Interop: Exploring the Biggest Trends and Opportunities in Cosmos 2023

Author: Sebastien Couture & Interop General Partner

Compiled by: Block unicorn

Over the past two years, we have seen the Cosmos ecosystem evolve from a handful of teams establishing early cross-chain channels to a thriving ecosystem built by projects and companies that are creating foundational applications and infrastructure to extend Web3 to the next billion users.

In 2022, the Cosmos ecosystem began to gain broader attention from the crypto industry, institutional participants, and tech giants. We believe that cross-chain, utilizing the Cosmos technology stack for blockchain and decentralized application networks, will become one of the most promising environments in the industry.

The narrative around sovereign dapps and blockchain interoperability is gaining popularity throughout the industry, including Cosmos and its founders. This comes before the concepts of roll-ups, modular blockchains, and minimal trust chain bridges are widely understood. It is very satisfying to see these ideas being discussed, funded, and implemented today.

As we look forward to the next cycle of Web3 applications, it is clear that the industry must invest heavily in infrastructure to onboard over a billion users in the next five years. While scaling remains a significant challenge, so do the barriers to adoption, as many issues surrounding user experience remain unresolved: self-custody, privacy, application interoperability, and access to stablecoins.

Source: Raoul Pal

The collapse of FTX reminds us that the value being built in this industry lies in open, permissionless, and censorship-resistant applications. However, the decentralized application stack has a long way to go to compete with the speed, reliability, and smooth experience offered by Web2.

As the cryptocurrency bear market settles, developers will build critical infrastructure and tools that will spark the next wave of decentralized applications. The next few years will lay the groundwork for the next wave of "crypto-native" innovations, moving towards users having more agency and sovereignty over their data, money, and economic transactions.

1. Interoperability Infrastructure

Driven by the implementation of IBC (Inter-Blockchain Communication), trust-minimized interoperability protocols will be increasingly utilized.

In 2022, 69% of lost funds were due to bridge hacks, particularly the Ronin bridge ($624 million), BNB bridge ($586 million), Wormhole bridge ($326 million), and Nomad bridge ($190 million). Many early bridge designs implemented liquidity pools for cross-chain assets, which became honeypots for attackers, and the TVL essentially became a bounty for hackers.

The Inter-Blockchain Communication protocol (IBC) operates on trust assumptions that reduce the security of participating chains, and the security of IBC relies on two principles:

• Users' trust in the chains they are connected to.
• Fault isolation mechanisms that limit the damage from malicious chains.

When the IBC protocol went live in the summer of 2021, it marked the beginning of a shift towards trust-minimized interoperability. The design space explored by IBC and similar protocols promises a future where blockchain interoperability is far more secure than previous cross-chain attempts.

Thousands of IBC transfers worth tens of millions of dollars are initiated daily, allowing assets to be transferred almost instantly and without barriers. Interchain Accounts (ICA) add cross-chain composability to IBC, paving the way for a new generation of interoperable DeFi applications.

While IBC is tightly coupled with the Cosmos stack, alternative implementations bridge the gap with other ecosystems. Axelar, Composable Finance, Nitro, Landslide, and Octopus Network extend IBC beyond the Cosmos ecosystem and affirm the protocol's advantages in other communities. Evmos is an EVM-based chain built on Tendermint that enables IBC for ERC-20 tokens and creates opportunities for Ethereum's DeFi platforms to enter cross-chain.

We also look forward to the industry's adoption of zero-knowledge proofs (ZKP) for interoperability. Some teams are leveraging ZKP to facilitate information transfer and transactions between chains with different finality and validity guarantees. Polymer Labs is an example, building ZK-IBC to extend the reach of IBC to the EVM ecosystem.

We believe that in the coming years, trust-minimized interoperability protocols will become the standard for cross-chain transfers and messaging.

