The USDC Consumer Chain

Before diving into the Cosmos 2.0 whitepaper, we'd like to take a brief detour and discuss what we believe to be Cosmoverse's most important statement - the USDC Consumer Chain. Cosmos DeFi is severely lacking in stablecoin liquidity. Its $85 million in stablecoins across the ecosystem (with only $16 million issued natively) is insignificant compared to nearly every other ecosystem and even Ethereum L2s. Stablecoins are required for a DeFi ecosystem to take off.

Step into the USDC Consumer Chain. To be precise, this will be a chain of generic asset releases, with USDC serving as the first and most likely largest link. We won't go into detail about Interchain Security because we have already done so

Cosmos: A fresh wind with vertical scaling solutions, but the basic concepts are that this will be an independent chain that will issue USDC as well as other generic assets guaranteed by ATOM validators and stakers. This means that Cosmos will earn the fees for every transaction on the consumer USDC chain.

Other chains will need to bridge USDC from the USDC chain in order to use it. After USDC is bridged, activity on the USDC chain is no longer produced by transactions on remote chains. Contrarily, cross-chain USDC transfers will, because USDC will almost certainly be bridged back to the USDC chain prior to actually moving to another location to avoid fragmenting liquidity. Additionally, the USDC chain will be the only chain that settles deposits and withdrawals from CEX.

In light of that, the costs involved will not be high. 75,000 transfers per day are made in USDC on Ethereum. Taking a generous 10% of this at $0.05 per transaction nets us $375 per day or $137,000 per year. Other assets and the ICS module will have fees, but the implication is that the Hub won't see a significant increase in revenue from them. Regarding the amount of USDC issued, we should anticipate demand from orderbook protocols such as Sei to follow quickly after a combined $500M from dYdX and Osmosis. The main advantage of this is that Cosmos chains won't need to rely on unique third-party bridges to gain access to stablecoins anymore. They will be solely dependent on IBC. Due to its security model and the extensive teamwork that went into its development over many years, IBC is generally regarded as the most secure option among current bridges, but it is still susceptible to implementation errors like other bridges.

So why is it crucial for the Hub if the fees collected are modest? because it further establishes the Hub's position as a key Schelling point in the ecosystem and highlights Interchain Security as the Hub attempting to establish an economic zone.

Before continuing, a little digression here regarding the censorship resistance characteristics of IBC USDC is worth making. Due to the fact that Circle has no control over the IBC USDC receipt tokens, it will not be possible for them to ban or freeze certain USDC tokens or addresses on other Cosmos chains. They are limited to blocking a channel to another chain. The debate is more comparable to Circle suspending all of the USDC in Maker since closing a channel to a whole chain is a very significant leap from closing a channel to a specific address.

Key points from ATOM 2.0 whitepaper

The whitepaper centers on a few key points, which we will summarize below. Interchain Allocator and Interchain Scheduler are two new concepts. Don't worry if much of this is going over your head right now. I'll go through each one as we go through the report. The paper's overarching goal is to:

Create a treasury for the Hub that is financed through ATOM issuing.
Through the Interchain Allocator, encourage the usage of Interchain Security by engaging in and promoting the long-term development of Consumer Chains.
Boost the liquidity and economic growth in these Consumer Chains guaranteed by the Hub, the ATOM "economic zone," by not just funding but also actively engaging in DeFi via the Allocator.
Monetize MEV in this area by establishing an on-chain MEV marketplace using the Interchain Scheduler.
Turn ATOM into the ecosystem's reserve asset by combining all of these factors into a flywheel. This will transform ATOM from an asset that is only dependent on a speculative monetary premium to one that has a monetary premium, asset support, and cash flows.

More focus on liquid staking

The initial sections of the whitepaper cover liquid staking and interchain security. Again, we won't get into the specifics of Interchain security in this discussion, but we do want to emphasize that ICS serves as the centerpiece of the ATOM 2.0 concept and that everything else in this paper revolves around it. A thriving economic region with Consumer Chains that are all protected by the Hub is the ultimate aim. The elements in the whitepaper are intended to make this vision a reality.

