<p>It is not a secret that governments control the money printing press. It is a powerful tool that allows the filling of the economy with liquidity when it is needed. This process usually dilutes share of currency holders and causes an inflation surge, but also may boost spendings and ability of entrepreneurs to borrow cheaper and pay their employees thus resulting in higher employment rates leading to higher tax returns for the government. Wise usage of currency emission allows governments to accumulate rising tax gains and earn interest rate paid on issued money, which are in fact profit from money creation - seigniorage. These gains are used to stimulate fiscal spending and support economic growth.</p><figure class="kg-card kg-image-card"><img src="https://p2p.org/economy/content/images/2020/09/1-11.png" class="kg-image" alt loading="lazy" width="1190" height="724" srcset="https://p2p.org/economy/content/images/size/w600/2020/09/1-11.png 600w, https://p2p.org/economy/content/images/size/w1000/2020/09/1-11.png 1000w, https://p2p.org/economy/content/images/2020/09/1-11.png 1190w" sizes="(min-width: 720px) 720px"></figure><p>One of the most common uses of money is as a convenient unit of exchange for buying goods and services. To earn some, people can produce goods or provide some useful services, but they do not have an opportunity to earn profit from the emission. This process is monopolized by centralized entities. But, imagine there is an option to participate in a novel currency emission and have rights to get a portion of seigniorage in an algorithmic and decentralized manner?</p><h1 id="terra-brief-overview"><strong>Terra brief overview</strong></h1><p>Terra project implemented the best practices of government fiscal policy and fulfilled them with solid additions that benefit e-commerce platforms (providers) and users as well. The concept combines features of cheap cross-border transactions in stablecoins and the ability for every user to participate in the growing e-commerce economy pretending on portions of transaction fees and seigniorage profit returning capital back to the people.</p><p>The core idea of Terra project is to bring on the market a stable family of cryptocurrencies without the necessity to store fiat collateral in the centralized bank and allow parties to transact not worrying about high volatility. This is very important for the crypto community and worldwide adoption. To achieve that goal, Terra developed a complex algorithm of price stabilization, which I will try to explain later.</p><p>There are three types of stablecoin implementations:</p><ul><li><em><em>Collateralized</em></em> (fiat or crypto or mixed) each coin is backed by a defined currency at some ratio which covers spikes in demand. This type is the most common one and include such prominent projects as Maker (DAI), TrueUSD or <a href="https://p2p.org/economy/kava-the-first-decentralized-lending-platform-in-cosmos">Kava (USDX)</a></li><li><em><em>Algorithmic</em></em> (utilizes various mechanisms to follow the peg)</li><li><em><em>Hybrid</em></em> (use both features)</li></ul><p>Family of Terra stablecoins represent the second type and include various coins maintaining the peg to different currencies, like USD, KRW, and EUR. The less volatile stablecoin in that group is pegged to a basket of currencies <a href="https://www.imf.org/external/np/fin/data/rms_sdrv.aspx?ref=p2p.org">SDR IMF</a>. To provide conversions between currencies, the protocol supports atomic swaps at the fair fiat exchange rate. This allows Terra to offer foreign exchanges efficiently and simplify cross-border payments.</p><h1 id="how-terra-achieves-price-stability-and-benefit-e-commerce-providers-maintaining-stable-reward-growth-for-stakeholders"><strong>How Terra achieves price stability and benefit e-commerce providers maintaining stable reward growth for stakeholders</strong></h1><p>Another important part of Terra project is a staking token LUNA. <strong><strong>LUNA may be considered as a decentralized collateral, representing a buffer absorbing volatility. It captures the value of the transaction flow and redistributes it among stakeholders</strong></strong> (everyone who stake) creating incentives for them to care about low volatility of stablecoin family. Terra protocol utilizes Tendermint consensus mechanism and another important purpose of staking token is securing the network creating incentives for validators, who play roles of price oracles for inner currency exchanges and broadcast transactions in the network to behave in the interests of the ecosystem and properly provide their services.</p><p>Without fiat collateral and centralized control over the “printing press” it is not easy to provide price stability and control the total supply as well as inner economics in general. To create the market for the own currency, Terra united an <em><em>alliance of e-commerce providers in Asia</em></em> who are interested in using stablecoins as a payment method offering it to their customers. Terra money is issued in a decentralized manner depending on the demand and total market size.