2. Modular Blockchain Infrastructure

With the launch of Celestia, Fuel, and specific applications on Ethereum, the narrative of modular blockchains will become more concrete.

The era of one-size-fits-all blockchains is over. Every peak demand and bottleneck on Ethereum indicates that applications sharing bandwidth on a general-purpose blockchain cannot scale.

Modular infrastructure diverges from previous designs by separating different functions of blockchains: data availability, consensus, settlement, and execution. This allows each layer to operate independently and specialize. It also creates a market where teams compete for the highest performance technology for each layer.

The modularization of the blockchain technology stack enables developers to create decentralized applications (censorship-resistant) that can support a large number of users (high transaction volume) while maintaining security (preventing transaction reordering) -- the blockchain trilemma. This approach shifts the focus from scaling blockchains (which was never the true goal) to scaling decentralized applications while retaining the ideal properties of blockchains.

Celestia first proposed this concept in 2021: a minimal blockchain that provides data availability and consensus. Other teams, such as Fuel and Eclipse, will provide compatible settlement and execution layers where developers can write application logic tailored to their needs. While we are still in the early stages, we believe that the speed and flexibility of roll-ups will become an attractive option for developers. We are excited to see the competitive landscape of modular components, each with different trade-offs.

This new era of modular blockchain infrastructure will inspire a new wave of developers in the next cycle. With reduced technical barriers, developing secure, scalable, decentralized applications will be greatly simplified, as developers, businesses, and hobbyists will be able to start directly.

3. Application-Specific Blockchains

More blue-chip protocols will follow the path of dYdX, establishing sovereign application chains. The notion of application-specific chains proposed by Cosmos is gaining broader support in the ecosystem. The idea of specific application chains has extended beyond Interchain and is widely accepted in the EVM world, as articulated by Vitalik Buterin in his rollup-centric roadmap.

For applications that require a high level of protocol, consensus-level customization, and tight vertical alignment between different layers of the stack, single-purpose application chains are a suitable design choice. Amazon, Facebook, and Google have all built their own data centers, network infrastructure, and hardware to achieve high vertical integration and economies of scale to remain competitive. At their scale, the only way to grow is to control the entire stack -- and this is also true for major DeFi players.

Osmosis is a flagship example of a sovereign DeFi application chain. Compared to protocols built on Ethereum and other smart contract chains, Osmosis benefits from customizability, better control over MEV (which they plan to internalize), and low fees. It is now expanding into a mature ecosystem that offers a variety of services to users.

The announcement by dYdX that it will build its own sovereign Cosmos blockchain is a strong signal validating this vision of decentralized application expansion. For the largest decentralized derivatives exchange, launching a sovereign blockchain promises higher transaction throughput, customization, and better vertical integration.

In his article "The Inevitability of the Uniswap Blockchain," Dan Elitzer describes the costs incurred by DEX traders: swap fees, transaction fees, and MEV. In the case of Uniswap on Ethereum, the swap fee is the only cost component that the protocol can control. Users must reason through network transaction fees, which can vary greatly based on demand, as well as MEV, over which the protocol has almost no control. MEV constitutes a significant portion of traders' total costs and represents the best opportunity for the protocol to capture value. This is the Osmosis approach, and we can speculate that dYdX also sees the opportunity to internalize MEV and return value to users.

Application chains may transcend the narrative of specific applications and take the form of first-layer protocols targeting specific industries. Chains tailored for niche industry sectors can offer special functionalities and better speeds. Sei Network is the first first-layer blockchain specifically designed for trading, aiming to provide fast finality and high throughput. This concept can be extended to the chain Stargaze, which primarily offers an NFT minting platform but is also building tools for creators and communities.

We expect that the architecture of application-specific blockchains will remain a suitable choice for projects with platform ambitions.

4. Cross-Chain Security

Interchain Security (ICS) allows the launch of dozens of new chains, leveraging the trust and security of the Cosmos Hub.

