Comprehensive Interpretation of Cosmos 2.0: From Loose Alliances to Economic Community

Written by: Morty, Deep Tide TechFlow

From September 26 to 28, the Cosmoverse conference was successfully held in Medellín, Colombia, aiming to help the South American crypto community better understand the Cosmos ecosystem. The most anticipated event was the release of the brand new 2.0 white paper by Cosmos during this conference.

This article brings you the latest interpretation of the white paper from Deep Tide TechFlow.

The white paper first reviews the brilliance created by Cosmos through Tendermint, IBC, and SDK. After realizing the low adoption rate of the Cosmos Hub network and the low utilization of the ATOM tokens staked on it, contributors hope to change this situation through Cosmos 2.0.

As Zaki, a core developer of the IBC protocol, said in his speech at the conference, "Today's ATOM is a MEME in the Cosmos ecosystem, and it can do more."

In my view, the biggest problem with the Cosmos ecosystem, or ATOM, lies in the Cosmos Hub, which is "the economic center of the Cosmos ecosystem," intended to be the adhesive that connects all blockchains and provides valuable services. ATOM is the token that protects the Cosmos Hub, but unfortunately, the development of the Cosmos Hub has not been satisfactory.

On one hand, many leaders in the Cosmos community choose to exit the Hub and build their own chains using the Cosmos SDK; on the other hand, they can completely bypass the Hub and develop smoothly. It can be said that the Cosmos Hub has become a sacrifice for the success of the Cosmos ecosystem.

How to change all this? To this end, Interchain Scheduler and Interchain Allocator will become important components of the Cosmos ecosystem, working with the newly launched interchain security margin expansion, interchain scheduling, new ATOM token economics, and ATOM staking liquidity certificates, to serve as catalysts for accelerating the development of the ecosystem flywheel, enhancing the connection and interaction between chains, and ultimately promoting the Cosmos ecosystem to become a resilient multi-chain ecosystem.

Extracting Value from MEV

In the public Cosmos stack, we see two new modules: Interchain Scheduler and Interchain Allocator.

Interchain Scheduler is a cross-chain block space market in Cosmos that generates revenue from cross-chain MEV.

According to the explanation from Ethereum.org, MEV can be understood as "the maximum value extracted from block production that exceeds the standard block reward and gas fees by including, excluding, and changing the order of transactions in a block." The high-frequency cross-chain activities in the Cosmos ecosystem drive opportunities for maximum extractable value (MEV).

Specifically, willing Cosmos blockchains can sell part of their block space to the interchain scheduler; the latter will then issue NFTs representing the "reservation" of block space, which will be auctioned regularly and may even be traded on secondary markets. The original blockchain will then receive a portion of the revenue. According to the white paper, the interchain scheduler will complement (rather than replace) external MEV relays and facilitate competition.

Interchain Allocator aims to simplify economic coordination across the entire Cosmos network, accelerate user and liquidity acquisition for Cosmos projects, while ensuring ATOM's status as the network's reserve currency.

For example, the revenue generated by the Scheduler will be distributed through the Interchain Allocator to promote promising new projects in the ecosystem and the long-term development of the ecosystem, while the emergence of new projects will drive more revenue distribution.

In summary: The Scheduler monetizes the economic activities of IBC, and the revenue ultimately flows to the Allocator, which supports new projects in the Cosmos ecosystem, expanding the potential market capacity of the Scheduler.

The greatest significance lies in that the Cosmos Hub will generate revenue from cross-chain activities by creating a block space market and charging matching fees. It is worth noting that the current Hub actually has little revenue.

Capturing ATOM Value from Interchain Security

Interchain Security is one of the most anticipated upgrades.

For applications built on the Cosmos-SDK, security has always been a fundamental issue. For large application chains with a significant number of users, like the previous Terra, this is not a major concern.

However, smaller application chains may have concerns in this regard because if newly launched applications are protected by stakers of tokens with a market cap lower than the TVL on that chain, there is a risk of being attacked.

Therefore, Interchain Security allows these application chains to rent security from the Cosmos Hub, requiring only a certain percentage of transaction fees, enabling these application chains to receive security guarantees provided by the validators of the Cosmos Hub. After all, the total market cap of ATOM is around $4 billion, and the cost of malicious actions is approximately $3 billion (2/3 * ATOM market cap, and it is difficult to collect such a quantity on the secondary market).

Interchain Security can be applied in several areas: Rollup Settlement (a standardized Rollup settlement system and scaling solution when external data availability providers publish fraud proofs), IBC multi-chain routing, chain name services (the Cosmos version of ENS), Multiverse (which can be understood as a testnet), etc.

