Exploring the Advantages and Disadvantages of Developing a Custom Layer-1 Blockchain

The simplified creation of a sovereign, horizontally scalable blockchain with its proprietary token economy, cheap and fast transactions, and access to a thriving ecosystem of interconnected dApps and services are some of the many advantages that the Nolus Protocol benefits from.

Introduction

The technological backbone of the Nolus Protocol utilizes a lightning-fast Layer-1 blockchain based on Tendermint’s PoS algorithm and built with the Cosmos SDK. In layman’s terms, Layer-1 refers to the underlying blockchain technology that enables the creation and transfer of digital assets. It is the foundation on which other features and functionality, such as smart contracts, can be built. However, many Layer-1s exist already — why did we choose to deploy our own?

Advantages

Creation of the Nolus Blockchain

First, a little bit about how the Nolus blockchain has been created. Nolus protocol was kickstarted using Starport - a command line tool developed by the Cosmos team. It provides all the tools to launch a new blockchain based on the Cosmos SDK and allowed us to skip some of the major obstacles involved in starting from scratch. Combining this user-friendly interface with the efficiency and low-level control of the Golang programming language, our developer team had everything they needed to produce a robust Layer-1 and set up our money market.

The Cosmos SDK is a pleasure to build on, with modularity and interoperability ingrained into its core. Since we can develop applications using a modular design, features are easily added/removed to allow us to tailor the Layer-1 to the requirements of our products. By communicating with other chains in the Interchain, Nolus can tap into liquidity and communities throughout Cosmos, improving sustainability and scalability by distributing the risk between networks. The entire process is permissionless, with low hardware requirements for users to create a node that connects to our Layer-1.

By utilizing products that are already built, Nolus inherits all the benefits they supply while allowing the team to dedicate time and resources to the actual products themselves. Now that the blockchain has been set up, what benefits does this bring to the protocol?

Extracting Value From the L1

The Nolus blockchain is based on Tendermint’s PoS consensus mechanism, meaning $NLS tokens must be staked to secure the network. This provides a significant opportunity to retain users and sustain liquidity in the long run by offering incentives for 3 types of users:

1. Borrowers — Staked $NLS grants borrowers lower interest rates when leveraging through DeFi Leases, and the longer $NLS is staked, the lower the interest rate. This incentivizes users to lock up $NLS for longer to decrease the cost of their loan, sustaining borrowing demand for greater periods of time.
2. Lenders — Staked $NLS yields lenders with increased rewards on their stablecoins. In doing so, Nolus ensures liquidity for borrowers is readily available at all times by offering higher APRs to stablecoin deposits. Participants who stake $NLS are more likely to be long-term users given the two-week unstaking period.
3. $NLS stakers — Stakers themselves accrue all transaction fees that occur on the network alongside token emissions. Due to the nature of money markets, there is likely to be a larger number of transactions per user, with the fees funneled to $NLS stakers.

Evidently, the network fees and incentives that Nolus offers are structured so that they bring value back to the protocol itself. The various revenue streams are extracted from the Layer-1 blockchain and used to incentivize participants to provide liquidity for extended periods of time.

Sustained liquidity in a money market is pivotal to its long-term success, especially under the current market conditions where liquidity is few and far between. The ability to funnel value through our ecosystem offers a major advantage over our competitors, but it also provides us with customizable infrastructure that we can tailor to maximize protocol efficiency.

Custom Blockchain Parameters

As Nolus protocol grows, we must be able to finetune the blockchain parameters and tailor them to the demands of the application at the time. By building our own Layer-1, we are in complete ownership over these decisions and can remain flexible with the ability to react to changes rapidly. There are a few examples that demonstrate how important this has been during the developmental and growth stages:

To begin with, we were able to introduce a custom tax module that charges a marginally higher transaction fee that is used to buy back $NLS tokens from the open market. These $NLS tokens are used to refill the incentives pool and directed to lenders on the protocol to encourage liquidity providers to participate on Nolus. In this way, increased activity and Total Value Locked (TVL) results in larger $NLS token buybacks and therefore higher rewards for lenders. The custom tax module creates a positive feedback loop that helps Nolus scale and sustains stablecoin deposits as it grows.

