Summary
Cosmos is a Layer 1 blockchain that is designed to be resolutely interoperable and composable, and to allow seamless interactions between highly-divergent blockchains the operate in its network. Cosmos utilizes the Inter‐Blockchain Communication protocol (IBC), and easy to use Software Development Kit (SDK), and a general consensus mechanism, Tendermint, to build out the core infrastructure for blockchains to join the network without friction. The protocol has recently implemented a variety of new features, including liquid staking and a redesigned tokenomics framework to further develop the network, onboard new chains, and increase security.
Overview
Cosmos is a network of independent blockchains that are powered by a shared infrastructure, the Cosmos Hub, along with three core primitives that drive the network, namely the Cosmos SDK, IBC, and the Tendermint Proof of Stake (PoS) consensus mechanism. Each of these features enables developers to build on the network with minimal friction. Tendermint, for instance, is a generic consensus mechanism, which means that any developer in the space can use it to run their protocol rather than be required to build out their own instantiations. The Cosmos SDK is designed to be resolutely easy to use and allows developers to build custom blockchains using Cosmos’ prebuilt templates or bespoke modules. Finally, IBC is a universal interoperability module that lets different chains communicate and interact with each other, which means that they can perform functions like sending different non-native assets and establishing finality in a secure manner.
The Cosmos Hub leverages these primitives and serves as the base layer for the network, enabling other independent blockchains to join and deploy their own protocols. Each blockchain that runs on the Cosmos Hub retains its autonomy, but remains interconnected with the rest of the system, allowing for less friction when communicating cross-chain. This design allows Cosmos to preserve sovereignty for each blockchain while simultaneously facilitating powerful interoperability throughout the system.
The core vision of Cosmos since its inception was to develop a network of interconnected blockchain applications that exist independently while retaining intrinsic interconnectedness and the ability to seamlessly interact with one another. In other words, Cosmos seeks to build the internet of blockchains. Today, this much of this vision has been realized. Many different blockchains, each with their own unique functions and features, have spun out of the Cosmos Hub, including the Binance Chain which serves the world’s largest centralized exchange, the recent addition of the popular derivatives protocol dYdX as well as the ill-fated Terra chain. There are now 74 applications that run on the Cosmos network with a combined total marketcap of nearly $60B.
The next step in the Cosmos roadmap is to cultivate a resilient, self-sustaining economy. The path towards this goal leverages the Cosmos Hub to further build out key infrastructure to support the growth and development of native applications and create new use cases for interchain coordination. A core focus of this initiative is to provide infrastructure services whose utility scales with network adoption. That is, as the network grows, so too does its underlying utility.
To this end, Cosmos is deploying a liquid staking mechanism to enable more capital efficiency and the rehypothecation of $ATOM, the protocol’s native currency, and Interchain Security, an extension of Cosmos’ core security layer which enables more function, efficiency, and cooperation. Both of these features will sit above the Cosmos Hub and serve to create a new layer for secure economic scaling. Moreover, the protocol is developing other mechanisms such as the Interchain Scheduler and Interchain Allocator to further drive value between chains as well as optimizing maximal extractable value (MEV) and blockspace. Collectively, these new features will improve Cosmos’ ability to scale, lower barriers of entry into the system, and ultimately derive more utility for the different blockchains operating within the system. The Hub will move towards becoming a more robust, self-sustaining economy that can further drive the growth of the Cosmos network to integrate new blockchains and better serve existing ones.
Scaling the Cosmos Network: Current Limitations
One of the most powerful features of Cosmos is that it enables different protocols to launch their own chain on the network and retain sovereignty and autonomy, while simultaneously allowing for seamless inter-chain communication with other chains in the ecosystem. A fundamental limitation of this approach, however, is that each protocol is responsible for bootstrapping their own set validators to run their chain. So there is a significant barrier of entry for anyone looking to join the Cosmos ecosystem which also creates an inherent bottleneck around scaling.
Cosmos is implementing liquid staking functionality and Interchain Security to overcome these challenges and scale efficiently. In short, Interchain Security removes the burden of security from each individual chain within the network enables chains to extend their validator set and staked collateral to secure additional chains on the Cosmos Hub. This creates an additional layer of utility and composability throughout the Cosmos ecosystem and unlocks scaling on the network. A core advantage of this approach is that any new project will be able to join the Hub and leverage pre-existing security from other members, allowing for a more seamless onboarding. It also serves to reduce fractionalized security as some blockchains can focus on security as a service while others are no longer beholden to these requirements.
