State of Cosmos Hub Q3 2023

Key Insights

• Neutron and Stride became the first two chains to be secured by Cosmos Hub’s Replicated Security, sharing its validator set. This marked the beginning of the Atom Economic Zone.
• IBC transfers in and out decreased 27.3% and 22.0% QoQ, respectively. Cosmos Hub’s role is shifting from an interoperability hub to a security provider
• Revenue increased 2.4% QoQ despite declines in ATOM’s price and Cosmos Hub’s activity.
• Daily active addresses and daily transactions decreased 19.8% and 6.3% QoQ, respectively.
• The Atom Accelerator DAO selected Blockworks Research, Binary Builders, and RMIT University to put forth a tokenomics overhaul for ATOM - the Tokenomics RFP. These teams submitted five forum posts detailing proposals.

Primer on Cosmos Hub

Cosmos Hub is an individual appchain focused on interoperability and security. Cosmos Hub is a Proof-of-Stake (PoS), sovereign blockchain with an account-based accounting model and with no native smart contract functionality. ATOM is Cosmos Hub’s native token. Cosmos Hub pioneered technologies such as Cosmos SDK, CometBFT (Tendermint), ABCI, and IBC, which were later used by many Interchain networks. The Interchain consists of sovereign networks connected by the common interoperability protocol: IBC. The Interchain is also referred to as the Cosmos Ecosystem.

The Atom Economic Zone (AEZ) is an ATOM-aligned ecosystem set, which includes networks with various affiliations and integrations with the ATOM token. Networks that rent security from Cosmos Hub validators, i.e., Consumer Chains, are part of the AEZ. Cosmos Hub security cannot be arbitrarily shared in a model like EigenLayer’s restaking due to the lack of programmability, but it can be passed through governance and enabled on an individual basis. Replicated Security (formerly referred to as Interchain Security) refers to the sharing of the full Cosmos Hub validator set with another chain, permissioned by a governance vote.

Cosmos Hub was launched in 2019, leveraging technologies built by the Interchain Foundation and Ignite (also known as Tendermint). Various groups continue to support the development of Cosmos Hub and the Cosmos tech stack, including the Interchain Foundation, Binary Builders, Atom Accelerator DAO, Informal Systems, Strangelove, and others. The Interchain is home to over 100 independent networks, each with its own unique supporting entities.

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Key Metrics

Financial Analysis

ATOM’s price declined for the second consecutive quarter, down 21.0% QoQ to $7.11. This lagged behind the overall crypto market, which was down 9.2% QoQ. ATOM’s total market cap ranking moved down QoQ from 23rd to 24th. Among network tokens, ATOM ranked 10th by market cap as of the end of Q3.

ATOM, the native token of Cosmos Hub, is ICS-20 compatible, which allows users to transfer ATOM between chains connected through the IBC protocol. ATOM has a total token supply of ~356 million and a circulating supply of ~293 million. The asset serves the following functions:

• Transactions on Cosmos require a transaction fee settled in ATOM.
• Tokenholders can stake ATOM to operate a validator, securing the network and earning rewards.
• Tokenholders can delegate ATOM to an existing validator to help secure the network and earn a portion of the validator’s rewards.
• All staked and delegated ATOM can be used to vote in the network’s governance process.

Revenue is measured as total transaction fees. Cosmos Hub revenue increased 2.4% QoQ. There was a spike in revenue on July 31, when the average daily transaction fee rose to $0.22, considerably higher than the quarterly average of $0.04.

ATOM Tokenomics

Cosmos Hub's real yield averaged around 4.5% in Q3, ending the quarter at 4.65%. ATOM has a high inflationary rate of ~14%, which nearly offsets the ~19% reward rate given to validators and delegators. Circulating supply is primarily affected by staking rewards for validators and delegators. With such a high reward and inflation rate, this places a heavy tax on ATOM holders who do not participate in staking.

As of Q3, there are two forms of deflationary pressure on the ATOM token that contribute to deflation.