Moreover, Nolus does not have to share block space with other applications on the blockchain. We are not exposed to any contagion risks if applications on the same network are exploited, yet we inherit the same security provided by the Tendermint PoS consensus mechanism. Supplying all the block space for one application can also lead to greater scalability in terms of the number of transactions Nolus can support at any one time. This is because we don’t need to compete with other protocols to include transactions in a block, allowing Nolus to fulfill thousands of transactions simultaneously.

The Cosmos SDK delivers a robust mint module that allows developers to define the properties of the tokens they want to create, such as the total supply, the rate at which new tokens will be minted, and the rules for how they can be transferred and traded. Our developers completely reworked this to align the inflationary minting with a time span of 10 years as noted in our Whitepaper. 15% of the total $NLS supply serves as staking rewards to incentivize validators of the blockchain, with nearly 50% of these entering circulation in the first 2 years. As you can see below, we have engineered the mint module to slowly decrease the number of tokens minted as time goes on to maximize the efficiency of the release schedule.

As you can imagine, it is difficult for a Layer-1 to tailor its infrastructure to fit the needs of “every” application that runs on it, so smart contract developers usually have to compromise on some aspects such as security or transaction speed. With full ownership of our Layer-1, we can modify very specific details at the core of the technology to maximize its efficiency for our products, as illustrated in the examples above. Yet, these changes can only be made through the power of decentralized decision-making, also known as governance.

Governance

Governance refers to the mechanism in which stakeholders (users who have staked $NLS) can vote on proposals to change details about the protocol, facilitating democratic decision-making. For example, a user can put up a proposal to distribute 10,000 vested $NLS tokens from the community pool to the lender’s incentives pool to encourage more deposits. Each individual stakeholder can then vote on whether they agree or not, with voting power proportional to the number of $NLS tokens staked.

The main advantage that this offers is the ability of the protocol to adapt and evolve to market conditions. If liquidity is low, the community can engage in healthy debates to discuss how the protocol can encourage user deposits before creating a proposal themselves. Governance provides an efficient management system where the users have the final say and can shape the future of Nolus via active participation.

Moreover, these decisions are truly decentralized, with no single entity dictating the outcome of a governance proposal. To pass, a proposal will need 50% of the total votes to be “YES”, and 33.4% of the active stake to pass quorum, meaning an individual/entity would need to own a massive fraction of the staked $NLS supply to force votes in their favor. As everything is on-chain and completely transparent, bad actors are dissuaded from manipulating votes and the community can verify each action taking place in real-time.

Finally, governance cultivates innovation and fosters a strong community camaraderie due to its permissionless nature. Since anybody can put up a proposal, the brightest minds within our ranks can develop strategies and policies that will help propel Nolus to new heights. New ideas will be continually encouraged and supported, laying out the framework for successful experimentation on our blockchain. This is often the result of “Temperature Checks”, where discussions occur to gauge community sentiment and level of support before governance proposals are submitted.

Governance also highlights a crucial point - Nolus is not reliant on support desks of other protocols to fix urgent issues.

Independence and Autonomy

An independent cryptocurrency protocol can take actions that are in the best interest of the protocol and its users, without being influenced by external factors. Instead of relying on support teams from other protocols whose priorities may not be aligned, our developer team can act instantly in developing situations. Any active governance participant will understand how challenging it can be to propose and pass governance through another community! This helps to mitigate risks more efficiently, but also promotes self-independence and sovereignty — core values that resonate throughout DeFi. However, independence should not prevent collaboration. Nolus grows off the foundations built by the Cosmos core team before us, and with their revolutionary work to facilitate interchain cooperation, we can utilize the fantastic applications built on Cosmos.

Interchain Interoperability

By taking advantage of interchain interoperability technology, Nolus continues the vision of the Cosmos Ecosystem — a network of intertwined dApps. Without Interchain Accounts, Nolus could not exist in the capacity it does today. Also known as IBC accounts, these enable the creation of an account on one blockchain (the “host network”) that can interact with another blockchain (the “controller network”) without needing private keys for a transaction. This allows a user to swap tokens, add liquidity, farm tokens, etc. on another network without manually signing a transaction there. For example, once Nolus is live, our smart contract will be able to swap tokens on Osmosis directly from the Nolus user interface without manually signing a transaction on Osmosis.

