Looking Up at the Cosmos: A Comprehensive Analysis of ATOM 2.0
The release of ATOM 2.0 provides Cosmos Hub with the opportunity to capture part of the ecological Alpha.Author: Yilan, LD Capital Research
Abstract
As a third-generation blockchain, Cosmos SDK and Tendermint BFT lower the barriers to developing and operating public chains. The Cosmos SDK establishes independent ecological chains, becoming an ideal way to build app-chains. Projects using these infrastructures will go beyond smart contract applications, becoming scalable systems with dedicated blockchains and their own communities.
Multi-chain cross-chain coupling and architectural decoupling characteristics. Cosmos has ecological expansion and coordination, and is likely to stand out in the next public chain narrative. However, customized application chains have the disadvantage of not being able to call upon other chains as freely as smart contracts.
On-chain sovereignty and strong operability. The founders of Cosmos believe that due to differences in opinions and views among groups/regions, a single blockchain will not operate on a large scale. Therefore, Cosmos emphasizes sovereignty on each chain to avoid "tyranny" and disagreements on-chain, providing equal interconnection communication relationships (IBC) for each chain. This weakens the value capture of $ATOM and Cosmos Hub but is crucial for ecological prosperity.
The decentralized power model of Cosmos allows more Alpha to exist within the Cosmos ecosystem. Cosmos Hub captures stable Beta, while the release of Cosmos 2.0 provides Cosmos Hub with the opportunity to capture some ecological Alpha.
The Cosmos system's circular flywheel optimizes token value capture capability. ATOM 2.0, based on cross-chain security and liquid staking, forms a circular flywheel of the Cosmos system with cross-chain coordinators and cross-chain allocators, changing the pure staking role of ATOM and increasing the overall attractiveness of ATOM as collateral. From the perspective of monetary policy changes, the overall inflation of ATOM will be more severe in the short term, but in the medium to long term, the Cosmos system is indeed shifting towards a more sustainable direction.
Introduction
On September 28, 2022, the Cosmoverse conference (The legendary Cosmos Conference) concluded in Medellín, Colombia, and the Cosmos 2.0 white paper was officially released, introducing interchain security ICS, cross-chain coordinator Interchain Scheduler, cross-chain allocator Interchain Allocator, liquid staking, and the latest token economic model. This article will introduce the advantages and risks of Cosmos, comprehensively interpret the significant upgrades of ATOM 2.0, and discuss the impact of this upgrade on the Cosmos system.
I. Top-level Design and Operating Mechanism of Cosmos
Cosmos divides the network into Hub and Zone. In fact, Hub and Zone are completely equal in status. The difference between Zone and Hub is that if a Zone is connected to many other Zones, it will be referred to as a Hub, thus Hub focuses on providing inter-chain services for the IBC network.
Source: Cosmos White Paper
The Cosmos stack is built with Cosmos SDK as the application layer tool, Tendermint as the network consensus layer, and IBC as the communication medium linking Hubs and hosted chains.
The consensus layer is designed with the Tendermint Consensus Mechanism by Tendermint Inc. The advantages of this consensus mechanism include scalable interoperability, a throughput of 10k TPS, and normal transactions can occur with 1/3 of validators online and 2/3 honest validators. However, due to the secondary complexity calculation of Tendermint, the verification system based on it is relatively centralized, with only 150 validators currently (growing linearly by 13% per year to 300).
Cross-chain interoperability is achieved through the inter-chain communication (IBC) bridging protocol. Each chain must implement IBC to connect with other chains. The operation of IBC is very similar to cross-chain bridges, but the most important difference between Cosmos's IBC and traditional bridges is that the asset locking mapping between IBC is secured by Cosmos's own consensus mechanism, which traditional independent bridge protocols cannot achieve. From a cross-chain perspective, IBC-supported cross-chain operations are superior to previous cross-chain technologies, but there are also significant limitations that prevent competition with new cross-chain technologies formed by MPC.