So why is liquid staking being pushed? To put it simply, to lower the hurdle rate for ATOM. All ATOM in Cosmos DeFi is unstaked because there are no liquid staking tokens.

atom liquid stake

Source: Cosmos 2.0 Whitepaper

As fewer tokens are staked or bonded on the Hub, this directly affects the security of the Hub. The issuance of security must expand in order to encourage more staking, however, this comes at a high cost! The Hub's inflation rate is around 13% (with a 19% staking APR) since they must inflate more to compete with the huge DeFi yields. Additionally, encouraging staking via DeFi hinders the development of the larger ecosystem since users of ATOM in DeFi must surpass the staking hurdle rate of about 19%. Everyone ends up overpaying as a result of the unpleasant competition it causes between the Hub and the Cosmos chains.

The answer to this problem is liquid staking, which is a key component of the ATOM 2.0 concept. In the not-too-distant future, the Hub will offer security to various liquid-staking consumer chains. Consider the ATOM/OSMO pool on Osmosis as an example to comprehend the advantages. Since this pool employs unstaked ATOM, anyone making a deposit immediately forfeits the 19% APR on their ATOM. The pool has an APR of about 23% (29% if superfluid) paid in OSMO as compensation. The ATOM in the pool would be receiving the 19% if a staked ATOM token, such as Stride's stATOM, was used in place of ATOM. As a result, the user would not have to choose between utilizing their ATOM in DeFi or staking. In order for these derivative tokens to be granted the same security as the chain they represent, the liquid staking tokens will be released on Hub Consumer Chains. Interchain Security and liquid staking are the Hub's two short-term priorities.

Changes in ATOM issuance schedule

The revised issuance schedule is the section in the whitepaper that has generated the greatest debate. Prior to continuing, it is important to remember that the primary near-term priorities—ICS and liquid staking—mean that any new issuance plan that is authorized will probably not take effect for another year. Liquid staking's widespread adoption is a crucial first step in ensuring that enough ATOM is staked and bonded since the plan would drastically reduce the amount of issues for staking. The particular figures shown here are also susceptible to change, but the overall concept is the same.

atom monthly issuance

Atom cumulative issuance

Source: Cosmos 2.0 whitepaper

In essence, the plan calls for financing an ATOM treasury beforehand. For the first month, issuance will commence at 10M ($130M), with 2/3 going to the Treasury and 1/3 to Security, and staking will begin at a rate that is similar to today's APR (19%). After 36 months, monthly issuance will reach a permanent rate of 300,000 ATOM/month (with 1% inflation) after declining by 12%/month. The 300,000/month that was supposed to go to the Treasury per the whitepaper appears to have been changed to stakeholder issuance as a result of community backlash.

It's important to reiterate that this breakdown is not final and is subject to change. The projected 55 million ATOM treasury would be worth $715 million at the current pricing and almost $2.5 billion at the all-time high. While spending has no practical effect on ATOM as it is non-circulating and kept by ATOM holders, a greater treasury may result in more extravagant spending since the psychological effects of having access to such a huge amount of wealth can affect decision-making. Additionally, because the monthly issue is only for show, it's feasible that they decide to mint the Treasury in advance. While there is still disagreement on the treasury's eventual size and issuance schedule, most people support the idea of supporting it because it is essential to the remainder of the whitepaper and the ATOM 2.0 goal.

What role does creating a big treasury play in the ATOM 2.0 goal, then? Introducing the Interchain Allocator, a concept that centers around converting the Hub into a decentralized fund and ATOM into an IBC index play, providing it a direct linkage to the expansion of the Cosmos ecosystem as opposed to the unstructured and indirect one it has previously had.

Interchain Allocator

The fact that new projects essentially automatically airdrop their tokens to ATOM stakeholders is one of the distinctive features of the Cosmos ecosystem. They do this as a marketing expenditure and to attract new consumers. The drawbacks of this are that long-term incentives are frequently out of alignment and tokens are frequently dumped. With covenant-based agreements and direct alignment of new protocols with the Hub, the Interchain Allocator seeks to provide protocols with a superior choice. The Hub may exchange ATOM with a new project for a percentage of their initial supply during these multi-year lockups. This ensures that some of the new project's tokens are long-term aligned and offer ATOM access to their treasury.

atom interchain allocator
Source: Cosmos 2.0 whitepaper

The Allocator's other objectives are:

Accelerate the establishment of new Cosmos projects
Boost project sustainability and growth.
Boost cross-chain blockspace's economics (Interchain Scheduler)
Align the Cosmos Hub's incentives with those for new initiatives.
Ensure ATOM is the most popular and commonly used reserve asset in the interchain.

