Is there an advantage to bonded, but unslashable, stake in a world of staking derivatives?

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Introduction

In the Staking Hub telegram channel, Gavin (from Figment) asked this interesting question - is there any social utility to bonded, but unslashable, stake in a world of staking derivatives? This post dissects the problem and presents my view on the topic. It would be great to hear alternative opinions.

Detailing the question

In recent days, Solana announced its intention to have 100% of staked capital slashable. That policy is a radical departure from the design of the Cosmos Hub. On the Cosmos Hub:

  • Delegators bond ~70% (~180 million atoms) of the supply.
  • Only 5% of the bonded amount is slashable. Therefore, 9 million atoms are slashable.
  • 171 million atoms are locked up but at no risk of slashing.

There might be an alternate design to the Cosmos Hub Alt, which makes all of the bonded capital slashable. It might end up at an operating point, such as:

  • 25% of the supply - 65 million atoms - are bonded. All of the bonded amounts are slashable.
  • 75% of the supply exists as liquid atoms.

The question is whether the 171 million atoms that are locked up, but at no risk, produce any utility. They provide social disutility due to the reduction in delegator options.

This question has existed for a while, but staking derivatives contribute a new flavor to the problem:

  1. Staking derivatives allow for the representation of locked up, but not at risk, bonded atoms as liquid assets. Everett bATOMs, delegation vouchers, and BHarvest delegation trading bring liquidity to this capital via derivatives.
  2. Is there something circular about this future? The Hub locked up 171 million atoms, only for them to be made liquid via derivatives. Why lock them up in the first place?

My position

There is utility in locking up atoms, without slashing risk, even if the supply were to be made liquid by staking derivatives. Consider the efficiency from the perspective of 3 different derivative inventions - delegation trading, delegation vouchers, and delegation tranches.

Delegation Trading

Probably the most straightforward derivatives system implemented by BHarvest in the Berlin Hackathon. They created a mechanism by which delegations are transferable from one account to another. An order book atom-delegation trading system exists atop the device. It enables one to sell Figment delegations for atoms via the BHarvest DEX.

Letā€™s think from an attackerā€™s perspective. The cheapest, but consequential, attack on the network is a 33% censorship attack. The attacker is somehow able to route 33% of voting power to validators controlled by them and censor the chain. They could benefit from short positions on the atom opened up before the attack. (Note: Itā€™s hard to execute this attack with known validators due to insider trading and criminal liability rules).

In the standard Cosmos Hub, such an attacker would need to buy delegations worth 60 million atoms (1/3rd of 180 million), re-delegate them to a malicious validator set, and then execute the attack. In Cosmos Hub Alt, with a 100% slashing rate, the attacker would need to buy delegations worth 21.66 million (1/3rd of 65 million) to execute the same attack.

Hence, even though 171 million are unslashable, they have produced utility in making it harder for an attacker to garner enough voting power.

Delegation Vouchers

Delegation Vouchers are an extension of delegation trading - they tokenize delegations into validator-specific vouchers. As such, the same argument from earlier stands for delegation vouchers. Unslashable atoms make it more expensive to mount an attack by buying up delegation vouchers.

Delegation Tranches

The bATOM system represents the 171 million bonded, but unslashable, atoms as a new liquid asset - the bATOM. The system is dependent on the existence of unslashable bonded atoms and does not generalize to the Solana proposal.

Since bATOMs are viable only on the current Cosmos Hub, not Cosmos Hub Alt, the creators of the system will strongly favor the current configuration.

Conclusion

There would be utility in locking up atoms without slashing risk, even if such assets were to be made liquid via staking derivatives. For Delegation tranches, the existence of bonded but unslashable atoms is a necessary pre-condition. Overall, the Hubā€™s current policy is future-proof.

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Tuckermint is experimenting with a 0% slashable model, which is the opposite of Cosmos Hub Alt.

Itā€™s possible that a whole spectrum of slashing models will prove to be viable.
I guess the validity of each model will be borne out in practice.

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Yeah, Iā€™m looking forward to Tuckermint with 0% slashing and the data it generates as a socioeconomic experiment.

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I want to reply to this thread with below viewpoint.

bonded atom as an investment

  • expected return : price gain(major factor) + reward(minor factor)
  • expected risk : price drop(major factor) * 3week unbonding period illiquidity(medium factor) * liquidity risk(major factor for large holders) + slash(minor factor)

As you see in above factorization, reward and slash is NOT a major factor for both return and risk side of atom as an investment. Let me calculate the REAL cost of total expected risk of double signing(which is argued that it is the main source of security of the chain) as below.

  • risk of double signing of power weighted average validator per year : 0.3%(estimated)
  • double signing slashing : 5% of bonded atoms
  • number of bonded atoms : 171m atoms
    ā€“> yearly cost of expected slash risk for the chain = 171m*5%*0.3% = 25k atoms = 87k USD
    ā€“> assume 3% risk free rate --> 87k USD / 3% = 2.9m USD at stake for security of the chain

I donā€™t believe that 2.9m USD is the total amount of security in this chain. It is rarely a practical guess.

Then what risk is staked on the chain for the security of the chain? It is easy. Just look at the factorization of risk of atoms as an investment instrument above. The major risk is ā€œprice volatilityā€ and ā€œliquidity riskā€.

One more interesting thing is that those three types of price/liquidity risk are multiplied. If you have more atoms, you will have more total risk than small holders. If your atoms are bonded, the overall risk is much larger than unbonded atoms.

So, from this, I donā€™t agree that unslashable staked atoms are doing nothing on protecting the security of the chain. Actually those are major capital contributing to the security than the slash risk because slash percentage is only 5% and the possibility is very rare.

Maybe it looks like unbonded atoms will not hurt when double signing happens right? But imagine that all the reputation is correlated in this market. Frequent double signing from large validators mean that the chain(validator set) is unstable, so it will cause significant price drop of atoms. Every atom suffers the risk together.

So these are my analogy that, slashable capital is NOT the main capital contributing to the chain. It is just theoretical motivated idea of PBFT and ignoring the real economic impact and environment.

I want to note that, if the atom is a very stable fiat currency, like USD, I can agree with you because the price/liquidity risk is minimal.

Staking Derivatives and Core Level Illilquidity Design

Now from my above arguements, I want to share my thoughts about why staking derivatives and core level illiquidity design has fundamentally different aspects.

Staking derivatives are a market of a subset of whole ecosystem. Derivatives always have buyer and seller. Only matched demand can lead to a transaction. What it means is that, all trades in this derivatives market is based on ā€œBONDEDā€ atoms. And no action in this market changes the state of ā€œBONDEDā€ to unbonded. In other words, there is no free liquidity in derivatives market. There exists only the ā€œtransferā€ of liquidity. If you get the liquidity from derivatives, your counterparty will burden the illiquidity. And of course, your counterparty will ā€œChargeā€ you for your liquidity.

But, if we change the parameter on bonded atom illiquidity design on the core, the overall picture will be changed. Remember the major risk of bonded atom holder is price drop * 3week unbonding period illiquidity * liquidity risk. If 80% of bonded atoms can be liquidated on protocol, those 80% of liquidated atoms will have significantly less risk than illiquid atoms with 3week unbonding period illiquidity. It means the overall security capital will drop significantly.

There exists a very clear incentives for larger holders to have more liquidity on their bonded atoms because if you see the equation, the risk is larger for whales than small holders because of the liquidity cost! But making changes on core level will degrade the whole security of the chain.

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