II. ATOM 2.0 and Its Impact on the Cosmos System
The Cosmos 2.0 white paper has recently been officially released, introducing interchain security ICS, cross-chain coordinator Interchain Scheduler, cross-chain allocator Interchain Allocator, liquid staking, and the latest token economic model.
Source: ATOM 2.0 Whitepaper
ICS Interchain Security primarily addresses the weak security issues of ecological blockchains built on Cosmos Hub. ICS allows the protection of smaller market cap Cosmos ecological chains by renting out the staking verification capabilities of ATOM, with ecological chains required to pay a certain fee as compensation, thus providing income for ATOM stakers. In addition to the ecological chain's security protection role, ICS's uses also include Rollup settlement, IBC routing, relay contract markets, and chain domain name services.
Currently, four Cosmos ecological chains, including QuickSilver and Neutron, have announced their integration of interchain security (ICS) solutions, and overall, their scale is relatively small. Larger Cosmos ecological chains like Evmos, Cronos, and Osmosis currently do not use $ATOM as verification staking. In terms of enhancing $ATOM's value capture, a significant portion of the rental income charged to ecological chains will be directly allocated to that ecological chain, with the remaining portion distributed to Cosmos Hub. The value captured by $ATOM is a portion of the fees paid for choosing to rent the verification nodes of Cosmos Hub.
Liquid Staking greatly improves user experience and capital efficiency within the Cosmos system by requiring providers to custody assets, borrowing to some extent from the Olympus liquidity as a service model, increasing staking rates while releasing liquidity. Liquid staking increases the staking rate of ATOM assets, making liquid staking assets the primary medium of exchange, and using the interest generated from staked assets to reward stakers. This is a significant change in the security model of Cosmos Hub. The most effective way to ensure long-term security is to ensure that individual providers and supply markets remain decentralized, rather than using unsustainable inflation rewards to incentivize stakers. As an indispensable part of ATOM 2.0, liquid staking provides an optimized solution to the security issues that the original monetary policy (i.e., purely staking $ATOM) aimed to address.
Interchain Scheduler is built on interchain security to regulate the block space market. The specific mechanism is that when an ecological chain activates the coordinator module, it can auction future block space in cross-chain contracts, and the coordinator will mint NFTs as proof of reservation for these specific block spaces. Moreover, these reserved NFTs can circulate in the secondary market before being redeemed by validators. A portion of the auction fees is allocated to the ecological chain to exchange for block space. The cross-chain MEV income generated by the interchain Scheduler will flow back to Cosmos Hub, promoting balanced growth across the entire ecosystem through the use of the infrastructure Interchain Allocator.
Interchain Allocator functions to provide new Cosmos projects with more effective user acquisition, liquidity, and long-term ecosystem balance pathways.
In interchain allocation, through contracts and rebalancing tools, the more tokens Cosmos Hub holds from its ecological chains, the more $ATOM this ecological chain holds.
The allocation DAO composed of $ATOM stakers can sign agreements with other chains (such as token swaps) through contracts. For a long time, there may be multiple DAOs within the Hub, and the voting rights of the DAO are related to the amount of staking and the duration of locking, which effectively transforms Cosmos Hub into a fund managed by multiple DAOs. The rebalancing system can reduce slippage in DAO investments, using dollar-cost averaging/Dutch auction to gradually move towards the target portfolio.
Through the tools of contracts and rebalancing, Cosmos Hub will become the largest DAO organization and DAO-managed fund, increasing the utility of $ATOM and the number of ecological chains on a broader scale.
Source: ATOM 2.0 Whitepaper
Based on cross-chain security and liquid staking, the cross-chain coordinator and cross-chain allocator together form a new circular flywheel of the Cosmos system, changing the pure staking role of ATOM and increasing the overall attractiveness of ATOM as collateral.
Source: ATOM 2.0 Whitepaper
III. Changes in Monetary Policy
ATOM 1.0 adopts an inflation model with a floating annual inflation rate, adjusted within a range of 7%-20% based on the total staking ratio. If the staking rate exceeds 67%, the inflation rate will gradually approach 7%; if the staking rate is below 67%, the inflation rate will gradually increase to 20%. The inflation of ATOM is actually more inclined to punish non-stakers rather than reward stakers; if the overall staking rate of the system decreases, inflation will accelerate.