However, the Allocator will be used for more than token exchanges. The Hub might engage in governance, lend money through loan agreements, and offer liquidity for an ATOM-backed CDP stablecoin, among other things, to assist new projects getting off the ground.

Additionally, there will be several sub-DAOs working toward distinct goals and methods, thus the Allocator won't be a single organization. A DAO that prioritizes lending to consumer chains, long-lockup seed rounds, or short-term yield farming operations might exist. ATOM stakers will be able to lock their liquid staking tokens to certain DAOs in order to express their purpose, increasing the amount of funding the DAO may get from the treasury. If the sub-DAO is effective and generates profits, participants may get performance incentives as well as continuous or additional treasury funding.

None of this, however, comes without danger, with human error in capital allocation being the most obvious one. With the goal of expanding the ecosystem and making the treasury work better than ATOM, The Hub is effectively producing its own money. This is not a charity... In order to avoid a direct dilutive event for ATOM holders, every ATOM issued and spent must outperform when valued in ATOM. For instance, if the Hub produces 9 ATOM and distributes 3 to stakers and 6 to the treasury, then invests the 6 from the treasury and flips it into 3, it is an objectively terrible deal for ATOM holders. As a result of the treasury's poor performance in the bear scenario, they are now taking on more execution risk.

Additionally, having ATOM in treasuries throughout the ecosystem causes some cyclicality. When the bear market hit in 2017, several ICOs that had raised money in ETH were compelled to sell. These treasuries might not need to sell ATOM during a bull market and instead decide to borrow money against it to cover operating costs. The dynamics are flipped in a bear, which might put pressure on ATOM if Cosmos treasuries are compelled to sell.

What about the bull case? The Hub may wind up with the best investments in the Cosmos ecosystem and be accepted into any seed round they choose. This transforms the Treasury into a kind of index bet for ATOM, giving it a more direct link to the rise in the IBC market cap. It may be quite profitable if you can create your own currency at a high market cap and buy a sizable amount of promising protocols at a low market cap. A person can just purchase ATOM if they want exposure to the entire ecosystem. Additionally, ATOM will provide passthrough exposure for regular investors who would never have access to early-stage investments.

The OHM whitepaper served as a model for the ATOM 2.0 whitepaper, and if we look at OHM and all of its forks, they are currently trading at parity or less than the value of their treasury. When the bear market hit, the speculative premium was fully eliminated, and prices swiftly returned to their treasury levels. With a $4 billion market valuation, ATOM now only has a speculative premium. $700 million is planned for the Treasury. Does the story change to making ATOM become an IBC index rather than a pure monetary asset as it starts to trade closer to parity with its treasuries as the backing gets more diversified with a variety of IBC eco assets?

While it is feasible, a handful of factors should be noted. Firstly, a strong treasury provides greater underlying value to ATOM than a pure speculative premium, and the upside is available if the treasury outperforms. Secondly, the Allocator is not just about developing a treasury that supports ATOM in isolation, but also about growing liquidity in an "economic zone" that includes the Hub. The Interchain Scheduler, a cross-chain MEV market and cash flow generator for the Hub, will provide a positive feedback loop as this zone expands.

Interchain Scheduler

This is the most complex and fascinating concept in the whitepaper, and we should start by emphasizing that it will most likely take 2-3 years to implement. The Interchain Scheduler allows blockchains to tokenize and trade blockspace futures by bringing MEV markets on-chain. Asynchronous composability adds delay and opens up protocols to many Interchain MEV in a cross-chain ecosystem like IBC. Validators in Cosmos have access to several chains at the same time, which is a unique feature, especially with Consumer Chains. This is much different from attempting cross-chain MEV in systems with vastly diverse validator sets. The desire is for an off-chain MEV market to emerge for cross-chain execution guarantees, resulting in a highly centralizing architecture that transfers MEV profits straight to validators and searchers. The Interchain Scheduler enables protocols to front-run this by selling MEV ahead of time and keeping a piece of the profit for themselves/their token holders.