Cross-chain security (ICS) is an important evolution for Cosmos, allowing application chains to benefit from the ecosystem of validators from the Cosmos Hub. ICS enables validators on the provider chain (e.g., Cosmos Hub) to protect consumer chains by leveraging their stake through participation in its consensus.

Shared security is not a new concept -- Polkadot implemented this idea in its relay chains years ago. Cosmos took a different approach, deciding early on that the ecosystem should grow and mature before enabling shared security.

Consumer chains that choose to leverage ICS (rather than forming their own set of validators) can access the security of the Cosmos Hub from the outset. Previously, chains needed to conduct validator roadshows, spending months of time and effort to build, while ICS chains will gain billions of dollars in trust security, which remains unparalleled in the cross-chain ecosystem.

While the scaling and security approach of ICS chains is entirely different from modular chain theory, ICS chains maintain a high degree of sovereignty over consensus and data availability (aside from certain aspects like slashing parameters).

Through Interchain Security (ICS), the Cosmos Hub can enter into agreements with consumer chains (chains that can generate revenue), with the revenue generated being used for ecosystem development (distributor model) or distributed to ATOM holders. The monetization design space for provider chains is vast, including transaction fees, MEV capture, block space auctions (Scheduler model), and revenue sharing.

ICS will launch in 2023, with a few blockchains renting security from it. The most anticipated projects include Neutron (CosmWasm cross-chain smart contracts), Duality (DEX), Stride (liquidity staking), SimplyStaking (on-chain ETF), Fair Block (MEV), and Noble (native asset issuance).

We firmly believe that Interchain Security (ICS) will play a significant role in attracting large-scale projects to Cosmos.

5. Adoption of Privacy Protocols

Several privacy chains will go live, enabling a new type of private design dapp. For the adoption of decentralized applications to develop, privacy must be prioritized. As billions of people, small and medium-sized enterprises, and corporations enter Web3, it is essential to enable anonymity features.

As on-chain data analysis becomes more accessible, government agencies openly utilize these tools, and the relative anonymity once enjoyed by early adopters is rapidly disappearing.

In the coming years, decentralized private applications will grow. Since the invention of Zcash, research on zero-knowledge proofs (ZK) has surged, leading to what is referred to as the Cambrian explosion of ZK elements. Developer tools are improving, making it easier for developers to leverage ZK in applications. As a result, privacy DeFi, smart contracts, and payments are now possible, with dozens of teams actively building in the privacy space.

Venture capital is also entering the privacy-focused market -- Espresso Systems, a privacy blockchain company, led by Greylock Partners and Electric Capital, raised $32 million. Privacy protocols such as Aleo, Aztec, Anoma, Penumbra, and Iron Fish have all raised significant funding. Grassroots projects like Juicer Protocol are taking steps to maintain anonymity and achieve DAO governance, learning from Tornado Cash.

We believe that privacy will play an increasingly important role, as the ability to transact and do business privately is essential in a capitalist society. While we see a massive influx of funding and developers into the blockchain space, privacy-focused projects have been comparatively undervalued and underfunded. This situation is changing -- development tools are maturing, making it easier than ever to build applications using zero-knowledge proofs.

6. Native Stablecoins

Native stablecoins are coming to Interchain, allowing new liquidity and user inflows into the ecosystem. When UST collapsed, it left a vacuum in the Cosmos ecosystem. As the most liquid dollar-pegged asset in Interchain, Terra's exit left the Cosmos ecosystem without an IBC-native stablecoin.

Fortunately, this situation is changing. In 2022, the Agoric team launched Inter Protocol (IST), a fully collateralized cryptocurrency-backed stablecoin designed to maintain parity with the dollar. The operational mechanism of IST is similar to Maker's DAI, maintaining stability through over-collateralization. While it is primarily backed by bridged dollar stablecoins, support for ATOM and other major assets in the Cosmos ecosystem is forthcoming.

