TL:DR - As a follow-up post to our Cosmos Hub Fiscal Policy post here, where we introduce a Dynamic Liquid Staking Tax, Blockworks Research is proposing to change ATOM’s fiscal policy from a static 10% community pool tax to a multi-pronged tax approach that includes a (in addition to the LST tax):
1. Vote Power Tax
2. Dynamic Community Pool Tax
Although outside of our scope for fixing ATOM tokenomics, Blockworks Research also proposes the idea of “Cubic Delegation”, which we go into more detail below. Cubic Delegation has the potential to fix the centralization concerns with respect to onchain governance while ensuring quorum can still be met.
Pitfalls of dPoS with Onchain Governance
Historically, the Cosmos Hub’s Nakaomoto Coefficient (number of validators required to reach 33% VP) has oscillated around 7 and 8, putting not only the liveness of the Cosmos Hub in the hands of a select few, but governance as well. This issue is not unique to the Cosmos Hub, but is inherent in dPoS systems as token holders vote with their feet via direct delegation. Although this incentivizes users to choose perceptually “good operators,” it is a major centralizing force since users typically select the largest operators in the set.
If the Cosmos Hub is to be seen as a credible long-term infrastructure provider, we believe a market mechanism must be implemented to help combat these centralization concerns, while also ensuring large validators are truly aligned with the success of the Cosmos Hub.
Explaining the LSM “Validator Bond”
To help solve the Principle-Agent problem inherent in dPoS systems, a “validator self-bond” was introduced to align node operators and their delegates by showing delegates that their validators have “skin in the game”. Unfortunately, the Cosmos Hub (and other dPoS chains to our knowledge) never instituted a minimum for how much self-bond a validator should have relative to how much stake is delegated to them. In theory, the primary concern is that a malicious validator could convince delegators to delegate, unbond all of their self-bond, then commit an equivocation and get their delegators slashed without incurring any punishment themselves.
These Principle-Agent problems are compounded with liquid staking providers since they have their own governance structures external to PoS chain’s native asset being liquid staked. As a risk-mitigation feature to ensure the safe adoption of liquid staking, the Liquid Staking Module introduced a requirement that validators self-bond ATOM to be eligible for delegations from liquid staking providers and be eligible to mint LSM tokens. This new mechanism called the “validator bond” is distinct from the current self-bond mechanism, but functions similarly.
To quote @zaki_iqlusion in the LSM forum post:
The maximum number of tokens that can be delegated to a validator by a liquid staking provider is equal to the validator-bond multiplied by the “validator-bond factor.” The initial validator bond factor would be set at 250 and can be configurable by Cosmos Hub governance.
With a validator-bond factor of 250, for every one ATOM a validator validator-bonds, that validator is eligible to receive up to two-hundred-and-fifty ATOM delegated from liquid staking providers.
Using a validator bond in the LSM got us thinking…
What other ways can we use this mechanism to fix the Principle-Agent problem as it relates to onchain governance? Can the Cosmos Hub benefit from the current poor distribution of stake while also creating a market mechanism to help fix this issue over time?
Below is a diagram of the current state of the validator/self-bond and the potential future state of how to leverage this validator bond. We explain each in more detail below.
Fixing Stake Distribution through a Vote Power Tax
In addition to a dynamic liquid staking tax, Blockworks Research proposes a Vote Power tax that disincentivizes delegating to validators higher up in the active set to help balance out the stake distribution issues over time. Those who delegate to validators with more Vote Power would be subject to a higher tax.
One concern with introducing a Vote Power tax is that not all Vote Power is created equal. Some validators own a large share of their delegated stake and don’t face the same Principle-Agent problem that validators with low ownership have. What we don’t want to do is tax validators that have skin in the game.
Below is our proposed formula for how to calculate the Vote Power tax.
- VPi=Total Vote Power of a given validator
- VPs=Total Vote Power of the active set
- VPsb=Vote Power Self Bonded by a given validator
In simple terms, this Vote Power tax takes the difference from the median Vote Power in the active set and the Vote Power of that given validator. It also gives the validator a chance to lower the Vote Power tax on their delegates by increasing the amount of self-bond to their validator. It is important to note that anyone who delegates to a validator with less Vote Power than the median of the active set would not face this additional tax burden (i.e the bottom 90 validators in the active set today).
As an example, lets look at three validators in the set that have more than the median (~0.17% VP today):
Coinbase Custody (7.17% VP, 0.0% self bond ratio): Vote Power Tax = ~7%
Dokia Capital (3.38% VP, ~15% self bonded ratio): Vote Power Tax = ~1.01%
Allnodes (3.56% VP, ~0.0% self bond ratio): Vote Power Tax = ~3.39%
Although Dokia and Allnodes have similar amounts delegated to them, Dokia Capital’s delegates see a ~2.38% lower tax burden (a ~70% decrease) because of the amount Dokia has self-bonded to their validator.
If this Vote Power tax was implemented today, the Cosmos Hub would generate an additional ~900k ATOM in tax revenue in year 1. This revenue could be equally distributed back to all validators as a subsidy (~5k ATOM/validator/yr) to keep all validators afloat as Interchain Security scales, allowing the Cosmos Hub to benefit from the poor stake distribution.
If the community decides to implement this tax, Blockworks Research recommends re-distributing this tax back to validators equally only if the Replicated Security soft opt-out is removed, as this tax alone should allow most validators to scale to ~5 consumer chains without running at a loss (at ATOM current prices).
