Blockworks Research is looking for community feedback on their recommendation of changing ATOM’s monetary policy from a dynamic inflation model (as a function of % bonded) to a static supply schedule due to the advent of liquid staking. We also request feedback on the parameters outlined for this new supply schedule. Blockworks will have a follow-up post around the Cosmos Hub’s fiscal policy sometime next week.
This post was first published on the Cosmos Forum. Be sure to join in on the conversation on the forum.
Introduction
In the AADAO grants process, the committee chose Binary, RMIT, and Blockworks Research to lay out a new vision for the Cosmos Hub as a security provider of the ATOM Economic Zone and the natural Schelling point of the wider Interchain. I suggest reading the Medium article here to understand better what the three teams are working on individually.
To introduce ourselves, Blockworks Research is a multidisciplinary team of protocol-specific analysts that cover the entire crypto space. We have extensive knowledge across all ecosystems, and are taking best practices and lessons learned to help inform and guide our thoughts on the future of the Cosmos Hub. Additionally, as Cosmos Hub community members ourselves, we have also long followed the discussions on the forums and believe we have a good understanding of the needs of the community. We were tasked with redesigning ATOM tokenomics, developing a mechanism to potentially help with validator stake centralization, and identifying the Cosmos Hub’s place in a rollup-centric world. We have also been coordinating between the other two teams to ensure our findings and end deliverables fit into a larger, more cohesive vision for the Cosmos Hub.
Taking lessons learned from ATOM 2.0, through the next few weeks leading up to Cosmoverse, we will be actively (and publicly) engaging with the community to provide initial findings of our research and our potential recommendations. We want the community to help inform the final recommendations that we will provide. While the three teams are working individually in separate swimlanes, we have been meeting frequently to map out dependencies across the work streams. What we want the Cosmos Hub community to take away from this is that there will be no omnibus bill.
Ultimately, these proposals will be presented so that the wider community can choose what they like from the three teams’ proposals and what they want to reject. In the event of a rejection of an idea, the community will know its downstream impacts on the other proposals they pass.
Example: If the community ultimately decides they want the “ATOM Alignment Treasury” proposed by Binary in an initial forum post here, but the community rejects an idea brought forward by Blockworks Research to fund a portion of the AAT with inflation as part of our scope of work (tokenomics), that is OK, but the community should know that this may lead to fewer funds in the AAT for Protocol-Owned-Liquidity to align ATOM with the growth of the Interchain.
Blockworks Research will outline the dependencies across all proposed ideas to ensure the community fully knows how their future decisions may impact the result.
The result of this work will likely culminate into multiple onchain proposals over the span of a few months to allow the community time to digest each proposal at a time. While this may take longer than some might like, we believe it is the right path forward to build social consensus on what the future of the Cosmos Hub should be.
ATOM is Not Interchain Money (YET!)
Despite not being a required gas token for IBC and the wider Interchain, the drama (feature or bug?) surrounding the Cosmos Hub, the lack of a dedicated team for 2+ years, and no service offering until recently with the launch of Replicated Security, the ATOM has naturally achieved product market fit as the “numeraire” for those in the Cosmos ecosystem. While this has allowed it to outperform most other assets in the ecosystem, it has still struggled to receive the same institutional and retail attention that assets like BTC, ETH, SOL, OP, ARB, and others have had.
From the outside looking in, ATOM is not money for all the above reasons. While that could change with the AEZ building out around the Cosmos Hub, we believe some changes to ATOM’s monetary and fiscal policy should be implemented to strengthen the Interchain Money 14 narrative and make ATOM a much more attractive asset to hold over the long term.
Monetary Policy
As we all know, ATOM has a dynamic inflation model that’s dependent on the ATOM bond ratio. If the % ATOM bonded is >66%, inflation decreases block-by-block to a minimum of 7% inflation, and if the bond ratio is <66%, inflation increases block-by-block to a maximum of 20%. The speed at which inflation increases/decreases is based on how far away the bond ratio is from 66% and a scalar factor set to “1” as part of Prop 48 9.
For example: At 70% bond ratio, ATOM inflation would decrease by ~6.06%/yr until it reaches the minimum bound of 7%. A bond ratio of 64% would increase inflation by ~3%/yr until it reaches the maximum bound of 20%.
But why have a dynamic inflation model as a function of the bond ratio? Outside of DOT, most other PoS networks do not have this feature. At the time when the Cosmos Hub launched, this mechanism made sense! PoS system security degrades when the asset can be used for security OR as a collateral asset throughout DeFi. If a DeFi protocol offered higher lending yields than staking yields by the network, rational actors would unstake to capture that higher yield. The dynamic inflation model creates a competitive equilibrium between staking and DeFi rates, as this research paper outlines. In a pre-liquid staking world, dynamic inflation was the best path forward to ensure the Cosmos Hub remained secure.
