Understanding the economic model of Nervos CKB
Nervos’ tokenomics remain the most unknown, misunderstood, and undervalued part of the network. In this article we are going to try to explain in a simple way the value proposition of Nervos CKB and why we think it makes sense.
What is blockchain?
For Nervos, blockchain technology is the basis of a new framework, a new paradigm and a foundational technology that offers a new set of capabilities that did not exist before in the field of data, information and record keeping. It is a powerful, high-value tool that should be used to store and secure important, high-value assets. Therefore smart contract platforms should focus on a Store of Value (SoV). The fundamental principles on which blockchain technology is based as a SoV are security, decentralization, censorship resistance and neutrality. These principles are not a meme, they are not optional and therefore, they cannot be sacrificed, for absolutely nothing, I repeat, NOTHING. To see it as a new way to process transactions is to lose the forest to the trees.
But can these important and valuable characteristics be maintained over time, or are there situations that degrade the value proposition of blockchain technology? The reality is that unfortunately there are situations that can damage decentralization, censorship resistance and security, jeopardizing the long-term viability and sustainability of the network.
- Recommended reading:
To scale, we must recognize that Blockchain is a foundational technology
State explosion and the tragedy of the commons
“The tragedy of the commons” refers to a situation where unrestricted individuals deplete a system’s common resource to the detriment of everyone, including themselves. Blockchain nodes are not immune to this phenomenon.
The growth of the global state must be limited to give predictability in the participation of full nodes. Ideally, the cost is within the range of non-professional participants to keep the network as decentralized as possible. Keeping this barrier low allows network participants to independently verify history and state, without having to rely on a third party or service. Full nodes are also the firewall of the network, effectively preventing the propagation of invalid transactions and blocks. They are, therefore, an indispensable part of the decentralized blockchain network, ensuring network security. This is fundamentally the reason why public blockchains are valuable.
Just as Bitcoin utilizes a price market on block space and Ethereum utilizes a price market on computational pricing, global state also needs to utilize a price market in order to maintain a decentralized and sustainable blockchain network in the long term. This is especially important for asset storage networks focused on preserving value, where network usage does not focus on the number of transactions, that mostly occur off-chain, but from the continuous occupation of the global state.
If the growth of the global state is not limited, the cost of running a full node becomes prohibitive, only professional users can run it (Amazon AWS, Google Cloud, etc). This trust requirement denies the core value proposition of permissionless public blockchains as trustless, peer-to-peer distributed systems.
In fact, Ethereum is already suffering from the problems of the state explosion today and we have not yet scratched the surface, because blockchain technology has not yet escalated to a massive level. Imagine what will happen when there are millions of applications and billions of users. When it happens, this problem will grow exponentially.
If you like science fiction you may see it clearer with this example: imagine a combat spaceship, where the ship is the representation of the global state and the shield is decentralization, security, censorship resistance and neutrality. This shield can only cover a limited global state, otherwise the power of the shield suffers and become vulnerable. Those who abuse global state end up running out of shield since you cannot protect unlimited state with it.
This would be another rather graphic symbolic example of the tragedy of the commons and what happens when you abuse global state:
The conclusion we must draw is that state under global consensus is scarce, limited, and of high value. This is tremendously important to understanding CKB.
- Recommended reading:
State explosion and the tragedy of the blockchain commons
How Nervos CKB solves the state explosion and the tragedy of the commons
CKB implements three fundamental measures:
1. Privatization of global state: 1 CKByte is equal to 1 Byte of onchain storage. This is of paramount importance, since by buying CKBytes you are buying ownership rights over state storage. CKBytes represent the cell’s capacity in bytes and give owners the ability to occupy a part of the overall state of the blockchain. You can use it to store data or you can also rent it. Each cell is independent and has a specific owner. This privatizes the state space, ensuring that the precious consensus space can be used more effectively. If we said that the state under global consensus is scarce, limited and of high value, CKBytes is also scarce, limited and of high value since CKBytes is global state, when you buy CKBytes you buy global state, when you own CKBytes, you have global state.
Important note: CKB is not the same as IPFS, Filecoin or any other distributed storage system.
CKB differs from distributed storage in that the latter only stores data without verification and therefore cannot reach a consensus on the data stored in it. Distributed storage capacity can grow in proportion to the development of storage technology. However, CKB’s capacity is limited by the efficiency of reaching a global consensus.
2. Constant size: In other blockchains the state does not have any type of limit, in Nervos it does. CKB emission, which is a constant and linear emission made up of the sum of the primary emission and the secondary emission, equals the global state issuance since 1 CKByte equals 1 Byte. Therefore the emission line of new CKBytes tokens and new state coincide, both growing at a constant size.