Moreover, Cosmos’ liquid staking initiative allows $ATOM holders to stake their tokens to secure the network and earn rewards, but also to deploy their staked $ATOM to other purposes. This functionality also promotes more unified security as users can freely deploy their capital between different Cosmos chains without having their capital locked into a staking contract. Liquid staking and Interchain Security push Cosmos towards a much stronger infrastructure layer of security that other projects in the system can leverage to grow and develop.
Liquid Staking: Reducing Fragmented Interchain Security
A general benefit of traditional staking in PoS systems is to allow participants to place an economic bond to provide security and settlement. Stakers have an economic incentive to stake in honest, performant validators, and are disincentivized to support poorly-performing or malicious validators by way of slashing. One shortcoming of staking as it’s currently composed is that it involves a significant opportunity cost. That is, stakers must forgo other potentially more valuable uses of their capital. So there is a constant tradeoff in capital deployment between network security and more optimal returns. Another issue is that once capital is indeed deployed to staking, it typically is confined to that native chain in which it has been deployed. This results on inherent constraints on that cross-chain composability and capital efficiency.
This is where the utility of a liquid staking primitive can be incredibly powerful. In its most general sense, liquid staking creates an additional layer of composability. Token holders can commit their resources to network security, but also have the ability to rehypothecate these same resources to pursue other opportunities.
Liquid staking, therefore, is a useful feature for Cosmos’ interoperable design as well as for the Interchain Security model itself. It not only allows participants already within the Cosmos ecosystem to extend the utility of their capital to other purposes, but also serves as an incentive for attracting agents beyond Cosmos to deploy capital to the network without completely locking their capital. Assets that utilize liquid staking can be easily exported across Cosmos and actively accrue staking rewards while composing with other protocols. This expands the utility of $ATOM within and beyond the native network. Without liquid staking, interchain growth is hindered by the constant conflict between staking or choosing to pursue other uses for $ATOM. Liquid staking eliminates this conflict and opportunity cost.
Interchain Security
A core function of Interchain Security is that it allows the Cosmos Hub to host a variety of applications with more seamless integration and less capital requirements. As a PoS chain, Cosmos builds security through staking. Token holders stake their $ATOM in validators that support the network and are at risk for sustaining the network in an honest, performant manner. Bad actors are punished through slashing. So there is an economic incentive to stake into validators that will behave accordingly.
So Interchain Security helps unify security across the Cosmos network, removing a previously highly-fragmented security, and makes the cost of attacking the network substantially more expensive. In addition, it creates a more cost-efficient method of security in comparison with requiring each individual chain to bootstrap and maintain their own set of validators. The end result is that chains on Cosmos now have the option to choose a path with much less frictionless, a less costly and less resource-intensive entry to market, and a way to accelerate innovation within the chain and beyond.
Interchain Security also creates a development layer that third parties can leverage to build out further utility for the Cosmos ecosystem. For instance, a protocol could create an optimistic rollup settlement mechanism that leverages the unified security layer similar to many Layer 2’s usage of Ethereum’s massive moat of security or a market for IBC relay contracts that aggregates all available relay providers to create a simple, cost-effective, and and more performant way of connecting blockchains in the network. Interchain Security also allows chains to join the network and pay a portion of their emissions and transaction fees to to cover security costs. Alternatively, core Hub functionality may be built on a consumer chain and receive financing for infrastructure buildout, opting for a fee split rather than a dedicated token, or some combination thereof. Overall, Interchain Security creates stronger security guarantees and a more secure platform for building applications on top of the Cosmos Hub.
Interchain Scheduler: Optimizing MEV and Blockspace
Another useful feature of Cosmos’ new design is the Interchain Scheduler. This serves as a secure cross-chain blockspace marketplace and MEV solution. However, before getting into the specifics, it is important to first mention some of the high-level value and current limitations of MEV.
Generally speaking, MEV relay networks can create channels for private transactions which are incredibly valuable for a variety of features, including sandwich attack prevention, front-running protection, and transaction guarantees. The value of these features grows along with the value of the underlying blockchain. So MEV becomes more critical as a blockchain gains traction. In terms of Cosmos, interchain MEV capabilities become increasingly important as the Cosmos economy grows, and developing relay service on multiple chains allows better cross-chain execution guarantees.
The Interchain Scheduler allows Cosmos blockchains to provide a portion of their blockspace to the marketplace. Any available blockspace that the chain seeks to sell is then tokenized by way of an NFT that represent a reservation for future blockspace on that particular chain. The Scheduler is then able to compile future blockspace availability through a collection of NFTs which are auctioned off periodically or traded on a secondary market.
