igital Nugget: Cosmos token yet to price in recent protocol upgrades

Digital Nugget: Cosmos token yet to price in recent protocol upgrades

As use cases for crypto proliferate and grow, the prices of individual tokens do not always reflect the underlying opportunities. One example is interoperability protocol Cosmos, which recently delivered important upgrades. Cosmos is implementing a development roadmap designed to accelerate the growth of its ecosystem and the value captured by the Cosmos token (ticker: ATOM). As certain trends in the crypto market are also supportive to Cosmos’s growth, the improved outlook for transaction volume and revenue growth does not appear to be priced in. Year-to-date, the Cosmos token has underperformed competitor Polkadot by 16 percent and bitcoin by 84 percent.

Greater value accrual to the ATOM token

Cosmos has been working on advancements to increase the growth potential, platform revenues and the token’s ability to capture value.

Cosmos offers ecosystem projects the use of its blockchain consensus engine (Tendermint) and software development kit (Cosmos SDK). The Cosmos protocol has only generated revenue so far from charging projects a transaction fee for communicating with each other through the Cosmos Hub.

This meant that transaction fees accruing to Cosmos validators have remained low despite the strong growth in the number of projects within the Cosmos ecosystem. Validators are instead rewarded with newly issued tokens – the inflationary effect of this, however, has had a negative impact on the token price.

Meanwhile its interoperability protocol (IBC) – although in theory it can connect any two blockchains – has mainly been used by Cosmos based projects so far, limiting demand and transaction fee revenues.

The recently delivered ‘Replicated Security’ feature solves a problem for new blockchain projects by allowing them to ‘rent’ the validators of the Cosmos networkand have strong decentralised security right off the gate. This also means that more transaction fees accrue to Cosmos validators.

Further development work is ongoing to expand and scale the Replicated Security concept to a full Interchain Security solution, allowing validators to opt in or out, enabling other chains in the ecosystem to lend out their security, and blending the validator set of projects to strengthen the security of each through features such as ‘Mesh Security’, ‘Layered Security’ and ‘Opt In’.

Additionally, Cosmos is looking to make ATOM the default currency for all IBC transactions. Although fees can still be paid in any token, setting ATOM as the default currency will drive increased demand.

The greater use of the token and higher transaction revenues increase the fundamental value of the ATOM token. In addition, the upgrades also target catalysing faster growth, and the project is considering a revamp of the token supply model.

Ecosystem growth

The Cosmos ecosystem currently encompasses 246 projects.

Building an application-specific Cosmos chain offers significant benefits, as it avoids the application being hostage to congestion or higher fees on a blockchain such as Ethereum and it affords greater flexibility and decision -making sovereignty to the project. Recently, leading decentralised derivatives exchange dYdX and decentralised exchange SushiSwap both decided to move from Ethereum to the Cosmos ecosystem.

The recently launched Replicated Security model (and further extensions of it) will likely accelerate this trend by lowering the barrier and making it more attractive for projects to build on Cosmos. In recognition of the Cosmos ecosystem’s importance, USD Coin issuer Circle also decided to launch the stablecoin on a Cosmos ecosystem blockchain.

In addition, as developers work on making the interoperability module easier and more feasible to connect to for chains outside the Cosmos ecosystem (such as Ethereum, Bitcoin, Polkadot, Avalanche, NEAR), this can unlock tremendous growth, and transaction fee revenues could increase substantially.

As the crypto industry matures and use cases develop, blockchain scalability is still a limitation. While protocol layer projects work on improvements to scalability, there is a growing trend for projects to build on blockchains optimised for a specific application or sector.

This trend favours Cosmos as it offers projects the ability to quickly and easily create a tailored blockchain, using Tendermint, the Cosmos SDK, and now also Replicated Security. The interoperability offered by Cosmos is an added benefit.

The growing interest in application specific and sector specific chains further improves the growth outlook for Cosmos.

Token supply model

The inflationary token issuance model is designed to incentivise holders to stake their tokens and thereby improve the security of the network. With the issuance of new tokens, the value of the protocol does not change but some of the economic value shifts towards those who choose to stake their tokens at the expense of those who do not.

Although the inflationary model has clear benefits, it can also act to depress the token price. If investors’ view on the protocol’s value is unchanged, the same market capitalisation will translate into a lower token price due to the inflationary issuance, and this has a negative psychological impact. Indeed, the market capitalisation of Cosmos vs Polkadot grew at the same rate year-to-date while the price performance of the ATOM token is 16% below the year-to-date performance of the Polkadot token.

Cosmos has been working on devising a new, less inflationary token supply model.

Summary

The underperformance of the ATOM token may be due to investors waiting to see evidence on transaction volume and fee revenue growth before increasing their forecasts, or waiting for clarity on the new token supply model. At the same time, the recent upgrades increase the value accrual to the token, while ongoing development on interoperability with major blockchains, the industry trend for application and sector specific chains, and the focus of the project on improving the tokenomics model imply a better outlook for the token and upside for the token price.

What is Cosmos? Cosmos is a blockchain and a Web3 interoperability protocol designed to connect blockchains, both within and outside of the Cosmos ecosystem. Interoperability protocols are also referred to as ‘Layer 0’, as they weave distinct blockchain networks into a single net, forming the foundational layer of Web3. They allow communication among different blockchains, data transfer and cross-chain transactions.

Read more about crypto assets from Sygnum here.

Disclaimer

This document is purely for educational purposes and has been issued by Sygnum Group. It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a marketing communication. It does not constitute an offer or a recommendation to subscribe, purchase, sell or hold any security or financial instrument. It contains the opinions of Sygnum Group, as at the date of issue. These opinions and the information contained herein do not take into account an individual‘s specific circumstances, objectives, or needs. No representation is made that any investment or strategy is suitable or appropriate to individual circumstances or that any investment or strategy constitutes personalized investment advice to any investor. Therefore, you must verify the above and all other information provided in the document or otherwise review it with your external advisors. Some investment products and services, including custody, may be subject to legal restrictions or may not be available worldwide on an unrestricted basis. The information and analysis contained herein are based on sources considered as reliable. Sygnum Group uses its best efforts to ensure the timeliness, accuracy, and comprehensiveness of the information contained in this document. Nevertheless, all information indicated herein may change without notice.

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