Merge, Surge, Splurge… Fusion?

Interchain Finality for Cosmos and Ethereum

At the end of the Silurian period 420 million years ago, jawed fish diverged into cartilaginous sharks (and rays) and their tougher cousins, the bony fish.

The latter gave rise to amphibians, some of which crawled out to conquer land and air, becoming dinosaurs and proto-mammals. 375 million years later, some of them returned to the seas, becoming dolphins and whales, which once again came together, this time to become warm-blooded, air-breathing mammals, using a familiar hydrodynamic strategy involving tails, fins, and lightweight skeletons to propel them.

A brief history of Cosmos and Ethereum

Separation: Cosmos and Ethereum split from their common blockchain ancestor, Bitcoin, in 2013-2014. But as both projects iterate on their respective roadmaps, their endgame has begun to converge on multiple connected execution zones.

While Cosmos’ design still favors application-level sovereignty, Ethereum has become increasingly modular, more willing to trade this freedom for universal security and settlement. Ethereum’s overall structure allows for the release and iteration of composable smart contracts at an extremely fast pace, a necessary prerequisite for the first major development of DeFi applications.

Its massive success has allowed it to develop solutions to many blockchain problems and make considerable progress on two of the most persistent problems in the space: scaling and maximum extractable value (MEV). Ethereum developers have pushed the technical and definitional limits of single-chain scaling, and they have brought the dark forest of block producer reordering transactions into the light.

Meanwhile, Cosmos abandoned the winner-take-all race to become the global financial AOL (the precursor to the World Wide Web) in favor of developing a secure, resilient backbone for the Internet of Money.

It pioneered three pluggable, adaptable technologies:

• Replicated state machine with Byzantine fault-tolerant consensus (Tendermint).

  
  

• A set of blockchain application modules (Cosmos SDK) that interact with the consensus engine.

  
  

• These can use the crown jewel of Cosmos: the Inter-Blockchain Communication protocol (IBC), to quickly spin up an immediately interoperable blockchain.

IBC is both a trust-minimized data transport layer for communicating between chains and an interchain application layer built on top of it. The most obvious application is token transfers, but a growing number of interchain standards are allowing for more complex cross-chain interactions, such as interchain queries, interchain accounts (allowing accounts on one chain to control accounts on other chains), and interchain security (sharing validator power between chains).

These IBC features are already live and are just beginning to see widespread use, creating the conditions for fully composable DeFi across chains.

Convergence: With these very different approaches, Cosmos and Ethereum are now beginning to converge again as they each adapt to the changing crypto landscape.

On the one hand, Cosmos is superficially beginning to resemble Ethereum at the application layer, which is an implementation of the Cosmos roadmap rather than an architectural change. With IBC now connected to about 50 chains, and CosmWasm smart contracts spreading throughout the ecosystem, applications are proliferating in various ways: single-purpose blockchains, general-purpose smart contract zones, and multi-team application suites like the Osmosis decentralized exchange.

As interchain DeFi begins to flourish, many of the first applications are ported from the most successful Ethereum applications. But many chains are doing things that are only possible on sovereign chains, and the applications that started out as clones largely serve as a bootstrapping mechanism to develop improvements that are only possible on the application chain while achieving product-market fit.

Ethereum, on the other hand, is clearly more like Cosmos in design.

With the merge complete, it’s now proof-of-stake like a Tendermint chain. More importantly, the original Ethereum 2.0 vision of sharding execution has long been deprioritized in favor of rollups, quasi-application chains designed to move most transactions off the Ethereum main layer. The recently announced parts of the Ethereum scaling roadmap — surge (data sharding), verge (stateless), purge (state expiration and cleanup), and splurge (account abstraction, proposer-builder separation, verifiable delay functions) — all support a rollup-centric model.

In Vitalik’s article Endgame at the end of last year, he envisioned three possible scaling futures for Ethereum: no rollup, a single dominant rollup, or a continuation of the current rollup scenario.

Because they are essentially like appchains, it seems likely that many rollups will continue to thrive simultaneously.

As each rollup attracts its own developers, applications, investors, and users, each rollup begins to develop its own unique community identity and its own business development. Currently, each rollup is a tax-paying, protected federation within the larger Ethereum federation, but the most successful rollups, having tasted sovereign application chains, may eventually want more control over their protocols, at which point they may easily become full-fledged fully interconnected application chains with access to the entire interchain.

Cosmos Application Chain Theory

Why would an application or rollup want to become an appchain?

The fundamental value proposition is sovereign interoperability.

Because they are independently sovereign, Lisks can precisely control their entire stack: execution, consensus, block size and timing, state and memory pool logic, rollups, fees, smart contract environments, validator requirements, governance rules, and any other area of ​​their blockchain structure and operations they might want to customize. And, unlike rollups, if a Lisk is exploited or attacked, it can fork and restore the previous state through social consensus and the rule of law.