</p><p>For example, if existing supply is not high enough, when transaction volumes grow significantly, demand for stablecoins may also increase. The price of a single unit may rise creating an arbitraging opportunity for the payment network participants who stake LUNA. They can exchange one to another with the inner price, and benefit from its deviations out of the peg. In response, to provide the exchange protocol mints requested amount of currency that can be used to release risk-free profit on the open market returning the peg.</p><figure class="kg-card kg-image-card"><img src="https://p2p.org/economy/content/images/2020/09/2-14.png" class="kg-image" alt loading="lazy" width="1062" height="334" srcset="https://p2p.org/economy/content/images/size/w600/2020/09/2-14.png 600w, https://p2p.org/economy/content/images/size/w1000/2020/09/2-14.png 1000w, https://p2p.org/economy/content/images/2020/09/2-14.png 1062w" sizes="(min-width: 720px) 720px"></figure><p>When protocol gets tokens in exchange for minting it distribute a part of that provisions to the treasury burning the rest with a <code>burn rate</code> which is defined by the protocol and depends on changes in the macroeconomic variables. This module is playing the role of <em><em>decentral algorithmic bank</em></em> regulating a transaction fee rate and weight of seigniorage that goes to stakers.</p><p>When the economy is in the growth stage, spendings are high. People purchase more goods and services. That results in rising inflation. When inflation surges people cut spendings, slowing them down. It leads to lower profits for companies resulting in the inability to pay their debts or make investments. The economy slows down. To fix it, according to a Keynesian approach, when the economy is rising and families spend a lot, Central Banks should do the opposite to control inflation and be able to step in when the economic cycle is moving closer to a recession. That is exactly the way how the economy is functioning today.</p><p>Treasury module is doing exactly the same for Terra economy. In periods of growth and rising transaction volumes it increases accumulation of LUNA earned in exchange for minting Terra by decreasing the <code>burn rate</code>. When the economy begins to contract in the cycle of lower transaction volumes Terra protocol facilitates spendings using accumulated funds in the treasury, bootstrapping stable demand and economic growth. Another purpose of these provisions is to provide discounts for usage of Terra stablecoin as a payment. If people prefer to pay that way, it obviously creates additional incentives for e-commerce providers to join the Terra network.</p><p>The core priority for the success of such a system is to create strong incentives for LUNA staking even in periods of instability. This mechanism works like programmatically determined equalizer, managing LUNA <code>burn rate</code> and <code>transaction fee rate</code> which together represent staking rewards. To provide stable staking reward growth, protocol measure and balance these components depending on the economic variables.</p><ul><li>When the LUNA <code>burn rate</code> is high it rewards holders as staking power of their assets is rising. To smooth that growth, protocol decreases the <code>transaction fee rate</code>.</li><li>When the LUNA <code>burn rate</code> is low it dilutes holders and staking power is falling. To compensate that, protocol increases the <code>transaction fee rate</code>.</li></ul><h1 id="decentralized-resource-allocation"><strong>Decentralized resource allocation</strong></h1><p>Terra may be applied to various sectors with different decentralized applications (dApps) built on top creating multiple token economies managed by the single programmable module. Treasury funds will be filling from various sources. Growth cycles and inflow changes from one sector will cover a decline in another.</p><figure class="kg-card kg-image-card"><img src="https://p2p.org/economy/content/images/2020/09/3-13.png" class="kg-image" alt loading="lazy" width="1049" height="482" srcset="https://p2p.org/economy/content/images/size/w600/2020/09/3-13.png 600w, https://p2p.org/economy/content/images/size/w1000/2020/09/3-13.png 1000w, https://p2p.org/economy/content/images/2020/09/3-13.png 1049w" sizes="(min-width: 720px) 720px"></figure><p>Capital allocations for dApps development would be managed by the network participants in a decentralized manner via governance. Every LUNA holder may cast a vote taking into consideration actual results of a particular dApp measuring potential benefit. This model creates motivation for dApp providers to investigate new incentive models and offers a unique value proposition competing with others for capital allocation.