The Scalability Trilemma & Cosmos

The perfect blockchain would be decentralized, scalable, and secure. It is decentralized to be credibly fair and censorship-resistant, scalable to handle the masses, and safe from exploitation.

Unfortunately, the perfect blockchain does not exist. Instead, what we have is the scalability trilemma. The tradeoffs required to develop a blockchain necessitate deprioritizing one of these pillars to benefit the other two.

Bitcoin and Ethereum have prioritized decentralization and security. As a result, both have run into performance and scalability issues as their blockchains have become more popular. To see how this plays out for consumers, let’s look at transactions per second (TPS) of popular blockchains and payment processors.

Scalability has traditionally meant sacrificing decentralization or security.

Let’s take Visa’s 65,000 transactions per second as the benchmark. Even with 335 million cards in circulation, we hardly wait more than a few seconds for our transaction to go through. Compare this experience with Ethereum and Bitcoin, which can process 20 and 10 transactions per second, respectively. It is not uncommon for network fees to be in the tens or hundreds of dollars while taking upwards of an hour to go through. Even worse, sometimes transactions fail altogether. A less-than-ideal experience and a non-starter for industries that require near-instant processing.

Other chains like Solana, Avalanche, Ripple, and Polkadot can process many transactions more per second and have prioritized scalability and security at the expense of decentralization. This tradeoff means the systems require trust to operate. Unlike decentralized chains, I have to put my faith in an organization rather than rely on immutable code. If the priorities of the organization change or they are compromised, I could be at risk.

For those who see decentralization and security as non-negotiable, solving the scalability trilemma is necessary for adoption. Within the Ethereum ecosystem, scaling solutions sporting super sexy names like Zero Knowledge Proofs and Optimistic Roll-Ups have taken center stage. Layer 2’s (L2) blockchains that process transactions on their chain and then settle on Layer 1 (L1)’s, like Ethereum, have integrated these scaling solutions to drive improvements in TPS. Polygon, the largest L2 on Ethereum, can handle 65,000 transactions per second. The exact number as Visa. As a result, transactions go through faster and cost fractions of a penny to finalize.

However, these L2s are not without their drawbacks. From a consumer perspective, interacting with L2s requires setting up separate bridges in your wallet. A cumbersome process that, if done incorrectly, can end up with you sending funds to an unrecoverable no man’s land. Additionally, these L2s are being developed in silos. You can send tokens between L2s and L1s but not between L2s. So much for an interoperable future.

Herein lies the fundamental difference in thesis between Ethereum and our star of today’s One Big Idea, Cosmos. The self-described “internet of blockchains,” Cosmos believes general-purpose chains are ill-equipped for a scaled, interoperable future. Their vision? To enable a network of sovereign, interconnected, app-specific blockchains. We will discuss how Cosmos operates today and its direction with Cosmos 2.0.

With $61B+ in assets under management, 263+ apps, and up to 49 active IBC-connected chains, the Cosmos ecosystem is red hot. Applications like Osmosis, Cronos, Kava, and notably dYdX (who recently departed from Ethereum), have opted for Cosmos stack and a modular app-specific approach.

The Cosmos stack consists of Tendermint, Cosmos SDK, and the Inter-Blockchain Communication Protocol or IBC.

Cosmos’ proof of stake (PoS) consensus mechanism, Tendermint, was launched in 2019. Predating Ethereum’s move to PoS by almost three years. Validators compete for the right to confirm transactions on-chain and collect network fees for the block. To become a validator, these machines stake tokens to the chain. The probability of a validator winning a given block is tied to the percentage of the total tokens staked. For the network to be compromised, a hacker must take control of 51% of the staked tokens—a practically impossible outcome.

Cosmos SDK is a modular blockchain framework. Rather than build on a general blockchain like Ethereum, applications build custom chains tailored to their needs. The SDK modules are interoperable and are powered by Tendermint to confirm transactions securely.

The IBC protocol enables each app blockchain (consisting of Tendermint + SDK) to communicate. The protocol facilitates the transfer of assets like tokens, NFTs, and account information.

