ATOM 2.0: debate and discussion about the future of Cosmos

ATOM 2.0 is the new and updated roadmap for Cosmos Hub and was one of the most anticipated announcements at Cosmoverse. Leading up to the event, discussions were mostly centered around potential tokenomic changes resulting in better value accrual for the $ATOM token. Since the announcement, there have been a lot of discussion in the community, between developers, and people involved in the Cosmos Network.

But what’s the fuzz? Can an updated direction of Cosmos Hub be beneficial for everyone? And why is ATOM 2.0 so divisive?

In a nutshell

The first version of a new whitepaper is intended to revamp the tokenomics of its native token ($ATOM). Authors of the paper proposed that the Cosmos Hub would be the heart of its new interchain security feature, and that there would be changes to the issuance and utility of ATOM.

The idea is to move $ATOM from a purely monetary asset with speculative premium and only loose ties to the rest of the IBC economy, to a reserve asset for the Interchain — one which is held by a multitude of incentive-aligned projects and backed by tangible value and revenues.

In sum, the aim is to tie $ATOM’s value to the growth of the ecosystem as a whole, without infringing on Cosmos’ values of sovereignty and non-coercion

Initial on-chain voting on the proposal was set for Oct. 3, but community members in the ecosystem voiced concerns centered around $ATOM issuance, Zaki Manian — the co-founder of Sommelier and a key member of the Cosmos ecosystem — told Blockworks.

In the existing ecosystem, staking rewards are fundamentally a value transfer between non-staked $ATOM to stakers, Manian said.

“Currently in the Cosmos, when a block is created, $ATOM tokens are distributed to stakers, validators and the community,” he added. “The mechanism of funding the system by diluting unstaked $ATOMs has a time limit, and we need to fix that.”

The ATOM 2.0 white paper, as such, proposes setting up a treasury that would be tasked with using capital to find sources of revenue that are sustainable and not inflationary.

The initial 1.0 version of the white paper proposed a big mint of $ATOM for the proposed Treasury and then a subsequent drop in $ATOM staking rewards — what Manian called a “tail emission.”

But the community wanted less front loading of that creation of $ATOM.

Taking into consideration community concerns, the Cosmos Hub pushed back the start of proposal voting to Oct. 24 — then again to Oct. 31 — releasing updated versions of the white paper to include suggestions from community members.

“So now, what we propose is a 4 million $ATOM mint into the community pool which currently has around one million $ATOMs in it,” Manian said. “Then optionally — at the discretion of $ATOM holders — ten more mints of $ATOM into the treasury, if the project of going out and finding new sources of revenue, that will eventually replace staking revenue, is succeeding.”

With ATOM 2.0, Cosmos Hub aims to continue providing infrastructure services such as:

• Interchain Security
• Liquid Staking
• Interchain Scheduler
• Interchain Allocator

Interchain Security

Interchain Security allows chains on Cosmos to reuse the same validator set and staked collateral of an existing chain to secure their network. Liquid Staking providers like LIDO (on Neutron) and Quicksilver will be among the first to utilize Interchain Security by leveraging the security of Cosmos Hub.

New blockchains can develop independently while being secured by the full validator set of Cosmos Hub, removing the need to bootstrap security of their own validator set. Chains may be independent economically by diverting a portion of inflation and fees to cover security costs, or opt for a fee split rather than creating a dedicated token for the network.

Interchain Security reduces the barriers and costs of entry for consumer chains and enables a number of potential applications, including:

• Rollup Settlement — the rollup settlement system and scaling solution enables external data availability providers such as Celestia to publish fraud proofs
• IBC Routing — a market for IBC relay contracts and multi-hop connections, allowing IBC-wide coverage for efficient cross-chain communication and transfers
• Multiverse — an infrastructure automation making the creation of a Cosmos Hub-secured blockchain as simple as deploying a smart contract
• Chain Name Service (CNS) — a secure identification and authentication service for IBC-connected blockchains; enables permissionless management of information on chains

Liquid Staking

Liquid staking (not to be confused with Liquid Proof-of-Stake increases the capital efficiency of staked assets by unlocking bonded capital via tokenized derivatives, which are essentially a representation of the bonded assets. This allows users to bond assets and participate in consensus and governance while being able to deploy the same capital in other DeFi applications. A popular example would be to stake an asset, take a liquid staking derivative (LSD) that represents that position, and deposit it as collateral for a loan. This is possible because an LSD is essentially a claim on future cash flow of the underlying bonded asset. Liquid staking, however, is not without risks, as misappropriation of held assets or slashing may lead to the insolvency of protocols relying on LSDs.

As mentioned above, liquid staking protocols will be among the first adopters of Interchain Security, enabling $ATOM stakers to earn staking rewards while utilizing their $ATOM for other earning opportunities. Thus, both Interchain Security and liquid staking work hand in hand to provide a base layer for interchain utility.

Interchain Scheduler

Maximal extractable value (MEV) has become an increasingly popular topic of discussion and the focus of many recent developments (e.g. implementation of MEV-Boost by Flasbots on Ethereum). In general, there are three forms of MEV:

1. Arbitrage (“good MEV”) — arbitrageurs find two DEXs offering a token at two different prices, buy the token on the lower-priced DEX and profit by selling it on the higher-priced DEX
2. Liquidations (“good MEV”) — searchers compete to be the first in line to submit a liquidation transaction to earn a liquidation fee from lending protocols
3. Sandwiching/Frontrunning (“bad MEV”) — a searcher watches the mempool for large DEX trades, approximate the price effect of the trade, then executes an optimal buy order immediately before the large trade, buying the asset at a lower price before selling it immediately to the original buyer for a higher price.

