Repost from GLOBAL COIN RESEARCH TEAM: Issue 236: “Can the Cosmos Hub be saved? The fight to rescue the heart of a visionary Crypto Ecosystem” The full report and all related findings are available on the official website of GLOBAL COIN RESEARCH.

The Cosmos ecosystem is renowned as a hub of crypto innovation, pioneering many now widely adopted technologies. Notably, Cosmos founders were the inventors of the proof-of-stake consensus mechanism, exemplifying the ecosystem’s knack for trailblazing new technology. But despite this strong technical ingenuity, Cosmos has lost momentum.

The Atom token has declined in market value. Cosmos trails rival ecosystems in metrics like total value locked, active users and revenues. Confidence in the ecosystem has diminished. For a network hailed for its inventive spirit, Cosmos’ lackluster performance has been troubling.

In this article, we’ll analyze the factors behind Cosmos’ stagnation. What has gone wrong? And more importantly, what can be done for Cosmos to regain its former position as a leader in crypto?

Competitive Advantage

Cosmos was founded with the foresight that no single blockchain could resolve the “blockchain trilemma” – the difficulty of balancing decentralization, security and scalability. This stems from inherent tradeoffs between these properties. For example, increasing transaction throughput often requires larger block sizes, which leads to centralization as fewer nodes can process and store larger blocks.

Years before the wider crypto industry came to the same conclusion, Cosmos realized that only a multi-chain architecture could overcome these trilemma tradeoffs. So they pioneered a vision focused on horizontal scalability, with each application powered by its own decentralized but seamlessly interoperable blockchain.

To make this multi-chain future achievable, Cosmos developed the groundbreaking Inter-Blockchain Communication (IBC) protocol. IBC enables seamless interoperability between chains, allowing the transfer of funds between different chains in seconds for pennies. This is far superior to the bridging experience on Ethereum, its layer 2s and other crypto ecosystems.

In contrast to Ethereum’s challenges, Cosmos already has seamless interoperability built and ready. This is Cosmos’ biggest competitive advantage – by far the best interoperability solution in the industry. 

A map of IBC connected blockchains and IBC volume

Cosmos is facing many Issues 

Unfortunately, being home to this exciting and pivotal technology hasn’t carried Cosmos to the heights many would’ve thought. But why is that the case? There are a couple of internal as well as external developments that have caused Cosmos’ struggles, so let us dive into each of them and highlight some possible solutions.

1. The Costly Reality of app Chains

As described earlier, Cosmos was designed around the app chain theory, which envisions that every app runs on its own sovereign blockchain. Unfortunately, the app chain theory is facing some issues. Setting up and maintaining app chains is expensive, both in terms of engineering resources and ongoing operational costs. This poses a significant financial burden, especially for startups in their early stages.

To address this challenge, most Cosmos chains turned to inflation as a means to pay validators. While this approach worked well during bullish market conditions, the bear market exposed its shortcomings. As validators continuously sold their inflation rewards to sustain their operations, token prices plummeted. Even after recent market recoveries, many projects, including prominent ones like Osmosis, remain down by 90% or more.

This makes launching an app chain a bad business decision for many developers. With Layer 2 solutions making Ethereum scalable and a variety of alternative fast Layer 1 blockchains, launching an app chain becomes less and less sensible for many developers.

Exceptions: When app Chains Make Sense

There are exceptions to this rule. Established projects with a strong user base and a tangible product benefit from launching their own app chains. These projects can internalize the benefits of MEV (Maximal Extractable Value), achieve higher throughput, and have full control over the blockchain. Once a user base is well established and the product generates sustainable revenues, transitioning to an app chain can make sense if the benefits to the specific business model outweigh the additional costs.

dYdX is one such project that recently embarked on this journey. Its success or failure could significantly influence the future of the app chain theory. If dYdX demonstrates that creating a superior product, thanks to its app chain, can outperform competitors like Gains Network or GMX, it would provide a significant boost to the app chain concept. Conversely, if dYdX falls short, it could cast doubt on the legitimacy of Cosmos and similar ecosystems focused on app chains.

Cosmos is facing stiff competition

To alleviate the cost pressure app chains face, a variety of solutions have been developed. Thanks to solutions like Eigenlayer, Optimism Superchain, and Polygon 2.0, app chains will be able to launch their own roll-ups or chains on Ethereum, benefiting from a larger community, more liquidity and lower set-up and maintenance costs. Within the Cosmos Ecosystem, Celestia offers a solution to build tailored roll-ups – offering almost the same degree of customization as Cosmos based app chains.