The Cosmos hub, the first application chain in the network, served as the origin of Tendermint, Cosmos SDK, and IBC. Its role as a neutral chain is to facilitate the adoption of the Cosmos stack to other chains. Therefore, the Cosmos hub and its native token ATOM have no advantage in the ecosystem. This decision gave applications confidence that the hub would not develop in direct competition with them, thus fostering further adoption.

However, not elevating the Cosmos hub and ATOM has drawbacks. For one, unlike Ethereum, the Cosmos community does not have a single decentralized foundation driving a uniform roadmap. Another disadvantage is not installing ATOM, as the network’s reserve currency has lessened its utility and market cap. This makes the currency less attractive as collateral (lower liquidity, higher risk).

These drawbacks will soon be addressed with the introduction of Cosmos 2.0.

With the Cosmos Hub achieving its goal of originating the playbook for building the internet of blockchains, the focus has shifted to building a resilient interchain economy. Cosmos 2.0 looks to establish the Cosmos Hub as the infrastructure service provider of the Cosmos ecosystem. The proposal has four main pillars. They are:

1. Accelerate secure economic scaling by installing Interchain Security and Liquid Staking.

2. Build out hub-specific functionality through the introduction of the Interchain Scheduler + Interchain Allocator

3. Establish ATOM as the interchain reserve currency

4. Expansion of autonomous decentralized governance with Cosmos Councils & Cosmos Assembly

The proposed Cosmos 2.0 stack

With Cosmos 2.0, the Cosmos Hub will become the security layer for app chains to build interchain-native applications and infrastructure.

Interchain Security provides new projects with the security of the Cosmos Hub. Remember that Proof of Stake requires validators to stake tokens to secure the network and confirm transactions. In the old model, each blockchain on Cosmos was responsible for its security. Typically this required validators to hold each chain’s native token to stake. With Cosmos 2.0, chains are secured to one another via validators staking ATOM. This has two significant benefits:

1. New projects can benefit from the entire network's security at almost no marginal cost to the validator ecosystem.

2. ATOM staking increases the utility of the token. A more valuable token should result in a higher market cap which benefits ATOM holders and helps to secure the network further.

Traditional staking requires validators to lock up capital to secure the network and earn fees. This comes at the opportunity cost of using the money elsewhere. Liquid staking removes opportunity costs by enabling validators to use their capital by exchanging the staked token for a synthetic at a determined rate. To receive their staked ATOM, the validator trades the same amount of synthetic tokens they received. In the interim, they can use the synthetic to participate in the ecosystem. Thus, liquid staking increases the network's security by making staking more attractive than other uses of capital.

A cross-chain block space marketplace, the Interchain Scheduler generates revenue by charging participants (searchers) to control the order of transactions within a block. Known as Maximum Extractable Value, searchers use control of block space to capitalize on arbitrage opportunities. These include: buying a token on one decentralized exchange (DEX) at a lower price and then selling at a higher price on another DEX within the same transaction, processing liquidation transactions, and sandwich trading (optimizing buy and sell orders to take advantage of large trades coming in).

Today, these MEV opportunities are handled independently, off-chain in black markets for each Cosmos network chain. The Interchain Scheduler looks to unify these disparate markets and allow searchers to buy cross-chain in one place. For Cosmos, the benefit is collecting these MEV fees as revenue to be used by the Interchain Allocator (more on this in a sec). For searchers, a cross-chain marketplace will be more robust in MEV opportunities.

Funded by Interchain Scheduler fees, the Interchain Allocator invests in new Cosmos chains and cross-chain collaboration projects. These investments increase the total addressable market of the Interchain Allocator, creating a flywheel effect. Fees lead to more scaling lead to more fees.

The scheduler x allocator flywheel

Before Cosmos 2.0, ATOM issuance aimed to balance liquidity with the network's security. With traditional staking locking up capital, the network needed to ensure that ATOM was kept in supply as working capital. Thus, a percentage of the total supply staked was the target. If the ratio went below the mark, issuance was increased until the target was reached. If the balance went above the target, issuance decreased to disincentivize staking, causing the ratio to fall back down.