The update of the ATOM 2.0 token economic model has far-reaching implications for the system. The token issuance model is divided into a transition period and a stable period, shifting from exponential growth to linear growth, significantly reducing the growth of the total supply of ATOM in the long term. However, in the short term (the first ten months), due to the need to issue subsidies for security expenditures to provide funding for the infrastructure needs of Cosmos Hub, the inflation rate of ATOM 2.0 will be higher than the previous range of 7%-20%. Specifically, during the 36-month transition period of the new monetary policy, 10 million $ATOM will be issued each month in the first month, with the issuance decreasing by about 12% each month thereafter. In the medium to long term (after 20 months), the total issuance of ATOM will reach neutrality, and the system's issuance will gradually stabilize towards a fixed and lower inflation rate (1%). As shown in the figure below, the total issuance/inflation rate of ATOM 2.0 in the first 20 months after implementation is higher than that of ATOM 1.0.
Note: Monthly issuance curve of ATOM, the dashed line represents ATOM 1.0, and the solid line represents ATOM 2.0
After 36 months, the issuance model will enter the stable period, the inflation security subsidy will stop, and the original staking income will be provided by revenues from ICS and other sources, with a total monthly issuance of 300,000 $ATOM to fund and stabilize the growth of ecological projects. Once in the stable period, the annual inflation rate of ATOM will decrease to close to 1%.
Note: Cumulative issuance curve of ATOM, the dashed line represents ATOM 1.0, and the solid line represents ATOM 2.0
IV. Value Capture Analysis
From the perspective of $ATOM's value capture capability, holders' income mainly comes from staking inflation rewards and IBC transaction fees. Currently, the transaction fees captured by $ATOM are actually minimal. To achieve supply-demand balance, meaning daily income offsetting daily inflation, transaction fees need to be increased by 500 times (currently, the daily income of $2.3k is offsetting the daily inflation of $150k of ATOM). The core philosophy of COSMOS is democracy and sovereignty. The main purpose of ATOM 1.0 is to provide staking functionality. ATOM 2.0 has improved on this point, allowing $ATOM to capture rental fees charged by ecological chains using Cosmos Hub's secure staking functionality, providing additional APY for ATOM stakers. However, $ATOM still faces the risk of value capture being diluted by the staking tokens of other Hubs.
V. Security Balance Point and Market Supply-Demand Analysis
The first balance point compares the cost of malicious behavior with the TVL value. Currently, the cost of corruption for Tendermint BFT is when 2/3 of the staking nodes behave maliciously. The market cap of 2/3 of the staked value is currently about 1.8 billion, compared to ATOM's 730 million TVL, which does not provide a motive for malicious behavior. However, as the ecosystem expands, the demand for security increases, which is also the reason why Cosmos's new monetary policy has set a higher inflation transition period and flexible execution.
The second balance point compares the daily new supply of ATOM with daily consumption. With the current annual inflation rate of ATOM at 12.8% and a total market cap of 310 million, approximately $154k worth of 10,871 $ATOM will be released daily. Currently, 204 million ATOM is staked, and the market supplies 196 million ATOM daily; ATOM currently has no burning mechanism, and the fees charged in IBC relays are relatively low. To achieve supply-demand balance, meaning daily income offsetting daily inflation, transaction fees need to be increased by 500 times (currently, the daily income of $2.3k while daily inflation reaches $150k). Currently, for $ATOM to form a positive supply-demand spiral, more consumption links need to be integrated into ICS to bring transaction fees that can cover security expenditures.
VI. Ecological Projects
Notable app-chains in the Cosmos ecosystem
Note: The yellow markings indicate the three most active chains in terms of IBC DAU (24hrs), which are Osmosis, Evmos, and Cosmos Hub, with IBC DAUs of 6978, 4728, and 2711 respectively.