Below is a sensitivity analysis that shows the approximate Vote Power Tax a validator and their delegates would face today depending on how much is self-bonded to a given validator. With Coinbase Custody and SG-1 at the top today with ~6.5-7% VP each, they would need to self-bond around 20-25% of their entire stake weight to no longer have this tax burden.
While we know a Vote Power tax will likely be a contentious point of discussion, we believe the community must start considering solutions to combat the centralization concerns of the Cosmos Hub.
One of the issues with combining dPoS and onchain governance is the overwhelming amount of power validators have in deciding the outcome of proposals with low individual voter turnout and validators receiving 1:1 vote power of their delegates.
This begs the question…should validators have 1:1 governance vote power of their delegated share? The idea of “quadratic voting” has been written about at length by Vitalik and other leaders in the space, but has seldom been implemented. With quadratic voting, each validator’s voting power equals the square root of the total delegated stake it accumulates (a simple example is shown below).
Today, Axelar uses quadratic voting to help combat the centralization concerns outlined above.
While quadratic voting does help lessen the influence large stakeholders have over swaying the result of a governance vote, we believe creating a mechanism where a validator’s governance vote power is a direct function of their validator bond ratio might better align validators and their delegates while also incentivizing node operators to put up more collateral. The problem with quadratic voting is that it assumes all Vote Power is the same. Going back to the example with the Vote Power Tax, if you assume Dokia Capital and AllNodes have the same total Vote Power, quadratic voting would give them the same weight in governance while not taking into account that a larger share of Dokia’s Vote Power is owned by them.
Below is our proposed formula for calculating validator governance vote power moving forward. Please note that a validator only gets the vote power of the delegates that choose not to vote individually. We propose the same mechanism, but instead of getting 1:1 vote power of delegates that don’t vote, validators should only get a proportion of that vote power since they do not own those assets.
- VPi=Total Vote Power of a given validator
- VPsb=Vote Power Self Bonded by a given validator
- 40% is the minimum quorum of the Cosmos Hub today
What this means is that for a validator to receive more than 40% of the delegated stake vote power that has not voted, they would need to bond over 6.4% (40%^3) of total delegated stake to their validator.
As an example, assume Validator A has total Vote Power (VPi) of 10 ATOM, of which 2 ATOM are self-bonded (VPsb) and none of their delegates voted:
Today, Validator A would get 10 ATOM of total Vote Power.
Under this new mechanism, Validator A would get 58.4% of their delegate Vote Power ( 20%^(1/3)) plus the 2 ATOMs they own, giving them a Total Governance Vote Power of ~6.67 ATOM (58.4%*(8 ATOM) + 2 ATOM).
We believe this puts more governance weight into direct voters and further incentive aligns validators with their delegates since they are putting up more of their own slashable collateral to secure the network.
While governance was not directly part of our scope, we think this idea (or a version of it) should be considered by the community. The validator bond mechanism imposed by the LSM opens the design space for how to solve the Principal-Agent problem with dPoS in all facets while ensuring the system is not too capital inefficient (forcing validators to put up too much collateral).
Dynamic Community Pool Tax
The Cosmos Hub is overpaying for security. High inflation is NOT a pre-requisite to a large percentage of the supply staked, as shown by other top PoS networks in the space.
The Cosmos Hub has more than enough issuance to pay for security AND fund strategic initiatives.
To properly bolster the community pool and fund initiatives like the ATOM Alignment Treasury, core development work, subDAOs, etc, Blockworks Research is recommending changing the community pool tax from a static percent of inflation to a known schedule that decreases block-by-block until a base tax of 5% is reached over time as inflation is reduced accordingly based on our proposed supply schedule here.
We propose the Community Pool tax be increased from 10% to 20% with a 20% annual decrease that decreases block-by-block until a base tax of 5% is reached.
Below we compare the current community pool tax (blue) to the recommended tax (red).
With this tax schedule, ATOM stakers can expect to see a lower community pool tax than they face today by Q2 2027.
Additionally, when applying this new tax schedule with our recommended supply schedule, it frontloads the community pool by about 18 months as seen below.
As the Cosmos Hub’s revenue grows through the economic relationships its fostering with its consumer chains, the need for as high a community pool tax reduces. Ultimately, to pull forward the community pool tax, which we believe will be critically important to properly right size the Cosmos Hub’s treasury to jumpstart the ATOM Economic Zone, fund core development, and subDAOs, we believe it is the fiscally responsible thing to do to lower the tax on the backend.
Fiscal Policy (End State)
Below is an overly simplistic view of what the fiscal policy and budget distribution of the Cosmos Hub could look like depending on what the community approves if/when these ideas move to an onchain governance vote.
If you recall in our post here, this is what the current state of the Cosmos Hub’s fiscal policy/flow of funds is:
We believe that by bucketing the community pool tax into smaller buckets (with the community deciding how much is directed towards each bucket), it should allow for greater accountability and better budgeting of the Cosmos Hub’s capital. This will allow the Cosmos Hub to be a true Port City that strategically allocates its capital to welcome the brightest development teams in the ecosystem that want to align and build on behalf of the Hub, foster economic growth of its consumer chains and the wider Interchain through the use of Protocol-Owned-Liquidity, and funds sub-communities (subDAOs) with specific mandates to help better the wider Hub community.
While what we presented above is not final, we hope this post furthers the discussion about the future of how the Cosmos Hub (and its community) operates in the future.
We will have one final post next week that directly links to all 3 separate forum posts and will also include a customizable model we created to allow the community to ultimately decide the parameters it wants to select if it does decide to move forward with any of the ideas proposed by Blockworks Research.