• Governance Burning - The Cosmos Hub features an onchain governance mechanism where ATOM tokenholders can vote and issue proposals, such as altering consensus parameters and community pool fund allocations. For a proposal to be submitted, it must have a minimum of 250 ATOM deposited to it from any tokenholder. If the proposal is vetoed, the deposit is burned.
• Slashing - Validator node rewards in ATOM can be slashed if a transaction is double-signed or a validator is offline for an extended period. Slashed rewards are subsequently burned.

The rejected ATOM 2.0 proposal reimagined ATOM tokenomics. The goal of the overhaul was to drastically reduce ATOM’s issuance over a several-year period before removing inflation altogether. Additionally, it aimed to improve capital efficiency and position ATOM as the Interchain reserve asset via liquid staking. Ultimately, these actions would drive value accrual to the ATOM token.

While the initial proposal was rejected (possibly due to its wide breadth and quick introduction), various components continued to be explored as individual proposals. Of note, two proposals (an increase in the treasury size and a liquid staking feature to improve ATOM capital efficiency) both passed in subsequent proposals following their initial introductions in ATOM 2.0. Other ATOM 2.0 features still in discussion around the community include permissionless shared security models and social coordination (i.e., governance) hubs for Interchain technologies (e.g., IBC, CosmWasm, etc.).

The community has since failed to pass additional tokenomics-related proposals, such as burning ATOM based on transaction fee volume or incentivizing holders to stake tokens held. Developers are also discussing options for improving the Cosmos Hub's fee mechanism to minimize spam transactions. One option is to use a model similar to EIP-1559 in which a portion of the fee paid to validators gets burned.

In Q3, the Atom Accelerator DAO (AADAO) selected Blockworks Research, Binary Builders, and RMIT University to put forth a new tokenomics overhaul for ATOM — the Tokenomics RFP. The five proposals from the teams explore governance, liquid staking, treasuries, public funding, relationships within the Atom Economic Zone, and ATOM issuance.

Blockworks Research has proposed a change to fiscal policy. The proposal aims to transition from the current static 10% community pool tax to a more diversified tax approach. This new approach includes the following components:

• Vote Power Tax: Introduces a tax that discourages delegating to validators with higher Vote Power to address stake centralization issues.
• Dynamic Community Pool Tax: Proposes changing the community pool tax from a static percentage of inflation to a schedule that decreases over time until reaching a base tax of 5%.

Network Analysis

Daily active addresses and daily transactions decreased 19.8% and 6.3% QoQ, respectively. Cosmos Hub continues to transition to the center of a new type of multichain ecosystem, one where Cosmos Hub serves as a security provider rather than just an interoperability hub. As the transition progresses, activity on Cosmos Hub mainnet may decrease as usage moves to its “child chains.” This is explored further in the Atom Economic Zone Analysis section.

Active addresses and transactions have been tightly coupled historically, which continued into Q3. The consistent coupling suggests that transaction activity spikes in August came from additional users coming online and interacting with the network rather than existing users simply transacting more often.

Staking and Decentralization

Cosmos Hub’s 67.6% staking rate, despite being down 3.6% QoQ, is still one of the higher rates among other L1 networks. Stakers consist of both validators and delegators. Users who stake ATOM and meet thesystem requirements can operate a validator to secure the network and earn rewards. Tokenholders can delegate a minimum of one ATOM to existing validators to receive a portion of the associated validator’s rewards. Delegators earn rewards relative to the number of tokens staked, although they’re charged a commission set by the individual validator. In Q3, governance Proposal 826 set validators' minimum commission to 5%.

Only the top 180 validators, ranked according to combined self-staked and delegated ATOM tokens, earn rewards. Of those validators, the top eight control 33% of the total stake, giving Cosmos Hub a Nakamoto coefficient of 8.

