Iqlusion on the Cosmos Hub Governance Proposal 1

By Zaki Manian and Kristi Põldsam

The first Cosmos governance proposal is live. It is an interesting proposition to adjust a parameter in the Cosmos Hub Network related to inflation and rewards rate. If passed, it would largely impact the rate at which new Atoms are being created and distributed to stakers and validators.

Below, we are going to analyze several parts of the voting proposal.

Iqlusion will back proposals that increase the rate of Atom issuance in the short term. However, we expect to switch our preferences after IBC and other features are in place.

1. Why do we use blocks per year to compute block rewards vs using BFT time?

The rate at which blocks are being produced in the Cosmos Hub is dependent on the distribution of voting power, timeout settings in validator configuration and network topology. As a result, it is difficult to accurately predict the future rate of block production. We know what the block generation is as of today. Even if validators choose to favor geographic decentralization, which might slow down block production, it is fair to say that it is not the upper limit of fast block production.

Tendermint provides BFT time. Why not use this for economic incentives? The current implementation doesn’t have a strong resistance to manipulation even if the voting power is honest. There is very little that prevents a dishonest actor from trying to accelerate time by voting with timestamps from the future.

Going forward, we would want validators to be able to reject a block if the time that the block proposer proposes is dishonest. This would introduce a clock synchronization assumption into Tendermint which the Tendermint engineering felt the user community was not yet ready for. However, it will be critical in the process of switching to BLS (Boneh–Lynn–Shacham) signatures where all vote messages are identical.

2. How do validators and stakers make money as Cosmos evolves?

Governance Proposal 1 says that validators should try to maintain the current block production rate and the network should be creating Atoms about 20% faster than it currently is. Note that yield on Atoms is equal to creation rate * 1/staking rate. Thus, at 1/3rd of the network being staked, it would translate into a 60% increase in Atoms yield to validators.

This takes us to the fundamental question of what purpose do Atoms serve and how validators make money. Ultimately, speculator taxation via inflation is going to offer diminishing returns for validators. This revenue will be replaced by fees that stakers earn from collateralizing useful transactions. Over time, as the revenue from collateralizing (from synthetic assets to smart contract computation) rises, the benefits of expansionary Atoms are expected to fall.

At this early stage in the Cosmos Hub’s lifetime, Atoms collateralize very little computation beyond their own asset ledger. The initial validator compensation model is speculator taxation via inflation. New Atoms are created at every block and distributed to validators and delegators who are participating in the consensus process. This creates an incentive to Atom holders to not just passively hold their tokens in wallets, but to put them at risk to secure the network. While Atom speculators are not willing to lock up their tokens, validators/delegators are. The proportion of the total network held by stakers and validators rises and the proportion held by speculators falls. Our expectation is that such economics are temporary in nature. In time, market structures will evolve that allow speculating on staked Atoms. We already know that several exchanges are planning to offer such staking products.

An important question to ask is how much speculator taxation is enough? Currently a validator with a one million Atom delegation, operating on a commission only basis is earning a return of $10-15K per year. That is going to contribute to an insecure and bare minimum setup. Commission rates should be higher and support secure validator operations. We should be pushing a higher speculator tax rate via inflation as well as hope that differentiation gives validators some additional pricing power. For this reason, Iqlusion will be voting in favor of the upgrades that increase Atom issuance in the short run and decrease the issuance over the long run as other sources of validator revenue will kick in.