Circle also plans to issue a native USDC on the Noble application chain (also known as the "Universal Asset Issuance" chain), with its security guaranteed by Interchain Security from the Cosmos Hub. This will enable Circle to mint institutional-grade assets that can be transferred across chains via IBC.

Currently, $12 million worth of wrapped USDC is placed in Osmosis' liquidity pool. By leveraging IBC, native USDC eliminates cross-chain risk, allowing it to be interchangeable with the native version of that asset living in other ecosystems (such as Ethereum, Avalanche, and Solana). As the largest consumer of USDC in the cryptocurrency market, dYdX's arrival as a Cosmos chain will bring more dollar liquidity to the ecosystem. Their presence in the IBC network will create more organic demand for stablecoins in Cosmos.

The liquidity of stablecoins is a crucial pillar of any cryptocurrency ecosystem. Increasing the supply of IBC-native stablecoins is an important legitimizing factor for cross-chain and will attract investors, entrepreneurs, future institutional asset issuers, and builders to Cosmos.

7. Liquid Staking Protocols

Liquid staking derivatives represent a powerful primitive capital that can unlock capital currently locked on Cosmos Hub and other IBC-connected chains. While liquid staking derivatives have existed in Ethereum for several years, with protocols like Lido holding most of the ETH, liquid staking derivatives in Cosmos are now taking off.

Liquid staking on monolithic chains like Ethereum and Solana means a single liquid staking asset (ETH and SOL), and these protocols do not support on-chain governance. In Cosmos, every native token staked on a chain has the potential to become a liquid asset, and should retain the interoperability that IBC brings. The vibrant validator ecosystem in Cosmos, which participates in community governance and has strong accountability to their delegators, is another key differentiator that has significant implications for protocol and mechanism design.

Therefore, liquid staking protocols in Cosmos must be cross-chain, considering users' preferences for validators and allowing users to retain governance rights on the chain where they hold liquid staking assets, which adds significant complexity to the issue.

Last year, two next-generation liquid staking protocols went live. The first is Stride, which currently offers liquid staking for ATOM, OSMO, STARS, and JUNO. Shortly thereafter, Quicksilver launched a user-centric mainnet, where delegators retain ultimate control over their assets and governance voting.

As these and other protocols mature and attract more stake, this will create more liquidity in Cosmos DeFi. At the time of writing, approximately 60% of ATOM tokens are still staked, with a small portion being liquid staked. Of course, there are also about 60 Cosmos-SDK chains, representing potentially billions of dollars in assets that could be transferred to liquid staking protocols. Therefore, the influx of DeFi liquidity could be substantial.

As more users turn to liquid staking, we are also excited about the prospects of new DeFi applications supported by this liquidity, such as stablecoins, cross-chain lending, and validator indices.

8. CosmWasm Smart Contracts

Designing secure smart contracts in EVM (Ethereum Virtual Machine) is rapidly gaining traction in the Cosmos ecosystem and beyond, attracting new developers.

CosmWasm was created in 2019 at HackAtom Berlin and has become the de facto smart contract EVM used by Cosmos-SDK chains. At its core, CosmWasm is a Wasm implementation as a Cosmos-SDK module, meaning any Cosmos chain can support robust smart contracts written in Rust.

Wasm is a highly optimized virtual machine with minimal overhead. This makes it a reasonable choice for blockchains with high computational constraints. Polkadot implemented a wasm-based EVM for its Substrate framework, and there was a brief discussion in the Ethereum community about Ethereum-style WebAssembly (Block unicorn note: WebAssembly is a new type of code in modern web browsers that provides new performance features and effects).

While Solidity has indeed been a success story in terms of adoption and value creation, it carries inherent issues with the language and EVM constructs. From a security perspective, CosmWasm eliminates reentrancy attacks (Block unicorn note: Reentrancy attacks refer to multiple calls to a business contract within the same transaction, allowing for an attack on the contract), which have caused billions in losses -- particularly with The DAO and Parity Multisig hacks.