With the introduction of liquid staking, working capital is no longer a concern, and the monetary policy can be re-evaluated. Cosmos 2.0 will look to balance interchain adoption, growth, and capitalization while maintaining security.

In the first nine months of the new monetary policy, issuance will increase to bootstrap the new Cosmos Hub Treasury funding. Over time the new policy will make ATOM deflationary.

To date, the development of the Cosmos has been carried out by a network of open-source projects and contributors. Each stakeholder develops to their needs and commits the code to the broader network for use by everyone. Contrast this to Ethereum, which leverages Ethereum Improvement Proposals (EIPs) to coordinate the decentralized development of its roadmap. This disparate, open development has led many to refer to Cosmos as an “idea” rather than a singular vision.

With Cosmos 2.0, the authors propose establishing a standard decentralized governance framework. Within it, language is set for autonomous hubs to communicate with one another.

The Cosmos Hub Assembly is a proposed decentralized organizational body whose mission is to represent the strategic interests of the Cosmos community. The assembly will manage the newly minted Cosmos Hub Treasury. Developing policies, priorities, and budgets.

Cosmos Councils are domain-specific DAOs that take the top-level strategy of the Assembly to establish tactics for implementation. The assembly may grant these councils funds from the treasury to execute their roadmaps.

With the white paper approved, the Cosmos Hub 2.0 roadmap is already underway. Development is currently staged through Q3 2023. You can follow along here. For further reading check out some of the links provided below.

Cosmos Hub White Paper (READ)

The Cosmos Hub Roadmap 2.0 (READ)

Cosmos 2.0 Breakdown by Westie Capital (READ)

The Cosmos Thesis with Sunny Aggarwal (WATCH)

The Mind, Body, & Soul of Cosmos (READ)

ATOM 2.0 (LISTEN)

That’s it for this week. Did you enjoy the deep dive or prefer more opinion-based pieces? Let me know in the comments and I will see you all here on Friday!

austin

The Scalability Trilemma & Cosmos

The perfect blockchain would be decentralized, scalable, and secure. It is decentralized to be credibly fair and censorship-resistant, scalable to handle the masses, and safe from exploitation.

Unfortunately, the perfect blockchain does not exist. Instead, what we have is the scalability trilemma. The tradeoffs required to develop a blockchain necessitate deprioritizing one of these pillars to benefit the other two.

Bitcoin and Ethereum have prioritized decentralization and security. As a result, both have run into performance and scalability issues as their blockchains have become more popular. To see how this plays out for consumers, let’s look at transactions per second (TPS) of popular blockchains and payment processors.

Scalability has traditionally meant sacrificing decentralization or security.

Let’s take Visa’s 65,000 transactions per second as the benchmark. Even with 335 million cards in circulation, we hardly wait more than a few seconds for our transaction to go through. Compare this experience with Ethereum and Bitcoin, which can process 20 and 10 transactions per second, respectively. It is not uncommon for network fees to be in the tens or hundreds of dollars while taking upwards of an hour to go through. Even worse, sometimes transactions fail altogether. A less-than-ideal experience and a non-starter for industries that require near-instant processing.

Other chains like Solana, Avalanche, Ripple, and Polkadot can process many transactions more per second and have prioritized scalability and security at the expense of decentralization. This tradeoff means the systems require trust to operate. Unlike decentralized chains, I have to put my faith in an organization rather than rely on immutable code. If the priorities of the organization change or they are compromised, I could be at risk.

For those who see decentralization and security as non-negotiable, solving the scalability trilemma is necessary for adoption. Within the Ethereum ecosystem, scaling solutions sporting super sexy names like Zero Knowledge Proofs and Optimistic Roll-Ups have taken center stage. Layer 2’s (L2) blockchains that process transactions on their chain and then settle on Layer 1 (L1)’s, like Ethereum, have integrated these scaling solutions to drive improvements in TPS. Polygon, the largest L2 on Ethereum, can handle 65,000 transactions per second. The exact number as Visa. As a result, transactions go through faster and cost fractions of a penny to finalize.

