Why another stable chain?
For crypto to achieve mass adoption, we need to overcome two main obstacles. We believe it is time to revisit the idea of stable chains as new and exciting developments may give us the path forward.
2022 is the year that the ‘everything bubble’ popped. Investors are hurting as the bear market drags asset prices down but more importantly, regular people who can least afford it are suffering from the effects of inflation. An unfortunate convergence of multiple crises from a deadly global pandemic to a bloody military conflict in Europe has triggered an unprecedented economic turmoil. It can also be argued that the loose monetary policy of the last decade put us into this precarious situation even before the aforementioned events. If you have been exposed to crypto lore then you would know that the latter is the prime motivation for the birth of Bitcoin more than a decade ago.
When Satoshi Nakamoto shared his creation, a form of money with a monetary policy defined by math and code instead of humans, he demonstrated that it was possible to transfer value over the internet without a trusted third party. This gave us a glimpse into a future that promised a more efficient financial system with more transparency and lower costs by cutting out the middlemen. Early adopters predicted that cryptocurrencies or ‘crypto’ would allow us to conduct all our financial activities without the help of banks. Crypto adoption has certainly grown steadily in the past 13 years since BTC’s immaculate conception but it’s easy to see we have not yet reached critical mass to make that promised future a reality.
If you joined the cryptosphere in the last few years, you would have no doubt heard (or read) the phrase “we are early” repeated often in the community. It is a form of reassurance for those that have recently invested in crypto that we are still in the early stages of its technology adoption lifecycle. This implies that there will be more users that will buy into crypto in the future which would drive up prices thus benefiting the “hodlers” of today, highlighting a simple truth — that the main use case for cryptocurrency today is speculation.
There is no inherent problem with speculation per se, speculators actually help markets function more efficiently. If we are being honest though then we can say that this is not the dominant use case we want to underpin crypto adoption. In fact, the current way to measure this is to count crypto owners which is then compared to the growth of internet users a couple of decades ago and is used to predict a billion crypto users in a few years time. But buying and holding crypto in a wallet or on an exchange is very different from using the internet to send an email to another person across the globe faster than anything before it or to share information to millions of people that was previously hard to find.
Sure there are crypto owners today that are actually using cryptocurrencies for genuine transactions but they are a small fraction of the current user base. Some of those users are paying with their crypto assets but are doing it over systems that are powered by legacy infrastructure such as Visa in the back end negating the benefits of blockchain technology altogether. If we want crypto to succeed in the long term and unlock its true potential, we argue that it is more productive for us to base our adoption metrics on how crypto is actually being used by people in daily life to buy or sell goods and services.
Keep in mind that CeFi wasn’t sleeping at the wheel while the digital revolution was underway. Today it is easier and faster than ever before to send and receive money online. Decentralization is compelling but cryptocurrencies need to offer more than just an alternative for the masses to choose crypto over the existing centralized financial system, it also has to match or exceed what the status quo already provides in the here and now. There are two main challenges that we need to overcome to finally realize Satoshi’s vision for a peer-to-peer electronic cash system — scalability and stability.
The Need for Scaling
When Bitcoin, Ethereum, and all the other early cryptocurrencies started to gain newsworthy adoption, it quickly became apparent that blockchain technology was lacking in its ability to process the volume of transactions required to become the backbone of a new decentralized financial system. It’s the decentralization itself, the innovation that crypto demonstrated, that limits the performance of blockchains. This was expertly summarized by Vitalik Buterin when he coined the Scalability Trilemma which posits that a blockchain has three desirable properties namely decentralization, security, and scalability, and if we stick to “simple” techniques, you can only get two out three. In practice, users experience this scalability issue in two ways:
High Latency: In payment systems, latency refers to the time between when a transaction is submitted and when the transaction is accepted. Today this usually takes only a few seconds after customers tap their credit card on a point-of-sale terminal which greatly enhances user experience. For cryptocurrencies, latency is dictated by the blockchain’s block time and finality. Block time is the duration for a new block to be produced while finality refers to the state when a block becomes irreversible which can either be probabilistic or absolute. Bitcoin for example has a block time of around 10 minutes and is considered probabilistically irreversible after 6 blocks so its latency is around 1 hour. This might be acceptable for high-value non-real time transactions but is definitely not tolerable for day-to-day type of transactions.
