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The Price of Sovereignty

Mar 25, 2024

Many thanks to Sreeram Kannan (EigenLayer), Dev Ojha (Osmosis), Kam Benbrik (Chorus One) and Myles O’Neil (Reverie) for their valuable feedback.

Outline

  • Introduction
  • Opt-in Shared Security
  • Revenue and Price
  • Separating the Consensus Layer
  • Execution Layer Tokens
  • Conclusion

Introduction

The maturation of blockchain infrastructure and SDKs has led to a Cambrian explosion of the number of L1s deployed. Whilst the status quo currently is for each PoS chain to be secured by its native token, we’re starting to see several forms of experiments across the design space that we call derived and shared security.

Smart contract rollups are the most obvious examples of derived security, where they inherit all their security guarantees from the base layer (data availability, censorship resistance and reorg resistance). Shared security differs, in that deployed services rent a subset of the cryptoeconomic security and validators from the baselayer. An instantiation of a shared security platform is Eigenlayer which allows for deployed services and blockchains (collectively called AVSs in the Eigenlayer parlance) to rent security from staked ETH and the validator set native to it.

Ethos is a validator coordination layer on top of EigenLayer, bringing ETH security to sovereign L1 chains.

Co-validation

One of the ways Ethos can provide security to sovereign L1 chains is through a process called co-validation. With this offering, all of the integrated chain’s validators will be provided by Ethos, but not all Ethos validators will be forced to validate the integrated chain. Security provision will then behave similarly to a free market, where Ethos validators can 'opt-in' to validate a specific chain depending on the profitability of running that chain's node software. However, the source of security/stake will remain restaked ETH.

Factors affecting participation

Blockchain networks have two main groups of stakeholders: security consumers (non-stakers / transacting users) and security providers (stakers / validators). The network itself is a coordinating mechanism allowing the flow of funds to go from consumers -> network -> providers. The funds the network receives from consumers can be classified as the ‘Provider Revenue’ and can be broken down as such,

Provider Revenue = Inflation + Transaction Fees + MEV tips (+ Application Revenue)

Inflation refers to the security providers’ increasing percentage of the overall supply through the block rewards distribution mechanism. Since the security providers accumulate new tokens with the native token issuance at every block, their relative ownership of native tokens as compared to that of the consumers (token holders) goes up.

Transaction fees, MEV tips, and application revenue are generated from user activity on the chain and depend on the applications and execution layer of the chain. Application Revenue applies mainly to app-specific chains where providers get extra revenue from the business model of the application, for example, taker fees on Osmosis, or commissions on marketplace sales (NFT, GPU..). At network launch, user activity may be minimal for a long time as the ecosystem reaches PMF and gains mindshare. During this period, Provider Revenue may rely solely on supply inflation, resulting in extremely high inflation percentages.

The funds the network needs to pay the providers are equal to the Total Value Staked multiplied by the Price of Sovereignty where,

Price of Sovereignty = Capital Opportunity Cost + Capital Risk Exposure (+ Hardware Cost)

Hardware Cost is the upfront node hardware cost plus the operational cost (maintenance / DevOps + utility) that is borne by the validators themselves. This is the only variable that remains fixed and does not scale linearly with the Total Value Staked. Capital Opportunity Cost refers to the yield that stakers could have received from other alt-L1s / appchains.

Capital Risk Exposure is related to the volatility of the staking token. As a staker, you are subjected to the illiquidity during the unbonding / bonding period that makes you take on price risk in the case of highly volatile assets, which new tokens tend to be.

Off-loading Network Validation

With Ethos’ Co-Validation mechanism, we can reduce the price of sovereignty by reducing each of its constituents except for hardware costs, which are dependent on the network chain code.

Through leveraging EigenLayer and the underlying restaking paradigm, capital opportunity cost is decreased to almost 0. This is because restakers can earn the native yield of mainnet Ethereum whilst subscribing to multiple AVSs with the same pooled capital. Therefore, yield battles between AVSs and comparisons are no longer needed.

Historically, to bootstrap validators, blockchain projects have had to rely on centralizing mechanisms like massive foundation delegations, complex testnet incentives, and pre-allocation of large portions of the token supply to launch validators. Such practices not only impact the token's stability by concentrating influence among early participants but also pose challenges to achieving genuine decentralization, amplifying the Capital Risk Exposure for all new validators. When integrating with Ethos, restaked ETH is used as the staking collateral, significantly reducing the risks to validators. This is primarily because $ETH is one of the most liquid and established digital assets, and so compared to new token launches, ETH provides a remarkably lower capital risk exposure.  

By reducing the Price of Sovereignty significantly, we can increase the total value staked, boosting the network's security and reducing the amount of Network Revenue needed. This means reducing inflation, and transaction fees, and maybe even redistributing MEV to security consumers as well! In this manner, Ethos benefits all stakeholders in the network; security consumers pay less, and providers take on less cost.

Execution Layer Tokens

Execution Layer Tokens are the native tokens of Ethos Integrated Chains. These tokens aren’t used as the staking token for the integrated blockchain, which some might view as a loss of utility for the token but we argue the opposite!

By isolating the consensus layer, the execution layer token value is no longer tied to inflation schedules, Total Value Staked and other extraneous security factors. It will likely closely follow the performance of the execution layer and the applications built on top, allowing for a fairer and more accurate pricing mechanism.

Additionally, since there is no need to stake the execution layer token, it will have a different distribution and user behaviours compared to traditional PoS coins. This is because, assuming a non-LST world, there is no illiquidity or locked assets. All tokens are free to transfer and be used where appropriate, which may result in more DeFi adoption for the token, as well as better access to liquidity for users of other networks to buy in. Even assuming LSTs for the network are live, the user behaviours for LST holders still tend to be inactive. This can be seen with most DEXs in the larger crypto ecosystem almost always have deeper liquidity for the canonical token than the LST token.

Conclusion

Ethos is a validator coordination layer where one of our products provides crypto-economic security to our integrated chains. Like any good service provider, the goal of Ethos is to provide the best form of its product at the lowest price possible. By reducing the price of sovereignty, chains can now afford to lower provider revenue and/or choose to redirect a portion of the provider revenue to spend on growth and incentivizing a healthy ecosystem. At the end of the day, Ethos benefits all stakeholders of the network.

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