With the advent of liquid staking, is this dynamic mechanism outdated since market participants that liquid stake can now get both staking rewards and DeFi yield? We believe it is. PoS networks no longer need to compete with DeFi by inflating its supply, ultimately creating larger supply overhangs.
With ATOM’s historical inflation being much higher relative to its peers, this has not only harmed the perception of ATOM’s monetary premium, but it has also led to constant sell pressure that has hurt its price performance. Additionally, we believe the uncertainty around the future supply of ATOM contributes to the negative perception as a reserve asset and store of value.
To show what we mean by uncertainty around supply, as of ~2.5 weeks ago, the bond ratio fell from 70% to 68%. At 70% bonded (red), ATOM was on pace to reach the 7% minimum inflation bound by November 2024. At the current 68% bonded (blue), this 2% difference in the bond ratio has kicked this out by a full year to the end of 2025.
This has altered the course of the current supply of ATOM by the end of the decade from ~590M to ~615M ATOM, a ~4% increase in total supply, as can be seen below (same colors for each bond ratio example).
Those opposed to changing ATOM’s monetary policy may argue that liquid staking will forever keep the bond ratio above 66% and that ATOM’s future supply will be more concrete. While that may be true, we believe for ATOM to ossify, so should its inflation schedule. As long as ATOM’s inflation is a function of the bond ratio, there will always be uncertainty around its supply, hurting its monetary characteristics.
Blockworks Research is initially proposing that ATOM move towards a more set supply schedule that is no longer a function of bond ratio.
If this is something that the community is not comfortable with, we believe that the next best thing is that the minimum and maximum bounds of ATOM inflation need to head lower at a set schedule so that the potential future swings in ATOM supply are dampened. While this is not our initial recommendation to the community, we wanted to present this second option.
During the ATOM 2.0 debates, there was conversation from those against it that lowering the minimum bound to 3% should be considered, but there was never a conversation about lowering the maximum bound of inflation too. In our opinion, this is something that the community should strongly consider if it does not want to go with a set supply schedule.
Recommended Inflation Schedule
We want to recommend a much simpler inflation schedule that will allow the ATOM asset to ossify and ensure a minimum security budget with a low inflation rate in perpetuity. Although the parameters we are showing to the community are not final, we want to give the community insight into our thinking. Hopefully, our discussions will help inform our final recommended parameters.
Unlike assets like BTC and OSMO that have large supply shocks (halvenings/thirdenings) baked into their future supply schedules, we believe a gradual block-by-block decrease in inflation, similar to what ATOM has now, is the most appealing.
We propose the following inflation schedule:
Once an effective annual inflation rate of 1.5% is reached, it stays there in perpetuity as a “minimum security budget.”
Below we compare ATOM’s inflation and expected supply schedules under the following 3 scenarios:
- Current Parameters (70% bond ratio at 7% min inflation) – blue
- Changing minimum inflation bound (70% bond ratio at 3% min inflation) – red
- Blockworks’ Recommended Inflation Schedule – yellow
Please note the first two scenarios assume 70% bond ratio throughout, but as discussed above, this fluctuates frequently.
As you can see, the recommended inflation schedule brings future ATOM supply from ~600M by the end of the decade based on the current parameters to ~500M. Additionally, this inflation schedule closely matches the minimum bound going down to 3% while removing the unknown around the bond ratio impacting future supply.
Another reason why we are recommending our supply curve over the current parameters (and lowering the min bound to 3%) is because of the uncertainty around Replicated Security economics in the short term. This new supply curve kicks out the time to reach 3% inflation from mid-2025 to late 2026, which gives the AEZ additional time to create sustainable value for stakers and validators. Once 3% annualized inflation is hit, we reduce inflation from 50% year-over-year to 25% to accustom validators and stakers into this low inflation environment gradually.
Fiscal Policy Follow-Up Post
Blockworks Research will follow up this post next week with a post about the future of ATOM’s fiscal policy (taxation and budget allocation). The fiscal policy will have dependencies on the work of both Binary Builders and RMIT (an example being what we outlined above concerning the AAT). While what we presented above is by no means final, we hope this initial post starts a community-wide discussion about the future of ATOM. We firmly believe a strong ATOM will not only lead to a strong AEZ but a strong Interchain as well.
Thank you for taking the time to read this, and we look forward to your feedback!
About the ATOM Tokenomics RFP
This post and research is part of the ATOM Tokenomics RFP by the Atom Accelerator DAO (AADAO). Blockworks Research, author of this post, was one of three teams commissioned by AADAO to research potential tokenomic & decentralization tooling that can help improve the state of the Cosmos Hub. Learn more about the motivations for the ATOM Tokenomics RFP and a recap of the ideas generated.