3. State Rent: Making use of the state, for example by storing an application, has a price that is passively paid through an opportunity cost through secondary issuance. State rent is automatically paid while CKBytes are locked.
- Recommended reading:
How Nervos is addressing the problem of the state explosion faced by smart contract blockchains.
Economic competition between L1 and L2.
There are contradictions between the demands for transaction performance (L2) and store of value (L1). Most users will live in L2 where fees are low, there is greater scalability and a better user experience. If L1 does not capture the added value of the entire network, L2 will cannibalize L1, by accumulating the far majority of asset value and fees. This causes a “top heavy” scenario where the security provided by L1 is not enough to protect the L2.
Avoiding this scenario requires that the native token of an asset platform capture the aggregate value of all network assets. In other words, demand for on-chain assets must have a clear way of generating demand from native tokens.
- Recommended reading:
Smart contract platforms have to be a store of value
How Nervos solves the competition between L1 and L2.
CKBytes represents a capacity claim in state storage. This means that the demand to keep assets on the platform directly requires the possession of native tokens. This creates an effective mechanism for capturing value in native tokens from the assets they preserve. For Nervos this is the only sustainable way that an “Store of Value” platform can grow its security budget over time, instead of basing it entirely on speculation and altruism. Neither staking nor the demand for transaction fees creates enough demand to capture the value of the entire network.
Only then can the success of L2 and its projects can contribute to the security of the platform and the entire ecosystem can be sustainable. This is a unique challenge for multi-active platforms, because in single asset SOV networks like Bitcoin, the native coins automatically “captures” the total value of the network.
- Recommended reading:
How the Nervos CKByte Gets its Value
Long-term economic sustainability. Tail emission.
A SoV platform should be able to increase its security budget as the value it protects increases over time; otherwise, invites attackers to double spend and steal assets from the network.
In a network based on value preservation, transaction rewards are not enough to maintain network security. By definition these types of networks produce very few transactions as they are very expensive and slow. To maintain network wages and security, miners need to be incentivized when the block reward issuance ends. Because of this there are already networks that have implemented or are debating to implement tail emission, which are fixed and indefinite block rewards, this way the rewards will never be reduced to zero.
For example, Monero has already implemented tail emission:
And in the Bitcoin community it is an open debate, for example Peter Todd, developer of Bitcoin Core since 2012, defends implement tail emission in Bitcoin.
At Nervos, secondary issuance ensures miner compensation is predictable and based on value preservation demand rather than transaction demand. This is also important in the future when most transactions move to Layer 2, leaving a hungry Layer 1 with hardly any transactions.
Miners are compensated with block rewards and transaction fees. They receive all the primary emission, and part of the secondary one. In the long term, when the primary issuance ends, miners still receive state rent income that is independent of transactions but is tied to the adoption and value of CKB. Therefore, the secondary emission acts in an equivalent way to a tail emission, with the fundamental difference that only affects those who make use of the global state and don’t hold their tokens in the NervosDAO. Does not affect NervosDAO depositors, therefore, it is an inflation directed at a specific group within the network that makes use of the state storage services of the network, not all users.
- Recommended reading:
Analysis of Bitcoin’s Economic Model
CKB can act as a token with maximum supply and as a token without maximum supply at the same time
There are two types of emissions in CKB. The primary emission has a finite total supply with an emission schedule similar to Bitcoin: the number of base emissions is halved approximately every 4 years until all tokens from this primary issue are mined. All of these tokens are rewarded to miners as incentives to protect the network.
The secondary issuance is designed to pay for state rent through targeted inflation and has a constant issuance amount of 1,344 million CKBytes per year indefinitely. After the primary emission ceases, there will only be secondary emission.
Therefore, primary issuance has a limited supply, like BTC, while secondary emission has an unlimited supply since 1,344 million CKBytes are issued each year.
The key to this puzzle is how the NervosDAO provides miner incentives and protect long-term holders. Keeping your CKBytes in the NervosDAO prevents the effects of the inflation caused by secondary issuance, which can be thought of as returning your state rent payment. Only the primary emission affects you. So, for a SoV user who deposits in NervosDAO, CKB acts as a token with limited supply. Same as Bitcoin.
On the other hand, for users who make use of the global state, such as an application or a smart contract, or those who prefer to have their liquid CKBytes outside the DAO, they are affected by both the primary and secondary issuance and therefore their CKBytes act as tokens with unlimited supply.
IMPORTANT TO BE CLEAR ON THIS: For tokens holders with a long-term vision, holders and SoV users on the network, as long as they lock their tokens in NervosDAO, the inflationary effect of secondary issuance is completely non-existent. For them it is as if the secondary emission did not exist.