However, these L2s are not without their drawbacks. From a consumer perspective, interacting with L2s requires setting up separate bridges in your wallet. A cumbersome process that, if done incorrectly, can end up with you sending funds to an unrecoverable no man’s land. Additionally, these L2s are being developed in silos. You can send tokens between L2s and L1s but not between L2s. So much for an interoperable future.

Herein lies the fundamental difference in thesis between Ethereum and our star of today’s One Big Idea, Cosmos. The self-described “internet of blockchains,” Cosmos believes general-purpose chains are ill-equipped for a scaled, interoperable future. Their vision? To enable a network of sovereign, interconnected, app-specific blockchains. We will discuss how Cosmos operates today and its direction with Cosmos 2.0.

With $61B+ in assets under management, 263+ apps, and up to 49 active IBC-connected chains, the Cosmos ecosystem is red hot. Applications like Osmosis, Cronos, Kava, and notably dYdX (who recently departed from Ethereum), have opted for Cosmos stack and a modular app-specific approach.

The Cosmos stack consists of Tendermint, Cosmos SDK, and the Inter-Blockchain Communication Protocol or IBC.

Cosmos’ proof of stake (PoS) consensus mechanism, Tendermint, was launched in 2019. Predating Ethereum’s move to PoS by almost three years. Validators compete for the right to confirm transactions on-chain and collect network fees for the block. To become a validator, these machines stake tokens to the chain. The probability of a validator winning a given block is tied to the percentage of the total tokens staked. For the network to be compromised, a hacker must take control of 51% of the staked tokens—a practically impossible outcome.

Cosmos SDK is a modular blockchain framework. Rather than build on a general blockchain like Ethereum, applications build custom chains tailored to their needs. The SDK modules are interoperable and are powered by Tendermint to confirm transactions securely.

The IBC protocol enables each app blockchain (consisting of Tendermint + SDK) to communicate. The protocol facilitates the transfer of assets like tokens, NFTs, and account information.

The Cosmos hub, the first application chain in the network, served as the origin of Tendermint, Cosmos SDK, and IBC. Its role as a neutral chain is to facilitate the adoption of the Cosmos stack to other chains. Therefore, the Cosmos hub and its native token ATOM have no advantage in the ecosystem. This decision gave applications confidence that the hub would not develop in direct competition with them, thus fostering further adoption.

However, not elevating the Cosmos hub and ATOM has drawbacks. For one, unlike Ethereum, the Cosmos community does not have a single decentralized foundation driving a uniform roadmap. Another disadvantage is not installing ATOM, as the network’s reserve currency has lessened its utility and market cap. This makes the currency less attractive as collateral (lower liquidity, higher risk).

These drawbacks will soon be addressed with the introduction of Cosmos 2.0.

With the Cosmos Hub achieving its goal of originating the playbook for building the internet of blockchains, the focus has shifted to building a resilient interchain economy. Cosmos 2.0 looks to establish the Cosmos Hub as the infrastructure service provider of the Cosmos ecosystem. The proposal has four main pillars. They are:

1. Accelerate secure economic scaling by installing Interchain Security and Liquid Staking.

2. Build out hub-specific functionality through the introduction of the Interchain Scheduler + Interchain Allocator

3. Establish ATOM as the interchain reserve currency

4. Expansion of autonomous decentralized governance with Cosmos Councils & Cosmos Assembly

The proposed Cosmos 2.0 stack

With Cosmos 2.0, the Cosmos Hub will become the security layer for app chains to build interchain-native applications and infrastructure.

Interchain Security provides new projects with the security of the Cosmos Hub. Remember that Proof of Stake requires validators to stake tokens to secure the network and confirm transactions. In the old model, each blockchain on Cosmos was responsible for its security. Typically this required validators to hold each chain’s native token to stake. With Cosmos 2.0, chains are secured to one another via validators staking ATOM. This has two significant benefits:

1. New projects can benefit from the entire network's security at almost no marginal cost to the validator ecosystem.

2. ATOM staking increases the utility of the token. A more valuable token should result in a higher market cap which benefits ATOM holders and helps to secure the network further.