These NFTs then effectively function as reservation tokens from all of the participating chains in the network. A major benefit for member blockchains to participate here is not only the prospect of extracting more value from their native blockspace and collecting increased revenue for otherwise underutilized blockspace, but also that the Scheduler splits revenues directly with the blockchain, not just the validators directly involved in execution. For end users, Scheduler functionality presents the ability to purchase a variety of block space on different chains that can be used to schedule cross-chain settlement transactions with strong execution guarantees.
Another important thing to note is that this system is entirely on-chain, unlike most existing MEV solutions that involve off-chain interactions. So the Interchain Scheduler is not subject to centralization risks or off-chain collusion, both of which can negatively impact the market for blockspace on any network. It allows blockchains to directly regulate blockspace themselves, and can provide a more fair and transparent system for returning value to their originating protocols and token holders, rather than limiting MEV value accrual to just the validators involved in managing order flow.
Tokenomics: Redesigning ATOM
The current token design of $ATOM has a few critical shortcomings related to its monetary policy. In short, the protocol is designed to balance security and liquidity by focusing directly on staking rates. As the supply of $ATOM staked changes over time, the protocol adjusts token issuance. More specifically, if $ATOM staking rates fall below a given target, then token issuance is increased until the staking rate also increases to a given target or a maximum threshold for issuance is reached. Under this monetary policy, therefore, Cosmos incentivizes additional staking through token issuance, which works to increase security, but also results in decreased liquidity. The same policy levers activate if the staking rate rises above a target level: issuance begins to pare down, staking is disincentivized, and liquidity is improved (at the expense of security). So there is a constant balancing act between security and liquidity.
However, the major challenge is requiring a significant portion of the token supply to be staked to ensure sufficient security. This is an immense capital burden that not only limits growth within Cosmos and hinders cross-chain composability, but also serves as a barrier for other participants to enter the system. Implementing a system of liquid staking breaks these barriers and allows token holders to stake $ATOM and then deploy it to pursue other opportunities, effectively removing the built-in opportunity cost of staking. A key takeaway is that monetary policy then shifts from a focus on balancing security with liquidity to one of adoption and growth.
Given that the implementation of liquid staking can resolve the interplay between security and liquidity, the protocol can now shift its attention directly to token issuance, rather than an abstraction of it. The focus is now on balancing interchain adoption, growth, and capitalization.
Under the new tokenomics of Cosmos, $ATOM issuance undergoes significant changes over the course of 36 months. In the beginning, issuance increases for the first nine months in order to bootstrap funding for a new Cosmos Hub Treasury which will be utilized to support the expansion of the ecosystem. Issuance then begins to decrease significantly at the end of nine months until it reaches a constant rate at the end of 36 months. More specifically, 10,000,000 $ATOM are initially issued per month. The rate of issuance steadily decreases over a 36-month period until it reaches a constant rate of 300,000 ATOM issued per month. This shift represents a net reduction of 97% in $ATOM issuance.
During this time, Cosmos will distribute a portion of token issuance to validators and delegators as a subsidy for network security. The remaining portion will be sent to the Cosmos Hub Treasury. The network security subsidy will decrease by 10% every month for 36 months, after which it will stop completely. In general, the revenue that is generated from Interchain Security is intended to meet or exceed the original subsidy. This approach enables Cosmos to effectively bootstrap the initial transition and then turn off the need to constantly support activity that should be self-sustaining.
Overall, an important takeaway is that this new token model shifts issuance from exponential growth to linear growth.
Network Fee Model
Under the current system, network transaction fees are paid to the Cosmos Hub and then split between validators, delegators, and the Community Pool. Once Interchain Security is implemented, however, a portion of each transaction fee and token issuance from each consumer chain will be sent to the Cosmos Hub’s distribution module, paying to secure all chains and replacing the current issuance subsidy. So Interchain Security replaces issuance as a means of incentivizing validators and delegators.
The network will also implement a global fee model that begins with a whitelist of accepted tokens along with corresponding fee minimums that is maintained by Cosmos Hub governance and shifts to a single $ATOM floor fee with an algorithmically adjusted base fee that continuously updates in response to demand. This helps avoids situations in which protocol governance must determine the pricing for every accepted token and removes some of the inherent difficulty of accurately pricing each token type.