Because contracts are written in Rust (a typed language with industry-leading testing suites and powerful tools), they provide solid test coverage for critical business logic. In other words, the development environment of Rust significantly reduces the risk of errors and common vulnerabilities being compiled.

Another powerful feature of CosmWasm is contract upgradeability. The migration feature allows for an optional management key that can upgrade contracts. Combined with a multisig account, contract upgrades can be achieved through community voting or zero-knowledge proof protocols. In contrast, EVM-based dapps must implement suboptimal proxies and library contracts to handle upgrade issues.

One of the biggest advantages of CosmWasm is that it is designed to support IBC, meaning it can send and receive assets and messages from other chains and CosmWasm contracts. These powerful capabilities allow any CosmWasm developer to implement new forms of cross-chain composability.

The true power of CosmWasm lies in its ability to serve as an innovation platform within the Cosmos ecosystem. Deploying CosmWasm allows development teams to rapidly prototype and implement new features in hours or days, rather than weeks or months, compared to building custom Cosmos-SDK modules. Some blockchains have already added permissioned CosmWasm, relying solely on SDK modules for low-level functionalities such as token transfers, governance, and staking. Osmosis, Stargaze, and Ki are blockchains that extensively use CosmWasm in this configuration.

To further accelerate rapid prototyping and ease of development, a fully CosmWasm-based SDK is in early development. Although it is far from production-ready, the CosmWasm SDK will eventually completely replace the need for Cosmos-SDK.

There are also some permissionless CosmWasm chains. Juno has attracted a community of hundreds of developers and dozens of teams building innovative decentralized applications with CosmWasm. Notably, the DAO DAO built on Juno is becoming a DAO toolkit for cross-chain networks, rapidly growing in functionality and adoption. Archway is a protocol based on CosmWasm that explores new economic models for protocols, allowing application developers to generate revenue on-chain.

CosmWasm Ecosystem

Block unicorn note: Juno is a global, open-source, permissionless network for decentralized interoperable applications. Anyone can create and use cross-chain applications on Juno. The ecosystem has fostered the development and adoption of CosmWasm, enabling developers to deploy secure and reliable cross-chain smart contracts in Rust.

In the past two years, over 20 Cosmos blockchains have implemented CosmWasm. Various projects are also porting it to other ecosystems -- Composable Finance is building the first universal CosmWasm virtual machine outside of Cosmos. The number of hackathons themed around CosmWasm is also increasing, with at least three hackathons in 2022 and more planned for 2023, including Nebular Summit, HackAtom, AwesomWasm, and HackWasm. The CosmWasm Academy, a free educational platform provided by the main maintainers of the project, is also attracting new smart contract developers and is entering its third cohort.

The speed of development, security, ease of maintenance, and modern design, combined with the quality and breadth of Rust learning materials, provide solid reasons for developers to adopt CosmWasm. As more liquidity flows into cross-chain, we believe the number of CosmWasm developers will continue to grow, sparking a new wave of innovative decentralized applications.

9. DAO Tools

Mature DAO tools enable new forms of collaboration and provide developers with incredible technical capabilities to build decentralization into their projects.

When it comes to Cosmos DAO tools, there is only one: DAO DAO. Projects built on Juno are growing at an impressive rate and creating a robust set of developer tools. DAO DAO is building some of the best tools for decentralized autonomous organizations and collaboration within the crypto ecosystem. It is written for CosmWasm and offers features that EVM-based DAOs cannot provide.

For example, compared to Solidity smart contracts, CosmWasm contracts can specify an administrator capable of upgrading the linked code. In the case of WYND, its community DAO acts as the administrator and is the final arbiter of contract upgrades.

Another use case of power is validator management by a DAO, where a DAO controls the operation key of the validator. Thus, its members decide through governance how the validator votes in on-chain proposals, with rewards flowing directly to the DAO treasury.