Traditional staking requires validators to lock up capital to secure the network and earn fees. This comes at the opportunity cost of using the money elsewhere. Liquid staking removes opportunity costs by enabling validators to use their capital by exchanging the staked token for a synthetic at a determined rate. To receive their staked ATOM, the validator trades the same amount of synthetic tokens they received. In the interim, they can use the synthetic to participate in the ecosystem. Thus, liquid staking increases the network's security by making staking more attractive than other uses of capital.

A cross-chain block space marketplace, the Interchain Scheduler generates revenue by charging participants (searchers) to control the order of transactions within a block. Known as Maximum Extractable Value, searchers use control of block space to capitalize on arbitrage opportunities. These include: buying a token on one decentralized exchange (DEX) at a lower price and then selling at a higher price on another DEX within the same transaction, processing liquidation transactions, and sandwich trading (optimizing buy and sell orders to take advantage of large trades coming in).

Today, these MEV opportunities are handled independently, off-chain in black markets for each Cosmos network chain. The Interchain Scheduler looks to unify these disparate markets and allow searchers to buy cross-chain in one place. For Cosmos, the benefit is collecting these MEV fees as revenue to be used by the Interchain Allocator (more on this in a sec). For searchers, a cross-chain marketplace will be more robust in MEV opportunities.

Funded by Interchain Scheduler fees, the Interchain Allocator invests in new Cosmos chains and cross-chain collaboration projects. These investments increase the total addressable market of the Interchain Allocator, creating a flywheel effect. Fees lead to more scaling lead to more fees.

The scheduler x allocator flywheel

Before Cosmos 2.0, ATOM issuance aimed to balance liquidity with the network's security. With traditional staking locking up capital, the network needed to ensure that ATOM was kept in supply as working capital. Thus, a percentage of the total supply staked was the target. If the ratio went below the mark, issuance was increased until the target was reached. If the balance went above the target, issuance decreased to disincentivize staking, causing the ratio to fall back down.

With the introduction of liquid staking, working capital is no longer a concern, and the monetary policy can be re-evaluated. Cosmos 2.0 will look to balance interchain adoption, growth, and capitalization while maintaining security.

In the first nine months of the new monetary policy, issuance will increase to bootstrap the new Cosmos Hub Treasury funding. Over time the new policy will make ATOM deflationary.

To date, the development of the Cosmos has been carried out by a network of open-source projects and contributors. Each stakeholder develops to their needs and commits the code to the broader network for use by everyone. Contrast this to Ethereum, which leverages Ethereum Improvement Proposals (EIPs) to coordinate the decentralized development of its roadmap. This disparate, open development has led many to refer to Cosmos as an “idea” rather than a singular vision.

With Cosmos 2.0, the authors propose establishing a standard decentralized governance framework. Within it, language is set for autonomous hubs to communicate with one another.

The Cosmos Hub Assembly is a proposed decentralized organizational body whose mission is to represent the strategic interests of the Cosmos community. The assembly will manage the newly minted Cosmos Hub Treasury. Developing policies, priorities, and budgets.

Cosmos Councils are domain-specific DAOs that take the top-level strategy of the Assembly to establish tactics for implementation. The assembly may grant these councils funds from the treasury to execute their roadmaps.

With the white paper approved, the Cosmos Hub 2.0 roadmap is already underway. Development is currently staged through Q3 2023. You can follow along here. For further reading check out some of the links provided below.

Cosmos Hub White Paper (READ)

The Cosmos Hub Roadmap 2.0 (READ)

Cosmos 2.0 Breakdown by Westie Capital (READ)

The Cosmos Thesis with Sunny Aggarwal (WATCH)

The Mind, Body, & Soul of Cosmos (READ)

ATOM 2.0 (LISTEN)

That’s it for this week. Did you enjoy the deep dive or prefer more opinion-based pieces? Let me know in the comments and I will see you all here on Friday!

austin