Governance and Grants

Cosmos Hub uses a combination of offchain and onchain governance processes. Network improvement proposals and parameter changes get designed and discussed through offchain means, typically in the Cosmos governance forum. Anyone can propose a network or treasury management proposal and participate in the discussion regarding whether to pursue the proposal. Users can also submit any network change request to the Cosmos Hub's onchain governance system as an official proposal. Once in the onchain governance system, ATOM stakers vote on whether to approve (and eventually execute) the proposed change.

There were 24 governance proposals in Q3, 10 of which passed. Notable passed proposals include V11, V12, and V13 software upgrades, as well as extending AADAO’s stewardship of ATOM protocol-owned liquidity (POL). The AADAO Transparency Report 4 detailed the financials and grants distributed by the DAO. In Q3, batch 4 and batch 5 of AADAO grants, totaling $1.097 million, were distributed to the winners. Projects funded by these grants include sponsorship for Cosmoverse, a hackathon from DoraHacks, and more. Later, Batch 6 was announced, and grants were distributed in October. These rounds brought the total number of issued grants by AADAO to 27, worth a combined value of $2.5 million.

Binary Builders’ “ATOM Alignment Treasury” aims to increase the decentralization of Cosmos Hub governance and voting. With the increasing operational costs of validators and concerns about network decentralization, Binary Builders proposed to allocate more stake to validators based on their voting power. The proposal aims to support lower-end validators and further decentralize the network. It also explores how ATOM can be used to execute voting power on other AEZ networks (more details in the Atom Economic Zone Analysis section).

Blockworks Research’s proposal has implications for governance in addition to the fiscal policy changes outlined in the ATOM Tokenomics section of the Financial Analysis.

• The Vote Power Tax discourages delegating to validators with higher Vote Power to address stake centralization issues.
• The Dynamic Liquid Staking Tax would be imposed on liquid stakers and would increase as the demand for liquid staking grows. It aims to find a natural equilibrium for liquid staking market penetration while generating tax revenue for Cosmos Hub.
• The removal of the 25% liquid stake cap would allow more participants to benefit from liquid staking. Cosmos Hub does not natively support liquid staking, but it is available through Stride, a network in the AEZ. This is explored further in the Atom Economic Zone Analysis.
• Cubic Delegation has the potential to fix the centralization concerns with respect to onchain governance while ensuring quorum can still be met.

IBC

Cosmos Hub has 56 IBC peers and 269 IBC channels. “Peers” refers to the number of distinct counterparties of Cosmos Hub with established IBC connectors; “channels” refers to the total number of routes available to connect to peers. Activity declined across the board for unique senders, unique receivers, and total transfers — both inbound and outbound. Inbound unique receivers decreased by 40.6% QoQ, the largest change. All of these IBC metrics hit yearly lows.

For the most part, inbound and outbound transfers are tightly coupled. There are exceptions, such as a massive inbound spike in May 2023. In Q3, there were several spikes where daily outbound transfers exceeded inbound transfers by 2-3x.

Atom Economic Zone Analysis

The Atom Economic Zone (AEZ) is an ATOM-aligned ecosystem set, which includes networks with various affiliations and integrations with the ATOM token. Several networks exist in the AEZ in varying capacities. Stride and Neutron receive Replicated Security, and Osmosis enables fees to be paid with ATOM. Other networks (such as Kujira or Agoric) rely on ATOM for much of their liquidity.

Replicated Security (formerly referred to as Interchain Security), a form of shared security, is the AEZ strategy being explored most by the Cosmos Hub community and other Interchain networks. Shared security refers to allowing the validators of one network to use stake on that chain to participate in the consensus of another network. This setup would allow smaller market cap networks to “rent” security from larger networks. The Cosmos Hub has the largest market cap of all Interchain networks and is a prime candidate to rent out security. As of Q3, Neutron and Stride are the only chains utilizing Replicated Security.

Binary Builders’ “ATOM Alignment Treasury” (AAT) aims to make ATOM the default currency within the AEZ as well as to align staking and governance between Cosmos Hub and Consumer Chains. The team intends to use AAT funds for development efforts and bootstrapping liquidity across the AEZ.