While MEV development has been growing on Ethereum, MEV in the Cosmos ecosystem is relatively nascent. According to Skip Protocol, a protocol focusing on MEV products on Cosmos, more than $6.7 million in arbitrage MEV has already been extracted from Osmosis alone since its launch. Compare this to MEV on Ethereum, where gross extracted arbitrage MEV by Flashbots reached over $490 million (data collected from August 2020, pre-Merge).

Thus, with Interchain Scheduler, Cosmos Hub plans to provide a secure tokenized cross-chain block space marketplace and MEV solution. Unlike existing MEV solutions like Flashbots’ which are off-chain markets, Interchain Scheduler brings MEV markets on-chain, facilitating a fairer and more transparent system. This is made possible via Tendermint’s ABCI++, which enables partner chains to tokenize reservations for future block space.

A typical Scheduler flow looks like this:

1. Consumer chains with the Scheduler module enabled can provide a portion of their block space (e.g. one block per minute).
2. The Scheduler issues reservation non-fungible tokens (NFTs) to represent each future block region on the consumer chain. NFTs from all participating chains are periodically auctioned in batches.
3. Reservation NFTs may also be traded on secondary markets until the reservation is redeemed.
4. A split of the proceeds from the Scheduler auction are sent back to the partner chain upon successful block execution.

Interchain Allocator

The Interchain Allocator is a system for capital allocation that aims to incentivize long-term alignment by facilitating efficient bootstrapping of users and liquidity for new chains. The more of ‘Coin X’ that Cosmos Hub holds and the more $ATOM that ‘Chain X’ holds, the more incentive aligned the two chains become.

$ATOM stakeholders could form DAOs to utilize the Interchain Allocator to achieve its mandate, which includes:

• Increasing velocity of new Cosmos projects
• Accelerating project growth and sustainability
• Expanding economy for cross-chain blockspace
• Aligning incentives between new projects and Cosmos Hub

Two basic tools provided by the Allocator to facilitate the above will be:

1. Covenant — a system for establishing multilateral agreements with designated chains and IBC-enabled entities; allows Allocation DAOs to enter into on-chain agreements with other chains
2. Rebalancer — a system for automatically managing asset portfolios with public liquidity; tool for execution of third-party capital allocation strategies by periodically buying or selling assets

Thus, the Scheduler and Allocator could potentially work together to create a positive feedback loop for Cosmos Hub as it supports other chains via capital allocation and Interchain Security.

New Tokenomics

Issuance

$ATOM currently has no cap on its total supply and uses token issuance (inflation) to achieve a target supply of $ATOM staked. This is done by reducing inflation to a minimum of 7% when $ATOM staking ratio is above two-thirds of its total supply and increasing inflation to a maximum of 20% when $ATOM staking ratio is below two-thirds of its total supply. As of the time of writing, $ATOM inflation rate is 12.87% with a staking ratio of 66.95% and a total supply of 311.8 million tokens.

The introduction of liquid staking increases capital efficiency by allowing staked $ATOM to be utilized elsewhere. Thus, the current monetary policy is reconsidered in the new white paper since users do not have to choose between staking their $ATOM or using it in other DeFi protocols. As such, a new monetary policy is proposed which involves a transitory and steady phase.

The proposed transitory phase begins with a significant increase of issuance that lasts for 36 months before reaching a steady issuance rate that lasts indefinitely. The issuance rate starts at 10 million $ATOM per month before declining until an issuance rate of 300,000 $ATOM per month.

The goal is to gradually remove security subsidies, starting from the current rate and decreasing by 10% every month for 36 months. By the end of this period, it is hoped that revenue from Interchain Security will meet or exceed the original subsidy.

This heightened issuance is meant to bootstrap the new Cosmos Hub Treasury that will be used to support and expand the network.

Fees

Currently, Cosmos Hub’s transaction fees are sent to the distribution module and divided between the Community Pool, delegators, and validators. The implementation of Interchain Security will add another stream of revenue from each consumer chain to the distribution module, which will replace the current security subsidy.

Pros and cons of ATOM 2.0

There are a lot of mixed reactions on the new white paper. Some are nuanced while others aren’t, and some do back it up with reasonable arguments while others do not. We bundled some of the pros and cons of ATOM 2.0 mentioned by developers and the community, so we have a glance of what points are being made and why. These pros and cons may not be objective and may be subject to personal beliefs.

Pros

• $ATOM must have more use to remain relevant.
• A new and polished roadmap may attract new projects, investors, and in a world where cryptocurrency becomes more and more relevant, $ATOM 2.0 may be more future proof.
• One may argue that decentralized finance is the future; having DeFi and Liquid Staking can be a the next logical step for $ATOM
• Removing the need to bootstrap security of their own validator set, can be a big plus.

Cons

• The Cosmos architecture and IBC is why most people love Cosmos, paying royalties for IBC usage is against the Hub’s ethos.
• Concerns about centralization, along with no experience in managing treasuries. The treasury controlled by a so-called council with vague transparency and next to no obligations to $ATOM holders and the community is too big of a threat to Cosmos Hub.
• Councils, treasuries and minting makes Cosmos too complex, and the Hub should focus what really matters: Interchain Security.
• The treasury and inflation may be a threat to the value of the coin.