Besides cheaper, more modern app chain solutions, Cosmos also faces competition from Layer-2 and modern rapid Layer-1 blockchains. With fast finalities, low transaction fees and good scalability, these solutions stripped app chains of a major argument in their favor. For many developers, launching – at least initially – as an application on such a blockchain is simply a more cost effective solution with almost no downside.

This shows in recent developments. Current trends suggest that the future of blockchain will likely involve a few strong Layer-1 chains with their Layer-2 networks hosting the majority of applications. For the Cosmos ecosystem to thrive, it therefore needs strong Layer-1 smart contract platforms where applications can launch. These platforms should leverage Inter-Blockchain Communication (IBC) to facilitate communication among themselves and with large applications running on their own blockchains.

Several efforts are already in progress to bridge Cosmos with other ecosystems. Composable, for instance, is connecting Polkadot and Cosmos via IBC. Landslide is working on an IBC-integrated Avalanche subnet, and TOKI is bringing IBC to the Binance Smart Chain. On the surface, these chains should bring a tremendous amount of capital and users to the ecosystem. In practice, this remains to be seen.

Just creating a connection won’t be enough. To truly achieve that vision of such a chain becoming a truly Cosmos based leading layer-1, those new chains would need to actively integrate and collaborate with a variety of Cosmos native projects. The likes of Avalanche and Binance Smart Chain likely have little incentive at this point in time to do so.

Therefore, having Cosmos native Layer-1 chains like Neutron, Injective, Archway or Juno emerging into serious contenders with a large amount of users and capital would be an important step for the entire ecosystem. Injective is already doing wonders on this front – for the sake of the entire ecosystem it would be great if it can sustain its rapid growth trajectory.

2. ICS failed to give the Hub a much needed value proposition

When Cosmos was designed, its founders made a deliberate choice: to offer Inter-Blockchain Communication (IBC) as a public good. Rather than routing all IBC transactions through the Hub or imposing a micro tax on IBC transactions, the decision was to stimulate innovation and growth by providing open access to this powerful tool. The Cosmos Hub was to find its role within this ecosystem as a credibly neutral service provider.

In May 2023, the much-anticipated ICS – Interchain Security – was launched with high expectations. It aimed to finally provide a revenue model for the Cosmos Hub and make app chains financially viable. However, approximately five months in, disappointment is setting in. Adoption has been lackluster, with just two ICS chains live: Neutron and Stride, and with Noble one more in planning. Stride has even hinted at the possibility of being acquired by the Cosmos Hub.

This situation highlights a fundamental issue – there are 4 options to launch within the cosmos ecosystem: own appchain (Cosmos Hub earns nothing), on another L1 (Hub earns nothing), on an ICS chain (Hub earns a percentage of gas fees) and finally on the Hub itself (Hub earns 100% gas fees). Many projects are finding it more sensible to launch on Layer-1 blockchains rather than as ICS chains or on the Hub. If this trend continues, the Cosmos Hub risks becoming a mere spectator to its own ecosystemHaving those applications on the Hub itself via permissioned CosmWASM which would allow the Hub to earn 100% of the transaction fees would be the most beneficial outcome for the Hub.

If running applications on the Hub is the best financial outcome for the Hub, then apps running on ICS chains would be the second best option, yet even that is not a clear win for the Hub. ICS chains actually pose financial challenges for the Cosmos Hub. The Hub validators must validate all transactions, and thus scalability is limited. Chains like Stride or Noble, while valuable additions to the ecosystem, don’t generate high-frequency transactions. Low transaction volume means low revenue for the Hub. Permissionless Layer-1 ICS chains like Neutron could bring significant transaction volume, but they also consume a substantial portion of the Cosmos Hub’s bandwidth while paying only 25% of the transaction fees to the Hub. Neither high volume nor low volume ICS chains thus seem attractive to the Hub, highlighting that the business model in itself isn’t well thought out.

In essence, Neutron threatens to undercut the Hub’s revenue potential. Opting for CosmWASM on the Hub, capturing 100% of the gas revenue, might have been a wiser choice for the Hub.