Because they are interoperable, application chains can interact freely and composably through IBC.

What does the application chain do with these functions?

They optimize the user experience, fine-tune access to blockchain data and mechanisms from front-ends and wallets like Keplr, and adjust protocol-level logic to make execution faster, easier, and more efficient. They secure the chain as they see fit, recruiting their own validators to implement code, generate blocks, relay transactions, etc., or borrow security from another validator set with inter-chain security (launched in Q1 2023).

Eventually, most application chains will choose a hybrid of these two options: chains will share their validator sets with each other, and the entire inter-chain will become a shared defense zone, protected by a mesh security armor.

Many application chain innovations combine security and user experience. For example, Osmosis has developed "superfluid staking", a major improvement to proof of stake that allows liquidity providers to stake the underlying token in their LP share to help ensure the security of the chain, thereby receiving staking rewards in addition to LP rewards. Currently, only the OSMO token benefits from this improved capital efficiency, but improvements to Tendermint (a Byzantine Fault Tolerant state machine replication software that is at the core of many Cosmos chains) will enable other application chains to choose to perform superfluid staking on Osmosis, or allow OSMO to be superfluidly staked on their chains.

Soon, entire interchains will be able to use their staked assets for DeFi without the centralization and chain security risks of traditional liquid staked derivatives.

Application chains are also good at dealing with MEV: whoever has the power to decide transaction ordering and block inclusion will reap the profits. MEV plagues DeFi users in all ecosystems, but application chains can develop on-chain solutions faster, greatly reduce malicious MEV, and redirect healthy arbitrage profits from third parties to themselves.

For example, Osmosis is developing a private mempool with threshold encryption (an idea that Ethereum is also experimenting with). These private transactions are visible to nodes only after they are executed, making front-running more difficult while also allowing limit orders and other future/ephemeral transactions to be placed privately on-chain. Similarly, appchains can reserve the first slot in their blocks for protocol-controlled arbitrage and liquidations: this is necessary for the health of lending and trading protocols, but on monolithic chains this often becomes a MEV game that leaks the value of the application to third parties. Instead, Osmosis will direct these healthy, user-safe arbitrage profits back into the DAO.

The remaining (much reduced) MEV could also be partially captured by auctioning off the second slot in a block to MEV seekers. Alternatively, it might make sense for chains to have all second slot auctions aggregated in one place, as the Cosmos Hub proposes, so that the cross-chain MEV market is transparent rather than a dark forest.

Lisks allow for radical blockchain experimentation at a rapid pace. While Tendermint and the Cosmos SDK are both amazing technologies that allow applications to quickly spin up IBC-ready blockchains, the entire Cosmos stack is not a requirement to be an IBC-connected Lisk. Many high-profile Cosmos ecosystem projects are building or adopting alternative consensus or state machines to better suit their needs, including Penumbra (private transactions), Anoma, and Nomic (Bitcoin on Cosmos).

Lisks are not by definition different from monolithic chains; rather, Lisk modularity is largely a philosophy of sovereign interoperability combined with IBC’s trust-minimized blockchain communication.

In contrast, monolithic chains generally adopt the so-called fat protocol theory, where one chain runs the vast majority of DeFi in the world, everything is centralized in one layer, and tokens accumulate monetary premiums. As we know, scaling such protocols is very difficult, and people continue to invest huge efforts in accelerating and modularizing execution, storage, data availability and other exciting technologies.

Rollups are amazing technical achievements, and so far they have served as closed application chains with no sovereignty or interoperability, although they certainly benefit from the tremendous security of Ethereum. While application chains do not yet have the blockspace limitations of monolithic chains, they will be able to adopt modular solutions such as rollups and data availability layers when necessary.

The Cosmos theory predicts a future of application chains that allows it to shard execution into separate blockchains by design, giving application builders the freedom to develop their own products and freely experiment with all layers of the stack.

At the same time, the Lisk vision assumed the inevitability of cross-chain bridging years before others and developed the most comprehensive and secure inter-blockchain communication system to date in an era when cross-chain bridge attacks are commonplace.

Security of IBC

One of the strongest arguments against the AppChain theory is that cross-chain bridges are inherently insecure. On the one hand, it is true that no protocol or inter-chain messaging system is inherently and always secure, but this is true for both Ethereum contracts and IBC.

Any code can have bugs, and adversaries are always trying to exploit them.

On the other hand, we’ve gathered enough evidence since the DeFi summer that users won’t simply limit themselves to a single chain — they’ll use available multisig to cross chains to the latest cookie-cutter EVM clone.

How eager will they be to use IBC and fully interoperable, UX-optimized, composable DeFi between chains?

If cross-chain bridges are inevitable, why is IBC the best? Why is it considered secure enough to be the future of finance? The answer lies in trust-minimized design.