Individual chains will be able to sell a portion of their future blockspace, The ability to tokenize and exchange over IBC the rights to order transactions in a future block is made possible by ABCI++. All of this tokenized blockspace futures trading will take place via a different consumer chain called the Interchain Scheduler. Tokenized futures of blockspace from protocols will be sent to this market, where blockspace purchasers may place bids using ATOM as the settling asset. When blockspace is sold, a portion of the proceeds goes to the Hub and another piece to the chain that supplied it. Then, in secondary markets, these tokenized futures (in form of NFTs) may be traded.

Let's run through a brief illustration. Token X is available on markets in chains A and B. On-chain A, token X is traded for $10, and on-chain B, for $9. However, since they are on different chains, there is no assurance that the arbitrageur will be able to obtain both sides of the deal in the precise sequence they want. They may use a flash loan to shut this arb in one block on a blockchain with synchronous composability, like Ethereum, and make a risk-free profit. There are hazards involved with completing one half of a deal but not the other in async. They may guarantee their transaction ordering on both chains by reserving blockspace on each one, ensuring that they purchase at $9 on chain B and sell at $10 on chain A, guaranteeing the benefit from arbitrage. They can close the arbitrage cross-chain once all transactions have been completed on each chain.

As profits from the Scheduler pour into the Allocator, the Scheduler and Allocator will collaborate. The Allocator will then put these gains to use by making more investments in the ecosystem, boosting the economy of the ATOM economic zone's liquidity and directly raising the available MEV for capture. The Scheduler will first be made available to the Hub's Consumer Chains, with the possibility that other protocols will eventually use it as well. This connects to the idea of "unfair advantage". Consumer Chains, as opposed to chains outside the ATOM zone, will have direct access to both the Allocator and Scheduler. This is a significant shift from the Hub's previous role as an impartial entity. Customer Chains will be given preference from the HUB in ATOM 2.0.

interchain scheduler

Source: Cosmos 2.0 whitepaper

How large is the market for MEV? On Ethereum, an estimate of $675M MEV over the last two years, with the majority of this going to miners (now validitors), has been made. We may refer to the most active Cosmos chain, Osmosis, for a Cosmos-specific number. To continue capturing this MEV, Osmosis will use the Skip Protocol. One significant distinction is that in Interchain Scheduler, rights to future blockspace are included in the consensus protocol and are therefore subject to the protocol's enforcement. These rights are dependent on a trusting connection between Skip and Osmosis validators in third-party solutions like Skip.

Although yet very young and underdeveloped, the Interchain MEV space will play a crucial role in the Cosmos ecosystem as liquidity and cross-chain interoperability increase over the coming years. In essence, the MEV possibility is much more profitable than the predicted gas fees from these consumer chains. By combining all of them, we have the new ATOM vision.

Conclusion

To sum up, there will be four value generators for ATOM. With partner chains, the Scheduler will divide earnings after capturing MEV. The Allocator will use the Treasury's fund from the issuance of ATOMs and Scheduler earnings to support their own profit-making venture. Although the bulk of the Allocator's revenues will be reinvested, some may also be distributed to token holders. Gas fees and Consumer Chain tokens, which will be awarded to validators, delegators, and the community pool, will serve as additional revenue sources for Interchain Security. These four factors are anticipated to generate enough revenue over time for the Hub to discontinue issuing ATOMs completely.

If all of these implementations go through, ATOM will lose its neutrality, and there are very real and serious execution risks to this new architecture, but ATOM has been marginalized in the ecosystem for far too long. If it does not begin focusing on itself immediately, mindshare towards the Hub will get indifferent and shift to other chains in the ecosystem. Detractors argue that ATOM 2.0 is dangerous, and they are correct. This is the riskiest thing the Hub has ever done. However, you may argue that the greatest risk to the Hub is doing nothing because it will become irrelevant and be forgotten.

Disclaimer:
This article is intended for and only to be used for reference purposes only. No such information provided constitutes advice or a recommendation that any investment or trading strategy is suitable for any specific name.

A deep dive into Cosmos 2.0