All other applications on the network have the autonomy to create their own fee mechanisms with the assumption of transaction inclusion. For instance, the Allocator and Scheduler can customize their fee structure depending on their chosen architecture, with returns flowing to the Cosmos Hub Treasury.
This is strategic in the sense that it essentially creates a way in which the system can organically diversify their holdings away from just 100% in their native $ATOM token.
Macro View
Like many other tokens in the Web3 space, $ATOM has suffered volatility and downward pressure on price. Over the last year, $ATOM is down nearly 75%, with daily volumes also lagging from highs of around $3.5B in January to around $200M currently. Interestingly, however, $ATOM has gained some traction against $ETH which could signal a shift towards broader adoption. Nevertheless, while much of this movement is not unique to $ATOM or the Cosmos ecosystem, there are different approaches to token design that can help mitigate some of these shocks to the system.
Liquid staking is a particularly powerful primitive in that it unlocks capital currently staked throughout the Cosmos Hub and allows users to pursue other opportunities without compromising network security. This has broader implications such as attracting other potential stakers to participate in the Cosmos network, given that they do not need to lock their assets into illiquid positions. So the tradeoff, and opportunity cost, between staking $ATOM in the Cosmos ecosystem or pursuing other opportunities becomes less consequential with the advent of liquid staking. Overall this has the potential to bring more new capital, and more user and developer interest into the next iteration of the protocol. One important aspect here is that in order for a system of liquid staking derivatives to work effectively, there must be a sufficiently liquid market available for users to be able to move in and out of positions without slippage.
Fragmented security is another major shortcoming throughout Web3. In many cases, essentially any new application that seeks to enter the space must also bootstrap their own network of validators in order to participate. This results in many smaller pools of security across the network. This is inefficient on many different levels, creates a substantial barrier of entry, and presents a potential attack vector. Cosmos’ approach of implementing the Interchain Security model is quite potent here in that it not only creates a unified pool of security which makes the cost of attacking the networking exponentially more expensive, but also allows a new project to forgo the responsibility of building out their own security, which can be expensive and resource-intensive, and creates another driver of $ATOM utility. Giving established blockchains the option to effectively rent out their network security reduces the barrier to entry significantly and shifts the focus for new protocols, and perhaps existing ones that do not want to spend resource on a system of validators, back to innovation and creating applications with actual use cases, rather than burdening them with the demands of decentralized trust networks. It also gives these blockchains a secondary revenue-generating mechanism; security as a service. At the same time, putting $ATOM at the forefront of rental fees helps create continuous demand for the token that can scale with network growth. That is, as the demand for new projects to join Cosmos increases, the demand for security will also increase, which will have broader implications on the demands for $ATOM if other things remain the same.
One concern, however, is that there will be certain limits to the extent of network security that the Interchain Security mechanism can provide at any given time. That is, existing security can only be stretched so far and lent out to so many consumer blockchains. Too much strain can break the system or at the very least weaken it enough to allow for easier attack vectors. So it is critical that thresholds are established and certain parameters are in place to allow this feature to function correctly. It is also important to filter different protocols seeking to leverage this mechanism. As Cosmos gains mass adoption, more protocols will seek to join the Hub and potentially rent out network security. It will be difficult to support each and every network at scale, so a system for evaluating the potential contribution that a new entrant might have would be useful for allocating limited security resources.
The protocol’s focus on creating on-chain solutions for MEV and blockspace present tremendous potential for optimizing transaction flow and value capture. Directing revenue back to participating blockchain serves as a better alignment of incentives and helps keep value from leaking out of the network. Moreover, developing a marketplace for blockspace helps drive a self-sustaining economy, especially as the value of blockspace becomes more valuable with network adoption and demand. These sort of approaches are critical for creating real use cases for the network.
Ultimately, liquid staking, the provisioning of network security through the Interchain Security mechanism, and the marketplace for MEV and blockspace serve as powerful features for sustainable growth. By removing many of the constraints the previously prevented new blockchains from joining without friction along with a deflationary monetary policy that focuses directly on issuance, Cosmos has positioned itself to further expand its network and onboard promising new projects on its way to realizing its goal of becoming the Internet of Blockchains.
Sources
- https://gateway.pinata.cloud/ipfs/QmWXkzM74FCiERdZ1WrU33cqdStUK9dz1A8oEvYcnBAHeo
- https://forum.cosmos.network/t/proposal-draft-a-new-vision-for-cosmos-hub/7328
- https://ebuchman.github.io/posts/phases-of-cosmos/
- https://v1.cosmos.network/resources/whitepaper
- https://cosmos.network/ecosystem/tokens/
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