The participating chains run each other's light clients, which means they each independently validate the block headers of the other chains. Therefore, an attacker cannot convince another chain with a lie unless they take over the entire chain. If this happens, the party controlling the chain could mint tokens on its own chain indefinitely, transfer them through IBC, and use them to steal funds in AMM or through other DeFi mechanisms.

This is in stark contrast to cross-chain bridges, where tokens are held in exploitable contracts (multi-sig or otherwise) that traditionally do not allow for general purpose messaging (although Axelar Lisk has made great strides in improving non-IBC cross-chain communication).

It is therefore important that application chains establish IBC connections with reputable, secure chains. However, it is also true that the window of vulnerability from an attack chain connected to IBC is very small. First, if a chain is taken over due to an economic or governance attack, or if it fails catastrophically, the IBC connection can be shut down immediately, meaning it cannot siphon off any value.

To compensate for the brief time before IBC connections are closed, IBC rate limiting will soon kick in. This will allow application chains to limit the flow of tokens in a given time period, allowing normal activity while limiting the value that an attacking chain can gain, making the economic calculation of any attack less favorable.

The above chart shows IBC sent and received between IBC-connected chains, with the size of the icons proportional to transaction volume. Even in this bear market, approximately 800,000 transactions and $264 million in value were sent via IBC in the past 30 days. Note that this is only cross-chain activity; it does not count single-chain transactions.

Still, it’s no secret that Cosmos has yet to be adopted in the same way that Ethereum has. Technical challenges remain for interchain DeFi to reach its full potential — though we’re starting to see what they might look like in areas like interchain security, encrypted memory pools, protocol control arbitrage, and synchronized block space auctions.

As interchain adoption increases, appchains that need to scale will also be able to use the full suite of rollups and other scaling solutions developed on Ethereum, as well as modular appchains like Celestia.

ATOM 2.0: The benefits of a monolithic chain to an interchain

We discussed above how Ethereum has become more like Cosmos over the years. In the recent ATOM 2.0 whitepaper, the Interchain Scheduler proposes an auction house for tokenized block space across the ecosystem, which, if there is enough participation, will enable future cross-chain block synchronization. The Interchain Allocator will allow the use of the ATOM treasury to invest in the entire ecosystem.

The Cosmos Hub is also developing Interchain Security v1, a precursor to mesh security and a plug-and-play security option for consumer chains that do not wish to take on the responsibility of recruiting and managing their own validators. In its final mesh security form, Interchain Security serves as another point of convergence between Cosmos and Ethereum, enabling interchains to implement a more flexible, sovereign version of the kind of monolithic, protocol-level security currently provided by Ethereum.

Application Chain: Hub and Outpost

Currently, blockchain activities have stabilized in some semi-liquid ecosystems.

Right now, these zones are loosely connected via bridges and centralized exchanges, but IBC could securely interconnect them all — though the development of cost-effective light clients for some chains is still a work in progress.

Applications on both app chains and monolithic chains are positioning themselves for an increasingly connected future. With ad hoc cross-chain bridges now clearly unpopular, most applications are adopting a Hub and Outpost model rather than relying on name recognition or trying to build a lasting technical moat while being constrained by protocol-level decisions beyond their control.

This Hub and Outpost model can take different forms. In all forms, the Hub is the home of the AppChain, responsible for managing and coordinating the Outposts. One of the main questions for the future of IBC is how to best handle liquidity. For Osmosis, at least for now, it makes sense to keep all liquidity in house and have its Outposts route liquidity from other chains through the Osmosis blockchain. But Mars Protocol is working closely with Osmosis to launch its first lending Outpost on its platform, with plans to have each Outpost have independent liquidity.

It depends on the trade-offs that different application chains make between decentralized liquidity (which may lead to poor execution) and the need for fully synchronized transactions. That said, as interchain mesh security grows and the market for interchain synchronized blocks grows, and as IBC evolves in ways we cannot yet predict, fully synchronized interchain DeFi transactions will inevitably emerge.

Endgame

Cosmos and Ethereum have always been close in philosophy, both drawing heavily from the original cypherpunk ethos. While Ethereum is committed to pushing the assumptions of monolithic chains to the extreme possible, and Cosmos chooses to maximize sovereign interoperability, it is perhaps unsurprising that many of their design choices begin to converge as the endgame approaches.

The line between rollups and appchains is becoming increasingly blurred, as evidenced by dYdX’s decision to move from rollups to appchains while retaining the possibility of returning to rollups in the future.

Other applications may spin off their own application chains while retaining Ethereum as their primary outpost.

Interoperability (of the limited, insecure kind) came to Ethereum a long time ago: once light clients are available, Ethereum itself will be able to connect to interchain more securely by using IBC, another sovereign, interoperable member of the broader ecosystem we share.