In this way, Nolus can utilize existing reputable applications that have proven their value already, enhancing the user experience dramatically. As the code is open-sourced, the developer team has been able to make a lot of refinements to the Interchain Accounts module that is explicitly tailored to the needs of a Money Market. The ability to perform token swaps, liquidations, and minting derivatives on the host network itself allows Nolus to be truly “platform neutral”. It also opens the door to multiple DEX integrations to leverage the individual functionalities and advantages of various permissionless chains, stimulating further collaboration.

Nolus will be IBC-enabled straight out of the box, allowing easy and simple transfer of assets to Nolus from other IBC-enabled networks within Cosmos. Furthermore, the team is developing the multihop handler for IBC transfers and custom routings to significantly reduce the complexity of bridging for the end-user. To do so, we will allow users to open a lease position with the down payment located on another network without needing to bridge this to Nolus beforehand.

Summary

• Utilize products already built;
• Extract value from transactions on the Layer-1;
• Custom blockchain parameters;
• Custom governance parameters;
• Independence and autonomy;
• Interchain Interoperability.

As you can see, the ability to build on the code developed before us and manipulate it to increase performance on our own blockchain has allowed us to create the perfect infrastructure for a money market on Cosmos. To quote our whitepaper:

“The simplified creation of a sovereign, horizontally scalable blockchain with its proprietary token economy, cheap and fast transactions, and access to a thriving ecosystem of interconnected dApps and services are some of the many advantages that the Nolus Protocol benefits from.“

Risks

We share continued faith in the Cosmos ecosystem and the technology being produced on it, and we believe our own sovereign Layer-1 allows us to extract the most value from the network. Nevertheless, there are some risks associated with this decision that we think users should be aware of.

Adoption Risk

Attracting liquidity is one of the main challenges for a new Layer-1 blockchain. On the assumption that users prefer to interact on blockchains they are familiar with, it is important Nolus provides something unique to tempt liquidity away. Users that do want to use our products will need to bridge their assets, so they will need a large enough incentive to take that risk, and spend time familiarising themselves with our products.

We have written several articles to convince users of our value, but to really mitigate this risk, Nolus must reduce the friction of onboarding. As we mentioned earlier, we will be developing the multihop handler for IBC transfers and custom routings to directly address this hurdle. It is imperative that the user onboarding process is as simple and frictionless as possible to encourage participation — by reducing the barrier to entry, we dramatically increase our potential user base.

Validator Set

Initial Startup and Infrastructure Costs

Setting up a validator carries a cost-associated risk for the operator/s whether they run their machines locally, allocated on a data center, or on a service provider. This means validating on a blockchain needs to be sufficiently rewarded to offset these costs and incentivize people to set up a node. To earn revenue, validators charge a commission from the staking rewards earned by users who stake with the validator. Nolus must ensure the costs associated with hardware and storage are less than the profits made via commission so that validators can profit.

If this fails, validators are likely to move their equipment to another Layer-1 where they can sustain profits. This can cause a few issues — for validators to leave, they need to unstake their $NLS tokens and sell them on the open market. For large validators, this offers the opportunity to purchase more $NLS, increasing their voting power within governance.

Therefore, it is of vital importance that Nolus has a robust, dedicated validator set that shares the same core values that we do. To encourage these teams to validate on Nolus, we announced the Nolus Delegation Program. Through this program, we can delegate locked tokens to 25 validators that fit specific criteria for two major benefits:

1. Promote decentralization by distributing voting power equally between the validators in the active set.
2. Maintain high standards for validators on Nolus, hand-picking those that fit our success criteria.

These validators are rewarded by receiving an equal genesis validation, with the staking rewards sold to cover the costs and maintain uptime. Nolus, like many other Cosmos blockchains, will also launch with a low circulating supply relative to its total supply. Inflation is therefore high, to begin with, before tailing off over 10 years to reward early validators that assume the most risk. Without the Delegation Program, the high inflation t, to begin with, would mean a malicious entity would find it easier to amass a large number of tokens quickly.