While the Hub and its ICS model has its advantages, it falls short economically. In a world where many blockchains already struggle to turn a profit, particularly those promising low transaction fees, further reducing revenue doesn’t appear to be a prudent decision.

3. Atom tokenomics aren’t sustainable 

Inflation isn’t just a concern for smaller app chains within the Cosmos ecosystem; it affects the Cosmos Hub as well. The constant selling of block rewards exerts downward pressure on the price of the Atom token. With no substantial revenue sources, Atom faces the same predicament as its smaller counterparts.

Efforts are underway to address these tokenomics challenges. While the expectation was that new tokenomics for the Cosmos Hub would be unveiled at this year’s Cosmoverse, this hasn’t materialized. However, Blockworks Research’s Effort Capital presentation at Cosmoverse 2023 offered a glimpse into the planned changes.

Two specific measures have been proposed to enhance Atom’s tokenomics and transform it into a true interchain currency:

First: Accelerating the pace at which inflation decreases to reach the final target of 7% more rapidly. To speed up this process even more, Cosmos core contributor Zaki Manian has introduced a “halving” proposal, aiming to cut Atom inflation in half immediately. This proposal has already passed governance and thus should be implemented soon. The governance process was a very close decision and didn’t go without controversy. Most large validators – who benefited the most from high inflation-  were voting against this proposal. On the last day it looked like the proposal would be narrowly rejected. Only thanks to a couple of some prominent Cosmos community members – including Osmosis Founder Sunny Aggarwal – buying large sums of Atom to add more yes votes on the last day the proposal passed.

Second: Introducing a liquid staking tax. Once a specific threshold is reached (Blockworks proposes 25% of all staked Atom in liquid form), liquid stakers will be required to pay a tax to the Cosmos Hub. If the liquid staking rate surpasses a defined ideal targeted rate (Blockworks suggests 33% of all staked Atom in liquid form), the tax rate for liquid stakers will increase more steeply. This approach aims to maintain an equilibrium in the ideal liquid staked ratio and prevent uncontrollable growth, an issue we can observe on Ethereum these days, causing heated debates in that ecosystem.

These additional revenues could be used to decrease Atom inflation with a burn mechanism or they could serve as protocol-owned liquidity, stimulating economic activity in the Atom economic zone and generating even more revenue. This sets the stage for a virtuous cycle of continually increasing revenue, reinvesting it to spur more activity, and in turn, generating even more revenue.

These proposals hold promise in crafting sustainable tokenomics for Atom. While the details are still evolving and with other aspects being developed by Binary Builders and RMIT Blockchain Innovation Hub, the initial impression suggests that Atom is moving in a promising direction to address these challenges.

4. Liquidity Fragmentation Poor UX, and Low Adoption 

The app chain infrastructure creates two major challenges: poor user experience and liquidity fragmentation.

Conducting simple token swaps on cosmos involves additional steps compared to more streamlined single-chain blockchains like Solana. Users must initiate an IBC transfer to send their tokens to the exchange’s chain for swapping and then perform another IBC transfer to return the coins to the application’s chain. While Cosmos applications and wallets offer user-friendly interfaces for these transfers, these added steps can create confusion, potentially discouraging new user adoption.

Another significant challenge is liquidity fragmentation. Within the Cosmos ecosystem, liquidity is dispersed across various chains, leading to reduced liquidity on each individual chain. Consequently, users, particularly larger traders, experience higher slippage when trading in the Cosmos ecosystem, making it less attractive for this user segment. This fragmentation also complicates arbitrage activities, which play a crucial role in maintaining price stability across different chains. 

These challenges are evident in the adoption metrics of the Cosmos ecosystem. Total Value Locked (TVL) and daily active users remain noticeably lower compared to competing ecosystems.

5. Lack of Organization, Direction, and Capital Efficiency

A major issue facing the Cosmos ecosystem is the lack of a clear and unified vision. In fact, quite the opposite is true. Core contributors often hold conflicting opinions, and there is no cohesive goal that everyone is working towards. The problems of missing product-market fit, tokenomics issues, and a lack of a compelling value proposition have been discussed earlier in this article. Due to its decentralized structure, Cosmos lacks a clear plan or roadmap to address these issues and make the Cosmos Hub and ATOM more compelling products.