- Recommended reading:
Understanding the Nervos CKB Issuance Model
A detailed description of Nervos (CKB) supply and issuance
CKB can act as an inflationary and deflationary asset at the same time
Once all CKBytes have been mined from the primary issuance, no more will be created this way. A long-term holder, who has his CKBytes in NervosDAO, is only affected by this primary issuance, which, as we have said, has limited supply. In the same way as BTC, when the 21 million are mined, no more will be created. Effectively, this means that Nervos will have achieved a completely deflationary economic environment as new coins will never go into circulation, but the coins will continue to go out of circulation.
For example, private keys of the coins that a person owns can be lost or a person may die without leaving their private keys to anyone else. Extremely small fractions of coins left over from transactions, known as “dust”, can be removed from circulation over time, since transaction fees to spend them are higher than the value of the coins. Over time, all of these factors continually reduce the supply of available coins. In fact Bitcoin, and by extension CKB (for those depositing holders in NervosDAO) can be effectively deflationary much sooner, since some time before reaching the end of the issuance, the amount of coins that will come out of circulation will exceed the amount of coins that are created through mining.
REMEMBER: A SoV user, long-term holder who has his CKBytes in NervosDAO is only affected by the primary issuance. Therefore his CKBytes act as tokens with limited supply and will be deflationary assets in the future, like Bitcoin. For those who are outside the DAO, both occupying state and those who keep their CKBytes liquid, it will continue to be inflationary, as it will affect secondary emissions.
- Recommended reading:
Bitcoin, Ethereum, Nervos: Inflationary or deflationary?
How CKBytes go out of circulation, increasing scarcity
All assets in Nervos require state storage. That is, CKBytes are required to maintain an asset in Nervos. For example, the minimum content of a Cell is 61 CKBytes, which is the most common basic cell since it represents a CKB balance. That is why the minimum transfer is 61 CKBytes, because 61 bytes are required to represent this information in the chain. To create a new cell, the user must have a quantity of CKBytes equal to the space that the cell will occupy, a basic on-chain smart contract script written in Rust requires approximately 17 thousand CKBytes. These CKBytes will remain locked as long as the cell exists and therefore go out of circulation, they become non-circulating tokens. When the cell is consumed, the lock is released and the CKBytes can be used again, they return to circulation.
Initially common storage is cheap and people will use it to store low-value data. As more applications emerge and more users join, the demand for CKBytes increases, the number of CKBytes locked in cells increases, the scarcity of CKB increases, and people must bid on a limited supply. Those who use storage for high-value data are willing to pay more than those who use it for low-value data. Low-value data will gradually be forced to layer 2, L1 value density will increase.
Economic pressure means that the ecosystem will not grow unlimitedly in layer 1, unlike blockchains that abuse global consensus and common storage. Instead, the ecosystem will grow horizontally and vertically simultaneously, with layer 1 always in healthy conditions.
It should be noted that part of the secondary issuance that goes to the treasury is currently burned. The treasury can only be activated by a hard fork if the community votes to do so. This treasury could be used by the community to continue funding additional growth within the ecosystem.
- Recommended reading:
Nervos CKByte Distribution, and Why We Are Burning 25% in the Genesis Block
Summary
If the value proposition of blockchain technology is to be a SoV, it needs maximum decentralization, security, censorship resistance and neutrality as an indispensable condition, these are the characteristics that make blockchain a unique and high value technology.
If those indispensable conditions are degraded or lost over time through abusive usage that treats the global state as an unlimited resource, then blockchain technology ceases to be a Store of Value, it ceases to be blockchain. So, state under global consensus is a limited, scarce and high value resource. CKB is global state (1 CKByte is equal to 1 Byte of state), therefore it is a scarce, limited and high value resource.
Furthermore, the use and adoption of the network directly generates CKB demand since CKB is needed to store any data, such as a balance. CKB captures the added value of the entire network.
For those SoV users, long-term holders of the network, as long as they lock their tokens in NervosDAO, the inflationary effect of secondary issuance does not exist. Only the primary issuance would affect them, which has a maximum limit, and therefore It’s like owning limited supply tokens just like Bitcoin.
Nervos’ economic model implements solutions to industry problems such as the state explosion and the tragedy of the commons, economic competition between L1 and L2, long-term economic sustainability, and develops the economic concept of Store of Value typical of Bitcoin, taking it to the field of multiple asset platforms, developing the concept of Store of Assets (SoA).
- Recommended reading:
¿What is CKByte? Twitter thread of Jan Xie, architect of Nervos.
Thanks to Jordan Mack and Travis for suggestions and review of the article.
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Original en español by Alejandro Ruiz AQUÍ