High Fees: Transaction fees for cryptocurrencies is usually a function of the throughput of the network measured in transactions per second or tps. When a blockchain’s tps is low, such as Bitcoin’s 3–7 transactions per second, users will have to outbid each other to have their transactions be prioritized by miners or validators. This fee market is fine when there are not a lot of users in the network but once there is a lot of demand, bidding wars would cause the fees to spike making it uneconomical to transact for low value transactions.
These two factors together make a decentralized financial system unusable for those who want to make normal transactions. A common example used to demonstrate this is buying your morning cup of coffee. It simply doesn’t work if you would have to wait an hour for your caffeine hit while paying a transaction fee that is probably more than what you pay for the coffee itself. But even if you are buying from the comfort of your own home, it doesn’t make sense for online merchants to accept unscalable cryptocurrencies in the age of one-click checkouts and free deliveries that we have grown accustomed to in recent years.
To their credit, the crypto community is fully aware of this and is hard at work trying to overcome this challenge. This article provides a good list of the different scaling solutions currently being worked on. Most “scalable” blockchains existing today most probably made a trade-off between scalability and decentralization as Vitalik described and so everyone in the crypto space is waiting if Ethereum 2.0 is able to deliver on their promise to solve the scalability trilemma without any compromise.
A concept that we particularly like is Polygon’s multi-layer dual-consensus architecture that is designed to optimize for speed and decentralization. This has made Matic Network one of the most adopted scalability solutions for Ethereum. Some of the Polygon team’s design decisions though has made a few crypto pundits anxious about the network’s security. Also, using a variant of Tendermint for the Heimdall verifier layer limits the practical number of nodes (less decentralization) in their Proof-of-Stake chain which compounds with concerns of stake centralization. We believe that refining Matic’s architecture together with a fairer distribution can yield a more secure design.
Resolving Volatility
Aside from better UX afforded by centralization, existing payment providers also benefit from the relative stability of fiat which we often take for granted. This doesn’t mean that the value of the money in your bank account is always stable though, it can and does change over the medium to long term as shown by the inflation figures this year. That said, the value of free-floating currencies are stable enough in the short term for us to have the confidence to use them as a medium of exchange at least for economies not experiencing hyperinflation. A 20% change in the dollar’s value over 2 years is more palatable for individuals and businesses than a similar change over 2 hours for crypto.
Let’s say you decided to become a full-time freelancer in 2021 and were offered to work on a project for 2 BTC which was worth around $100,000 at the time. Given the positive outlook on the price trajectory of Bitcoin, you accepted the offer and proceeded to provide your services to the client. After 12 months of work, the project is complete but at this point the market sentiment has soured and the value of your bitcoins is slashed in half, forcing you to make a decision between selling your BTC at a loss or holding and hoping that the price of BTC recovers. Both outcomes are not ideal if you need that income in the present for you and your family.
Stablecoins were developed to address this problem by allowing an on-chain asset to peg its price to another asset with a more stable value such as the US Dollar. This excellent post from Nevin Freeman of Reserve neatly explains how this peg is maintained and the different stablecoin designs that are being explored by the crypto community. Note that each stablecoin approach brings varying levels of stability and confidence depending on the transparency and soundness of the mechanisms used to keep the peg, with some designs being less sound than others.
One promising approach to taming volatility while remaining decentralized is Reserve’s soon-to-launch RToken platform. Once launched on the Ethereum network, their protocol would allow anyone to create a stablecoin backed by a basket of on-chain assets such as cash, gold, Bitcoin, other stablecoins, and whatever else could be tokenized in the future. RSV, their first stablecoin, uses a basket of fiat-collateralized stablecoins that reduces risks associated with the token issuers by virtue of diversification. This relative safety has allowed Reserve to grow the user base of their payment app RPay to more than 650,000 users together with 25,000+ of merchants at the time of this post.
Even more exciting is the ability for RTokens to be insured in the case of collateral failure. This is comparable to how our bank deposits are insured by the government up to a certain amount but for Reserve this is all done in a decentralized way. Holders of Reserve Rights (RSR), Reserve’s utility token, are able to stake their RSR to any RToken of their choosing to serve as insurance for that particular stablecoin and receive yield as compensation for the risk they are taking on. We believe that this is a game changer for cryptocurrencies by imbuing crypto with stability and confidence, setting the stage for true mass adoption.