With the introduction of Interchain Security, the Cosmos Hub becomes a security hub and helps ATOM capture value from the security needs of other application chains.

Additionally, another way for the ATOM token to accumulate more value is through Liquid Staking.

Today, ATOM holders can earn interest by staking their tokens with validators, but doing so involves locking the tokens in an address on the blockchain, meaning they cannot be sold for at least a period of time. Third-party applications provide "Liquid Staking" solutions that allow users to trade their staked assets through derivative tokens representing their stakes.

At the conference, core developer Buchman stated, "The Cosmos Hub will soon incorporate Liquid Staking into the core of the network code. With a native Liquid Staking module, a better user experience will be provided. Now ATOM can start to become more liquid, and even though it has already provided security, we can also start to offer new ways to link the security and liquidity of ATOM with other tokens launched in the ecosystem."

New ATOM Token Economics

A somewhat subjective observation is that when it comes to Cosmos, people praise the SDK and some ecosystem projects but complain about ATOM.

First, there is a high and unstable inflation rate. Currently, the inflation rate of ATOM is between 7% and 20%, depending on the percentage of staked ATOM relative to the total supply. In March 2019, the total supply of ATOM was approximately 214 million tokens, and now the circulating ATOM tokens exceed 292.5 million, an increase of about 36.68%.

Second, there is a lack of value capture mechanisms, which contrasts sharply with the Polkadot ecosystem. Although the Polkadot ecosystem is not as vibrant as the Cosmos ecosystem overall, DOT can firmly capture the value of the entire ecosystem through mechanisms like parachain auctions.

To put it another way, if Polkadot is a centralized federation, then Cosmos is a loose confederation.

The new ATOM token economics will change its issuance quantity and value capture, with ATOM's issuance adjusted to two phases: the transition phase and the stable phase.

The transition phase lasts for 36 months, starting with the issuance of 10 million ATOM per month. If this is approved for immediate implementation, the inflation rate will skyrocket in the short term, briefly reaching 40%, and then the inflation rate will steadily decline until it reaches a monthly issuance of 300,000 ATOM, effectively reducing ATOM's inflation rate to 0.1%.

As shown in the figure below, the issuance of ATOM will become linear rather than exponential.

Once entering the stable phase, through Interchain Security, a portion of transaction fees and inflation from each application chain will be sent to the issuance module of the Cosmos Hub to cover the security expenditures of all chains, replacing the current issuance subsidies.

In simple terms, the 2.0 white paper replaces the token inflation used to incentivize validators and stakers with the security fees generated from Interchain Security to reward validators and stakers.

Intuitively, the rewards for validators and stakers will decrease. However, to enhance the capital efficiency of ATOM, Cosmos has launched the ATOM liquidity staking certificate protocol. This means that users can gain liquidity through staking certificates, allowing them to participate in more on-chain activities, such as engaging in more DeFi activities.

The economic reforms driven by Interchain Security in the Cosmos ecosystem will be realized through a new distribution model via the Interchain Scheduler and Interchain Allocator, as shown in the figure below:

Inflation rewards and value distribution from the Interchain Allocator will directly point to the Cosmos Hub Treasury, which is the main driver of new projects and long-term development of the ecosystem, aiming to establish a resilient economic system within the Cosmos ecosystem.

Overall, the Cosmos ecosystem may no longer be in a "loose alliance" state but is moving towards an economic community.

Conclusion

Core developers Buchman and Zaki stated at the end of their speeches at Cosmoverse that the development of the Cosmos Hub will depend on ATOM holders, who can vote to support or oppose any changes to the blockchain. From the current reactions on forums and Twitter, most people hold an optimistic attitude.

The most optimistic is Zaki, who stated, "The new features of the Cosmos Hub will make EIP-1559 look like a joke," and even named his speech "$1K ATOM LFG."

Additionally, we also see some skeptical voices, mainly focused on the 36-month transition period issuance, arguing that the transition period is essentially a new round of financing for the Cosmos Hub. Assuming the staking ratio remains unchanged, it will raise over 37 million tokens for the Cosmos Hub (currently valued at $525 million), diluting the current ATOM token holders.

But overall, we still see that the Cosmos Hub has a way to generate actual revenue, and ATOM has more value capture, no longer being a completely loose confederation, but more like an economic community. As Mindao commented on the Cosmos 2.0 white paper: Cosmos 2.0 is trying to turn ATOM into a permissionless euro for the "Cosmos Union," providing shared economic security and decentralization, while member chains retain complete sovereignty.