But DAO DAO goes beyond the Juno chain. IBC compatibility means that other chains can leverage these tools to manage their community treasuries, as seen with Chihuahua's CommunityDAO, which pays developers' salaries from its community pool. IBC support also means that DAOs can hold any Cosmos tokens (fungible or non-fungible), allowing companies and investment funds to use these tools for internal finance or asset management.

One of the powerful features of DAO DAO is the ability to create sub-DAOs. In this configuration, a DAO can control an infinite number of sub-DAOs in a structure similar to a cross-chain DAO. The Juno chain uses sub-DAOs to manage its delegation program, and other chains are exploring this concept for fund management.

While DAO version 2 is still in development, version 3 is also underway, expected to include privacy features and new voting mechanisms.

As the foundation for large-scale decentralized collaboration, DAOs will continue to play a significant role in project funding and community decision-making, and we are closely monitoring the development of DAO DAO and the ecosystem of projects leveraging this powerful technology.

Wallets and Custody

Seed phrase wallets are outdated, replaced by more user-friendly custody solutions that leverage MPC and account abstraction. A part of the spirit of blockchain is self-sovereignty (not your keys, not your cryptocurrency). However, due to poor private key management, hundreds of billions of dollars have been lost. While initially designed for hardware wallets (where private keys never touch a connected computer), most desktop and mobile wallets generate seed phrases, placing the burden of secure storage on users. Custody in centralized exchanges is equally poor. Billions of dollars in user funds have been lost to exchange hacks, mismanagement, and fraud.

Block unicorn note: MPC accounts refer to the fragmentation of private keys stored in different locations, allowing for the merging of fragmented private keys when needed. This eliminates the risk of single-point storage, as conventional wallets require you to securely store the wallet mnemonic, which, if lost, cannot be recovered.

Account abstraction: Account abstraction refers to the future abstraction of wallet signature mechanisms. It revolves around Roll-up mechanisms, reducing gas fees. MEV seekers, validators, you or I will bundle all transactions into large transactions placed in Ethereum blocks.

The future of digital asset custody lies in a hybrid approach. Advances in cryptography, utilizing threshold signatures through multiparty computation (MPC) and on-chain solutions like smart contract wallets and account abstraction, create a win-win scenario where self-custody ensures security and user-friendliness.

ZenGo is the best example of an MPC-based wallet, providing everyone with a simple login experience using just an email address and secure account recovery if the device is lost or stolen. Users' accounts use biometric scans to encrypt MPC shares, which can be securely backed up locally or in the cloud.

Better developer tools enable builders to leverage this approach. Web3Auth and Dfns provide infrastructure and APIs to build custody solutions, utilizing single sign-on (SSO) and social logins while providing simple recovery, both improving support for assets in the Cosmos ecosystem.

On the platform side, Odsy Network is a truly novel idea that could fundamentally change the concept of custody. Their blockchain functions like a decentralized Fireblocks, executing account permissions on-chain. Wallets become completely abstract and can exist in the form of NFTs.

We hope to see more large tech companies adopt MPC as well. Google announced its Confidential Space product, leveraging MPC for secure digital asset management. Strangelove Labs, a core contributor to Cosmos, is collaborating with Google to build key management integration.

Argent pioneered smart contract wallets, allowing user wallets to link to trusted friends' and family members' wallets, enabling trusted family or friends' wallets to help recover the wallet or impose restrictions on wallet payments.

We have already seen the building blocks needed to create similar experiences in Cosmos. The combination of mature DAO tools and cross-chain accounts can create interesting account permission systems for companies and individuals.

There are trade-offs between on-chain and MPC methods, but we are excited to see more wallets adopting hybrid custody. Just as the invention of SSL (Secure Sockets Layer) was crucial for the growth of e-commerce, data privacy and asset custody in crypto are similarly essential.