Scalable + Stable
We at SPEAR Labs believe that to maximize the power of RTokens, we need a blockchain that would allow us to match what CeFi can deliver. It needs to be secure and decentralized enough with the ability to scale while leveraging the stability that the incoming Reserve Protocol would provide. To build this ideal blockchain, we drew inspiration from xDai — the first stable chain that was able to weave scalability and stability to enhance the experience for crypto users. (The xDai chain has been rebranded as Gnosis Chain. For now we will refer to the previous specs of the xDai chain as its architecture will undergo changes once it merges with the Gnosis Beacon Chain.)
xDai is a fast and low-cost Ethereum sidechain created by the POA Team to solve the crypto payments challenge. It uses a proof-of-authority based consensus mechanism called AuRa (Authority Round) that enables high throughput and low latency kickstarting adoption from both users and project developers. Sure there are other side chains where you can bridge stablecoins like USDC such as Polygon/Matic which is comparable in terms of performance. The main difference is that with the xDai chain, the transaction fees are paid using the xDai stablecoin. This has the benefit of reducing friction for users by making fees non-volatile and thus predictable.
There are a lot of positives with the xDai chain but we also see a number of potential issues that need to be resolved. First is the limited number of validators which was done to achieve an acceptable level of throughput. Validators are chosen in a DPoS process trading-off decentralization for scalability as to be expected with solutions to the Scalability Trilemma. This decreases the attack surface that a malicious user needs to compromise to take control of the blockchain and steal funds or perform double spends. Proof-of-stake mechanisms such as DPoS are also susceptible to the “rich getting richer” problem that tends to centralize the control of the blockchain over time weakening its security.
Another cause for concern is that the bridges used to transfer assets from the Ethereum main chain to the xDai side chain are also somewhat centralized. For example, the xDai bridge that is used to convert Dai to xDai and vice versa is managed by 13 governors via a 7/13 multi-signature scheme. The actual bridge transactions are handled by 5 bridge validators requiring 3 out of 5 signatures to process an xDai bridge transaction. Thus the bridge’s security relies on trusting the entities serving as governors and validators. This is important as bridges that lock tokens similar to the xDai bridge are prime targets for hackers similar to what happened to Axie Infinity’s Ronin sidechain.
Lastly, since xDai is essentially wrapped Dai, it inherits the collateral risk of Dai which is backed by Ether (Ethereum’s volatile native coin). Dai is now the largest decentralized stablecoin and has proven its robustness so this risk is less likely compared to algorithmic stablecoins such as Terra’s UST. A black swan event is still possible though and has actually happened once before which triggered a sort of a “reboot” for Dai. If the xDai chain had mass adoption with a bigger TVL (total value locked) when this happened, there is no telling what ramifications this could have caused. If a large economy in the scale of hundreds of millions or even billions of dollars was dependent on this system, the economy could have stopped in its tracks while Dai is undergoing a reboot.
For these reasons, we believe there is a lot of room to iterate on stable chain designs to produce one that is performant yet still sufficiently decentralized, powered by a more secure bridge, and underpinned by a more robust stablecoin.
Stable Chain 2.0
SPEAR stands for Stablecoin Payments, Exchange, and Remittances. Our vision of the future is a world where anyone can carry out these essential financial activities using a fully-backed and insured stablecoin over a high-speed and inexpensive blockchain network that is also decentralized and secure. We are building SPEAR Protocol, a scalable Ethereum commit-chain with a non-custodial token bridge and low fees paid by a native stablecoin. Below is a quick summary of its design:
- The Spartan DAO, a representative governance system overseeing SPEAR Protocol that has a fair distribution (via PoW) and no premine.
- Multi-layer architecture inspired by Polygon’s Matic network composed of a scalable EVM-compatible block production layer with instant finality (using Tendermint) and a decentralized permissionless PoW security layer for staking and validator management.
- Dual-token model comprised of a USD-pegged RToken for paying transaction fees and a staking coin for aligning validator incentives and DAO voting.
- Secure non-custodial bridge on the Ethereum network powered by the NOCUST protocol, giving users the ability to exit the commit-chain at any time circumventing the mass exit problem of Plasma chains.
Cryptocurrencies, together with blockchain technology that power them, promise a financial system that is fairer, more efficient, and less opaque that would benefit individuals as well as society at large. To gain and maximize these benefits, crypto must first achieve critical mass by becoming a compelling alternative to traditional finance as a decentralized, secure, scalable, and stable form of money. Stable chains is one pathway to such a future by solving the scalability and stability challenges that are currently hindering true adoption in the real world. It is our mission to build the stable chain of the future that would open the door for crypto mass adoption.
We are hard at work on creating the next-generation stable chain. If you are interested in what we are building, please stay tuned for our next post where we get into more detail about SPEAR Protocol’s design.
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