Cosmos is built by a variety of smaller companies, each developing features that align with their interests and preferences. There is no higher coordinating organization that prioritizes tasks, formulates a comprehensive plan, and ensures that efforts are directed towards achieving a common objective. The absence of a central coordinating body capable of taking responsibility, finding solutions, and guiding the ecosystem in the right direction has resulted in a state of stagnation.

Consequently, the ecosystem’s progress is hampered by disputes among prominent players and their organizations, each advocating for different approaches and solutions. This lack of cohesion puts the ecosystem in a state of paralysis. In the innovative Web3 space, success often relies on experimentation, hypothesis testing, and agile adaptation, which necessitates clear vision and a willingness to change strategies. 

The slow governance process in Cosmos, marked by influential players following their own interests, contrasts starkly with the agile leadership needed for success in the rapidly evolving Web3 landscape. The outcome is uncoordinated efforts and a general state of inaction.

Furthermore, each of these independent companies in the Cosmos ecosystem must manage overhead costs related to legal, accounting, management, and other administrative functions. This creates redundancy and inefficiencies compared to a single organizing entity like Polygon Labs or Solana Labs for their respective ecosystems paying overheads only once. To cover these costs the companies charge the Interchain Foundation and community pools extra fees, adding to the overall cost of development and maintenance in the ecosystem.

What Needs to Happen

Cosmos still has a significant technological advantage over other ecosystems, particularly through its unmatched interoperability solution, IBC. Yet, the competition isn’t sleeping. Ethereum has long recognized the inevitability of a multi-chain future. Great efforts like Optimism’s Superchain and Polygon 2.0 – that will rival or even exceed IBC’s capabilities – are already in development. While these solutions are still in development, their ecosystems are already well ahead in terms of user adoption and Total Value Locked.

This puts Cosmos under pressure. It likely has approximately a year to launch applications that can successfully attract users and capital to the interchain. If this effort fails and Cosmos lags significantly behind in terms of adoption when the competition rolls out their interoperability solutions, it could be a game-over scenario Cosmos.

Therefore, more than anything, Cosmos needs stellar proactive business development. Instead of focusing on building infrastructure, the ICF needs to reach out and get serious developers to build on Cosmos. ICF, together with the ATOM community pool, should focus on incentivizing killer applications with funding. The idea is not to spray and pray on a large quantity of small projects, but offer a few large grants to organizations not yet involved in the Cosmos ecosystem with a track record of launching successful products. The aim should be to replicate the success of projects like Friends.tech within the Cosmos network.

These products should not launch as independent chains. They need to bring value, users, and transaction volume directly to the Cosmos Hub. In an ideal world, they would launch directly on the Hub via permissioned CosmWASM. But with the direction the Hub has chosen, this likely won’t find any consensus. So creating ICS chains or launching them to the Cosmos Hub aligned Layer-1 Neutron are the next best options.  Ideally they launch without a token, leveraging the ATOM token instead. One or two killer applications aligned with the Hub driving major volume is all that’s needed to put ATOM on a great path again.

On the economic front, the Cosmos Hub requires a significant redesign. Promising efforts are already being worked on, especially regarding tokenomics. Support from the broader ecosystem is essential, even if the proposed changes are not perfect and may not fully align with everyone’s interests. Stagnation is the worst option in the current landscape, and these efforts represent a positive step forward.

The ultimate aspiration should be to make the Cosmos Hub to the Cosmos ecosystem what Ethereum is to its ecosystem – the central piece that makes the ecosystem tick and position Atom as the interchain money. This positioning can create excitement, attracting the users and capital needed to transform the ecosystem into a thriving hub of Web3 activity.

With a strengthened Hub and successful interchain projects like Kujira and Injective gaining traction as Layer-1 blockchains and DeFi hubs, the Cosmos ecosystem will garner more attention from developers seeking to launch projects. This will benefit the Atom economic zone as well as Layer-1s like Injective and Neutron. A virtuous cycle of adoption driving further adoption can be started and the vision of interconnected Layer-1s via IBC, flagship applications on their own chains, and a vibrant Hub with ATOM at its core can become a reality.

To achieve this vision, all actors within the Cosmos ecosystem must collaborate, make necessary changes, and support those who initiate change. While certain challenges stemming from the decentralized structure may persist, the outcomes can be improved. The Cosmos ecosystem boasts brilliant and creative minds, and the need for bold decisions beyond the status quo is evident. Despite significant challenges, it would be unwise to underestimate Cosmos; a glorious comeback is certainly possible.