</p><p>In existing centralized decision making on fiscal spending, a small group of people decide how resources should be allocated. There is a high probability of corruption schemes or lobbying interested parties. In those cases, resources may not be spent efficiently. Future economic outcomes may suffer, undermining the entire ecosystem.</p><p>Terra is aimed to become a convenient medium of exchanging programmable money that enables easy foreign currency swaps and cross-border payments bridging traditional economies with advantages of decentralization.</p><p>An optimal economic resources distribution, a sophisticated stability mechanism, strong network effects and an ability to provide incentives for users is a big step towards mass adoption for digital currency. Now the community can participate in the economy that distributes wealth back to society without the need to trust a limited group of individuals, that may be accumulating lots of money and power, fighting their desire to put some in their own pockets.</p><hr><p><em><em>I am not an economist or financial adviser, all opinions expressed in this article are my own thoughts on that topic. Special thanks to Do Kwon and Nicholas Platias for their answers and assistance. For deeper dive into the protocol concepts you may visit <a href="https://agora.terra.money/?ref=p2p.org">Agora, Terra research forum</a>.</em></em></p><hr><p><strong><strong>P2P Validator</strong></strong> offers high-quality staking facilities and provides up to date information for educational purposes. Stay tuned for updates and new blog posts.</p><hr><p><strong><strong>Web:</strong></strong><a href="https://p2p.org/?ref=p2p.org"> https://p2p.org</a></p><p><strong><strong>Stake LUNA with us:</strong></strong><a href="https://p2p.org/terra?ref=p2p.org"> https://p2p.org/terra</a></p><p><strong><strong>Twitter:</strong></strong><a href="https://twitter.com/p2pvalidator?ref=p2p.org"> @p2pvalidator</a></p><p><strong><strong>Telegram:</strong></strong><a href="https://t.me/p2pvalidator?ref=p2p.org"> https://t.me/p2pvalidator</a></p>

<p>We can define a cosmos network as a <em><em>social galaxy</em></em> with various entities and different types of participants who are fully self-responsible for decisions they make. To make such system as healthy as possible, minimize cheating and other fraudulent behavior that cause loss of confidence, it should contain a set of rules, instruments and other incentives which will determine the right direction together with moral ethics.</p><p>Slashing is an event, which results in a loss of stake percentage, depending on the type of network violation and jeopardizing the safety of other participants. It represents not only a financial incentive to act properly but also is a measure to prevent nothing at stake problem.</p><p>Cosmos is a complex ecosystem where atom act not only as an economic incentive but also represent a governance unit playing a crucial role in ecosystem security. In that way, slashing becomes a tool that influences voting power distribution.</p><p>Besides, it affects the authority of caught fraudlent participant, motivates validators to improve their infrastructure and in case of delegators, to provide a deeper due-diligence and diversification amongst validators. Slashing also act as a decentralization mechanism motivating re-delegate atoms to more reliable or even smaller validators with equal level of security and infrastructure set up.</p><p>For now this motivation can be not so obvious but after enabling Inter Blockchain Communication (IBC) and feature of shared security when validators will be slashable on multiple validated chains slashing risk will be different for all validators depending on conditions and number of chains they operate.</p><h1 id="slashing-events"><strong>Slashing events</strong></h1><p>There are two types of events when stake liquidation happens:</p><ul><li><strong><strong>Downtime</strong></strong> occurs when validator is offline and do not participate in block commitment signing less than <code>5%</code> of the blocks in a row of <code>10 000</code>. This situation leads to loss of <code>0,01%</code> stake not only for validator but for bonded to him delegators as well. In addition, validator drops out of the consensus and do not earn block rewards for at least <code>10 minutes</code>. After fixing the issues validator can re-join validators set by sending un-jail transaction.</li></ul><figure class="kg-card kg-image-card"><img src="https://p2p.org/economy/content/images/2020/09/1-14.png" class="kg-image" alt loading="lazy" width="647" height="151" srcset="https://p2p.org/economy/content/images/size/w600/2020/09/1-14.png 600w, https://p2p.org/economy/content/images/2020/09/1-14.png 647w"></figure><ul><li><strong><strong>Double-sign</strong></strong> can lead to more harmful consequences than the previous one. It can cause double-spend or chain fork. The wrong setup of the validator’s infrastructure or key compromise are the most common occasions that cause this type of slashing. In this case, stake penalizes by <code>5%</code> and validator loses the right to propose blocks and earn rewards without an ability to un-jail. All delegators of this validator enter the unbonding period, which lasts <code>21 days</code>.    </li></ul><figure class="kg-card kg-image-card"><img src="https://p2p.org/economy/content/images/2020/09/2-17.png" class="kg-image" alt loading="lazy" width="652" height="195" srcset="https://p2p.org/economy/content/images/size/w600/2020/09/2-17.png 600w, https://p2p.org/economy/content/images/2020/09/2-17.png 652w"></figure><p><strong><strong>Slashing also affect atoms, which were in unbonding phase</strong></strong> at the moment when one of these events happened. If a validator have low self-bonded ratio (low self-delegated amount) and large amount bonded then, in theory, it could have economic incentive to double-sign. This behaviour will lead to a loss of confidence in this validator and as a consequence inability to earn transaction fees and atom provisions in future missing opportunity of the long term ecosystem adoption and development.</p><p>Validators with low self-delegated amount should be able or will have to find the way to maintain resilent infrastructure with low costs in order to increase self-delegation and/or commision rate while bonded atoms to them are increasing.</p><p>If self-bonded ratio is decreasing or low in some cases (for instance, validator bonded to other validators in order to diversify holdings or increase network decentralization), if validator charges fair commission long term incentives should overcome short term gains. Commission rate should be reasonable and cover existing expences. If a validator with high stake is not earning to maintain infrastructure and operations (by self-bonded amount that generate rewards and/or commission rate) it is at least concerning.</p><h1 id="how-slashing-works-in-theory"><strong>How slashing works in theory</strong></h1><p>Assume that we have three validators:</p><ul><li><code>V1</code> with a commission of <code>5%</code></li><li><code>V2</code> with a commission of <code>8%</code></li><li><code>V3</code> with a commission of <code>9%</code></li></ul><p>If delegator bond to <code>V1</code> with an annual return on staking (RoS) around <code>10,2%</code> for <strong><strong>5 years</strong></strong> and <em><em>without taking advantage of compounding</em></em>, then his cumulative interest for five years nominated in atoms will be <code>48,5%</code>. Let’s have a look at how <em><em>monthly compounding</em></em> with slashing will affect this number. To simplify calculation we assume that: <strong><strong>In the case of downtime</strong></strong>, it happened <em><em>three times</em></em> and delegators stake passively without re-delegating after the first event:</p><ol><li>End of the 2^nd month and <code>2 days</code> passed before un-jail</li><li>End of the 7^th month and <code>1 day</code> passed before un-jail</li><li>End of the 11^th month and <code>1 day</code> passed before un-jail</li></ol><p><strong><strong>In the case of double-sign</strong></strong>, slashing and unbonding period occurred once at the end of the 12^th month. After <code>21 day</code> of unbonding delegator bonded to another validator with the same commission rate. I will use the same conditions for other comparisons in this article. Overall result for delegator will look like:</p><figure class="kg-card kg-image-card"><img src="https://p2p.org/economy/content/images/2020/09/3-16.png" class="kg-image" alt loading="lazy" width="1062" height="535" srcset="https://p2p.org/economy/content/images/size/w600/2020/09/3-16.png 600w, https://p2p.org/economy/content/images/size/w1000/2020/09/3-16.png 1000w, https://p2p.org/economy/content/images/2020/09/3-16.png 1062w" sizes="(min-width: 720px) 720px"></figure><p>We can notice that:</p><ul><li>Delegator who took advantage of monthly compounding even with a double-sign event outperformed another one who just delegated once and forgot. The magic of this feature I will cover in the next article.</li><li>Downtime has not much influence on the result for delegator even if it happens quite often and validator re-join validator set much later than current jail time for downtime (10 minutes). It has a bigger influence on the validator in the long term. His delegators will lose confidence and will immediately re-delegate their holdings to others. Until validator un-jail, the staked ratio will be lowered by the number of atoms delegated to him. This will increase voting power of other validators resulting in higher probability of proposing a block and may lead to higher transaction fee gais in comparison with validators who often go offline.