD to hedge against market volatility).
ATOM buys incentivization: The vault revenue would incentivize USD and BTC vault depositors to reinvest their yield into the ATOM vault via a structured dollar-cost-averaging mechanism. Opting in would automatically convert USD and BTC yield into ATOM and deposit it into the ATOM Inflow vault, with an ATOM-denominated incentive and a required lockup period to encourage long-term commitment. The approach has the benefit to onboard a new cohort of ATOM holders
Q: This proposal requests a large portion of the CP. What if those funds are needed later?
Today, community pool funds sit idle until they are disbursed to fund different initiatives (AADAO, Stargaze etc.). We’re proposing to put these funds to work in DeFi strategies so they can be generating stable, risk-adjusted yield, and use this yield to fund the development of an ATOM LST that will benefit all ATOM holders. None of these funds will be spent, and the expectation is that at least some portion of them will be returned to the community pool over time, as needed for other efforts. Hub governance controls all of Hydro’s DAOs through a nested DAODAO structure and can claw them back at any time.
So if someone thought that the funds should be used in a different way, or that Hydro wasn’t fulfilling the expectations laid out in this proposal, a new proposal could be submitted to claw back the funds, which would forcibly remove the funds from Hydro’s Inflow vault and send them back to the community pool. If a specific amount was needed for something else, this could be just a portion of the total amount.
Similarly, if Hub governance passed a text proposal simply asking Hydro to send some of the funds to another project, we would comply without a clawback being required. Later on, when the ATOM-Aligned Apps (AAA) organization launches, custody of the funds will be transferred there by having the Hydro committee transfer the funds into an AAA-controlled wallet.