From the ecological chain data, Osmosis not only features a cross-chain trading AMM DEX but is also an application chain independently developed based on Cosmos SDK IBC, with a TVL of 252 million, ranking first in the Cosmos ecosystem. The IBC interface of Osmosis is significantly higher than that of Cosmos Hub, making it one of the most active hubs, theoretically allowing the OSMO token to have similar value capture capabilities as ATOM at the Hub level. In horizontal comparisons with other public chain DEXs, Osmosis currently has a relatively high P/S ratio, with a total market cap of 1.38 billion compared to its monthly trading income of 2.5 million, which seems high. However, due to Osmosis's public chain attributes and Hub functionality, its market cap is relatively low when compared horizontally with public chains. Osmosis combines transaction privacy (using threshold decryption to prevent front-running) with cross-chain AMM and achieves cross-chain functionality through IBC.
Kava is a DeFi platform for crypto assets that supports multi-asset collateral, self-issued loans, and the creation of stablecoins, among other CDP creations. Currently, Kava has a TVL of 271 million, far exceeding direct competitors like Evmos, partly due to its extremely high staking yield, currently at 2800%, while Evmos's staking yield is 181%. The top two TVLs in the Kava ecosystem are both lending protocols, indicating a very high leverage ratio in the Kava ecosystem. Kava's mainnet activation has enabled the Ethereum Virtual Machine (EVM) on Kava Network, allowing users to wrap and unwrap KAVA assets as ERC-20 on MetaMask, and Kava Network can now directly connect to these resources and thousands of active developers, dApps, and blockchain projects in the network.
Evmos has a TVL of 1.6 million, with 54% composed of Dex Diffusion Finance. Among the 11 projects currently being built on Evmos, 7 are Dex; Secret has a TVL of 10 million, with 68% composed of the privacy protocol Sienna Network, and currently, 4 projects are under construction.
Other notable app chains include the liquid staking application chain Quicksilver; Kujira, which bridges multi-chain assets, with Dapps like Blue and FIN focusing on deploying only high-quality projects; the universal cross-chain basic protocol Axelar, which aims to unlock cross-chain composability and liquidity but charges higher relay fees than Kujira; and JUNO, which hopes to become a sister chain to Cosmos and allocate 47% of its tokens for a 1:1 airdrop to ATOM holders, as well as Sei Network, an app chain focused on DeFi with built-in order books to prevent front-running.
Conclusion
Cosmos Hub competes with other chains that have Hub scale and functionality, so the impact of $ATOM on the Cosmos ecosystem remains unclear. If larger ecological chains like Juno, Evmos, Osmosis, and Axelar want to become Security Hubs, it will reduce $ATOM's market share and pricing power.
From a cross-chain perspective, IBC-supported cross-chain operations are superior to previous cross-chain technologies, but there are also significant limitations that prevent competition with new cross-chain technologies formed by MPC. Moreover, the customized application chains in the Cosmos ecosystem have the drawback of not being able to call upon other chains as freely as smart contracts, resulting in poorer interoperability at the invocation level. Cosmos Hub decentralizes token rights in exchange for long-term ecological development, but this also raises the issue that Alpha is likely to exist within the Cosmos ecosystem, with Cosmos Hub's $ATOM capturing stable Beta, while the release of Cosmos 2.0 provides Cosmos Hub with the opportunity to capture some ecological Alpha.
ATOM 2.0, based on cross-chain security and liquid staking, forms a new circular flywheel of the Cosmos system and changes the pure staking role of $ATOM, increasing the overall attractiveness of $ATOM as collateral. From the perspective of changes in monetary policy, the overall inflation of $ATOM will be more severe in the short term, but in the medium to long term, the Cosmos system is indeed shifting towards a more sustainable direction.
【References】
[1] https://informal.systems/2022/08/11/interchain-security-pre-release/
[2] https://www.stakingrewards.com/earn/cosmos/metrics/
[3] https://v1.cosmos.network/resources/whitepaper
[4] https://www.reddit.com/r/cosmosnetwork/comments/xort1i/atom20whitepaperisofficial/
[5] Data retrieved 2022.09.18