Centralization

A single entity holding a large proportion of the total token supply is dangerous for many reasons:

• The contradiction of a core belief held throughout crypto;
• If they hold enough tokens, validators can censor transactions or cause an invalid state transition;
• Risk of corruption in the voting process;
• Ability to force governance proposals through.

Some of these issues are addressed in the Delegation Program, however, the governance parameters have also been set to discourage malicious actors. As we mentioned, a large number of votes from the active set are required for a proposal to pass quorum, and over 50% of the votes must be “YES”, so a validator would need to purchase a lot of $NLS off the open market. The additional cost involved with acquiring a large proportion of $NLS tokens acts to discourage this behavior and increase the risk of attempting an attack. These custom governance parameters are useful for deterring this attack vector and are ubiquitous throughout Cosmos.

Risks Associated With IBC

Bridge Reputation

Unfortunately, bridges have been associated with recent large nine-figure hacks that have caused irreparable damage to the affected blockchains. Naturally, the trust lost in bridges will spill over and affect the reputation of IBC, the method used to transfer assets and information across the Cosmos network. If IBC is exploited, it would be extremely detrimental to liquidity on Nolus, but more importantly to the reputation of Cosmos.

Yet, unlike many trusted bridge solutions, IBC does not depend on an intermediary to verify the validity of cross-chain transactions. Instead, IBC is designed in a way that requires trust in the proof verification provided by the light client, and not in the relayers themselves. In a scenario where all the relayers are faulty or behaving maliciously, the availability of the network may be affected, but the value transfer and security of data would remain intact. Put simply, the IBC protocol has been designed to remain secure even in hostile conditions, where packets are not accepted if relayers become bad actors.

Latency

Latency refers to the amount of time it takes for a packet of data to be sent from one blockchain to another and processed. This is increased when using IBC for a few reasons:

• Network congestion: If either network (source or destination) is congested, it can take longer for packets to be sent and received;
• Proof verification: The light client needs to verify the packet commitment proofs, which can add additional latency to the process;
• Consensus mechanism: The consensus mechanism used by the receiving blockchain may require additional time to process and confirm the received packet. The Tendermint consensus mechanism adopted by the Cosmos ecosystem is designed to reduce latency and can process thousands of transactions per second;
• Block time: The block time of the receiving blockchain can also introduce latency if it’s high. Nolus has opted for a block time of 6 seconds, the standard for Tendermint, for faster transaction processing and confirmation times.

High latency can slow down the network’s overall performance, making it less responsive and efficient for the end user.

Security and Maintenance

Since we have developed the Layer-1 independently, the security of our network is only as good as we make it. We have a highly skilled team of developers that have dedicated months to this project, however we cannot guarantee that we have not missed any bugs in the code. Therefore, when Nolus launches, we will not have a robust history of security and users will need to trust that the developer team has removed any possible attack vectors in the code. However, Nolus will be open-source from inception, meaning users can verify the security for themselves by scrutinizing the code. We have also received two security audits from Oak Security, a third-party company that specializes in cyber security and safety, and reviewed their suggestions to ensure that Nolus is designed with safety at the forefront.

Building and maintaining a Layer-1 is also time-consuming, with many additional costs that can accumulate over time. The maintenance of the core Layer-1 infrastructure requires both time and money, potentially stalling the growth of Nolus as less time can be spent on product/innovation. We hope that after reading this research piece it is clear that the advantages an independent Layer-1 provides are integral to the Nolus product, and therefore time spent maintaining this is not wasted. In our opinion, the value obtained and funneled through our products far outweighs the costs associated with keeping things running!

Conclusion

By showing you the potential risks, we can demonstrate the steps Nolus has taken to reduce them individually. The ability to tailor a custom Layer-1 blockchain and mitigate risks helps to keep our money market secure and sustainable in the future too. We hope it is clear that time has been spent to ensure any possible attack vectors have been considered and dealt with. A user’s security while using our products is of utmost importance to us, and we have taken no shortcuts to compromise on user experience.

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