Neutron

The passing of Proposal 792 saw Neutron become the first chain to leverage the Cosmos Hub’s validator set and security through Replicated Security. Neutron serves as a CosmWasm extension to Cosmos Hub and has effectively become Cosmos Hub’s DeFi center.

Neutron is still a relatively new network, having only launched this year. Proposal 72 allocated Cosmos Hub funding for the development of Neutron, and Proposal 819 reallocated that funding directly to the Neutron Foundation.

Stride

Stride implemented Replicated Security shortly after Neutron. This network enables liquid staking for various Interchain networks and assets. As ATOM is a core part of Stride’s activity, it was an obvious early choice to adopt Cosmos Hub security. Liquid staking is a big market and a narrative across various other ecosystems. The Cosmos Hub benefits from having a liquid staking solution in the AEZ via Replicated Security as the utility is aligned by governance.

Stride-staked ATOM, stATOM, is integral for other AEZ networks as well. Cosmos Hub Proposal 805 (an amendment to Proposal 800 — Liquidity as a Service) will have AADAO deploy 450,000 ATOM to an ATOM/stATOM constant product pool on Astroport Neutron. On Osmosis, the ATOM/stATOM accounts for over $20 million in TVL.

Governance Proposal 817 seeks approval from the Cosmos Hub community for the selection of a 5-member advisory council responsible for evaluating and selecting host-chain validators through the Stride Delegation Process.

Osmosis

The Osmosis AMM DEX has been deeply integrated with Cosmos Hub and ATOM since its inception. The very first pool on Osmosis, and still the largest by TVL as of Q3 2023, is the ATOM/OSMO pool. About 75% of total Osmosis TVL comes from ATOM pools (mainly ATOM/OSMO and ATOM/stATOM).

Osmosis’ “ATOM alignment” and role in the AEZ go deeper than liquidity pairs. ATOM is an alternative gas token on the DEX. While ATOM is being used for gas in certain cases, many of them are suspected to be bots due to activity patterns.

Proposal 810 on Cosmos Hub would enshrine the Osmosis DEX for the purpose of flexible gas fee payments. The proposal would allow for transaction fees on Cosmos Hub to be paid with any token, leveraging Osmosis to swap alternative tokens for ATOM.

Other Networks

More chains may soon join the AEZ in varying capacities. Composable Finance submitted a proposal to join the AEZ and receive Replicated Security from Cosmos Hub, just as Stride and Neutron did. With Neutron as a programmability and DeFi hub and Stride as a liquid staking solution, Composable proposes to become a rollup settlement hub, as it is connected to other multichain ecosystems.

While Replicated Security is easy to define with its rigid definition, “ATOM alignment” is more subjective. Some community members argue that networks such as Agoric and Kujira are already part of the AEZ due to their ecosystems being intertwined with ATOM. In other words, the ATOM token can provide large portions of liquidity or Cosmos Hub, facilitating large portions of interchain activity.

Closing Summary

Since its inception, Cosmos Hub’s role has been an interoperability hub and a Schelling point for the broader Cosmos ecosystem. In Q3, Cosmos Hub took major steps towards shifting its role to that of a security provider. Through Replicated Security, Neutron and Stride became the first chains to be secured by Cosmos Hub. Cosmos Hub’s new position as a modular security provider is increasing its role as a cultural center of the broader Cosmos ecosystem as chains join the Atom Economic Zone.

The Cosmos community has since submitted proposals to include even more chains, such as Composable Finance. Additionally, other Interchain networks are exploring other forms of “ATOM alignment,” such as using ATOM for fees, to become part of the Atom Economic Zone.

Following the rejected ATOM 2.0 proposal, which reimagined ATOM tokenomics in various ways, most concepts continued to be explored as individual, smaller proposals. Governance, decentralization, liquid staking, treasury management, and tokenomics were among the topics explored in Q3. AADAO has been delivering grants to various teams to address these topics, including the Tokenomics RFP.

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