</li><li>Double-sign has the most harmful event on RoS and the difference is about <code>9%</code> in comparison with delegator who have chosen an honest and secure validator</li></ul><p>If we will compare the performance of delegators who bonded to different validators with a various commission rate, we will see that RoS for <code>V3</code> is higher than RoS for <code>V1</code> and <code>V2</code> if double-sign occurred. For a taken period of 5 years this will be correct even if the commission of <code>V3</code> will be <code>16%</code> that is more than three times higher than the <code>5%</code> commission of <code>V1</code>.</p><figure class="kg-card kg-image-card"><img src="https://p2p.org/economy/content/images/2020/09/4-11.png" class="kg-image" alt loading="lazy" width="1062" height="535" srcset="https://p2p.org/economy/content/images/size/w600/2020/09/4-11.png 600w, https://p2p.org/economy/content/images/size/w1000/2020/09/4-11.png 1000w, https://p2p.org/economy/content/images/2020/09/4-11.png 1062w" sizes="(min-width: 720px) 720px"></figure><p>You can notice that in the longer term (in our example &gt;5 years) current double-sign slashing do not cause huge effect on the performance and there still exist high incentive for delegators to choose validators basing predominantly on the commission rate. In theory, this may cause weaker decentralization level of the network.</p><p>Downtime slashing has even less voting and economic influence. Current slashing conditions should be considered as a starting point for further discussion on that topic and may be changed in future via governance mechanism.</p><p>For example, every repeating downtime event over the period of <code>X</code> could cause atom slashing equivalent to <code>prev_slashing_percentage * 2</code>. If a validator constantly goes offline this will cost more for him and his delegators thus increasing incentive to properly maintain the state of own infrastructure and for delegators to re-delegate to others. One of concerns about changing initial parameters is a lack of empirical data so as the network evolve we will see more experiments in this field.</p><h1 id="smart-ideas-for-delegators-to-protect-from-slashing-consequences"><strong>Smart ideas for delegators to protect from slashing consequences</strong></h1><p>No one can predict the future and <strong><strong>one of the best ways for delegators to protect themselves from misbehavior is diversification</strong></strong>. Suppose that delegator bonded all his atoms to <code>V1</code> with the lowest commission possible, <code>5%</code> in our case. Another delegator diversified amongst all three validators equally - <code>33%</code> for each. If <code>V1</code> will be caught on double-sign, the second delegator will get <code>2,5%</code> higher RoS than the first one who put all atoms in one basket even if <code>V2</code> &amp; <code>V3</code> went offline for some reason.</p><p>Another idea is responsible behavior. Bonding to a validator is not a blind step and simple way to earn passive income. To be up to date delegators should continue to monitor validator uptime. Frequent downtimes may indicate unreliable infrastructure.</p><ul><li>What actions validator take in order to prevent slashing conditions?</li><li>Does valiadator disclose an infrastructure setup?</li><li>Is it secure?</li><li>What upgrades and improvements are in the roadmap?</li><li>Is the commission rate sufficient to support validator activities and maintain reliable infrastructure?</li><li>What is the responsibility level of a validator and how valuable is it's contribution to the ecosystem development?</li></ul><p>Answers to these questions can help delegators to diversify amongst the most remarkable validators.</p><p>The most prominent validators who set up well-protected infrastructure and have a high level of confidence can offer refunds for their delegators in case of slashing event. In this case reserve funds or the idea of developing slashing insurance for delegators make sense. For some delegators who have no ability to follow up with the state of their atom performance this could be a reasonable solution.</p><blockquote><em><em>The first rule – do not lose your money, the second rule – remember of the first one.</em></em><br><em><em>"Warren Buffet"</em></em></blockquote><p>In the cosmos ecosystem, your atoms are your assets, which can generate additional income for you. Take care of your holdings and be responsible for the decisions you make.</p><hr><p><strong><strong>P2P Validator</strong></strong> offers high-quality staking facilities and provides up to date information for educational purposes. Stay tuned for updates and new blog posts.</p><hr><p><strong><strong>Web:</strong></strong><a href="https://p2p.org/?ref=p2p.org"> https://p2p.org</a></p><p><strong><strong>Stake ATOMs with us:</strong></strong><a href="https://p2p.org/cosmos?ref=p2p.org"> https://p2p.org/cosmos</a></p><p><strong><strong>Twitter:</strong></strong><a href="https://twitter.com/p2pvalidator?ref=p2p.org"> @p2pvalidator</a></p><p><strong><strong>Telegram:</strong></strong><a href="https://t.me/p2pvalidator?ref=p2p.org"> https://t.me/p2pvalidator</a></p>