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Intro

The Avalanche blockchain is looking to continue pushing the Layer-1 (L1) landscape in scalability and sustainability via its subnet ecosystem. To that end, the Avalanche developer community is proposing significant changes to the subnet design with the introduction of Avalanche Community Proposal (ACP) 77. This proposal seeks to transform the foundational dynamics between subnets and their validators while simplifying the subnet creation process. By addressing the technical and financial barriers faced by new developers under the current model, ACP-77 promises to foster a more inclusive and scalable blockchain environment. 

Additionally, this report will highlight several exciting projects within the Avalanche ecosystem, such as Particle Network and its Universal Account technology, Salvor's NFT lending platform, and BitNote's encrypted note storage dApp. These projects demonstrate the innovative use cases and robust ecosystem being built on Avalanche, further underscoring the significance of ACP-77 in enhancing the network's capabilities and accessibility.

ACP-77

The Avalanche blockchain, with its strong L1 ecosystem and subnet technology, is currently proposing big changes with the introduction of Avalanche Community Proposal (ACP) 77. This proposal is designed to alter the core relationship between subnets, their validators, and the creation of new subnets/tokens. It simplifies and democratizes the process, removing technical and financial barriers for new developers under the current model.

Here are the highlights of ACP-77:

• Subnet validators would be separate and distinct from Primary Network Validators
• Remove the 2000 $AVAX requirement to launch a subnet
• Ownership of Subnet validator set management moves from P-Chain to Subnets 
• Continuous P-Chain fee for Subnet Validators (Continuous Subnet Staking)

Current Subnet Design

Avalanche is unique in its innovative approach to blockchain architecture and scalability thanks to the concept of subnets—dynamic sets of validators that reach consensus on specific blockchains. Within the Avalanche ecosystem, each blockchain is validated exclusively by one subnet, although a single subnet can validate multiple blockchains. The Primary Network, consisting of the P, X, and C-chains, is responsible for everything within the Avalanche ecosystem, including subnets. The P-Chain specifically is a blockchain that is used for subnet coordination/administration and staking, it is also now used to register BLS signatures for Avalanche Warp Messaging.

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Subnets give developers more flexibility and customization options compared to the C-chain to support their needs and use cases. Unlike other networks that have a single virtual machine (VM), such as EVM in Ethereum, subnets in Avalanche can have multiple VMs, including Ava-VM, EVM, WASM, and more. They can also support multiple programming languages, fee structures, KYC requirements, gas tokens, and more. Subnets provide all this optionality while leveraging Avalanche’s fast finality, network effects, and liquidity, allowing for seamless communication between subnets. Avalanche’s long-term scalability strategy is to have hundreds to thousands of subnets. This distributes the load across the network and prevents any one subnet from reaching capacity. 

Problems with the Current Design

Under the current subnet creation protocol, an individual or entity wishing to establish a subnet on the Avalanche network must first become a primary network validator. This role comes with a substantial staking requirement of 2,000 AVAX, which serves as a significant financial barrier for most startups. Additionally, this process involves complex interactions between multiple chains within the Avalanche ecosystem: the X-chain, C-chain, and P-chain. Each serves distinct functions, from asset creation and exchange to smart contract execution and platform management. The necessity for token transfers across these chains to meet staking requirements adds layers of complexity and potential points of failure that can deter innovation.

Additionally, the success of the C-Chain might hurt subnets' ability to flourish. Subnet validators need to validate the C-Chain, and as the C-Chain and its transaction history grow, those validators will need more and more powerful hardware to keep up. This represents an additional friction for anyone looking to launch a subnet. As of Q2 2024, 40%+ of Avalanche validators are hosted on Amazon and other data providers. If hardware requirements continue to get more complex and burdensome, that percentage will likely increase, leading to increased centralization/single-point-of-failure risk.

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What ACP-77 Changes

ACP-77 looks to address the major obstacles to current subnet adoption by

• Removing the significant “startup cost”:  Staking 2000 AVAX per validator will no longer be required.
• Redefining the relationship between the P-Chain and subnets: subnets will have more autonomy and an easier time managing their validator sets 
• Removing the regulatory hurdles for institutions: Many regulated entities could not validate permissionless, smart contract-enabled blockchains like the C-Chain, thereby prohibiting them from launching their own subnet. With ACP-77, this issue is eradicated. 

The P-Chain can now authenticate the addition or removal of validators from a subnet using BLS multi-signatures, which secure Avalanche Warp Messaging. This enhancement allows subnets to enforce specific requirements for joining their validator sets. For instance, a subnet may require validators to lock up tokens on the C-Chain or the subnet itself. These requirements can extend beyond Avalanche to include token lock-ups on Ethereum (ERC-20) or Solana (SPL), providing substantial flexibility for subnet creators in controlling their validator sets.

The revised relationship between the P-Chain and subnets also facilitates a dynamic fee model. Subnets can leverage the P-Chain as an arbiter to modify parameters and validate incoming Avalanche Warp Messages. If a validator misbehaves, subnet validators can collectively sign a BLS multi-signature to diminish the weight of the errant validator. This process, along with any validator removal procedure, is secured by the Avalanche Primary Network, ensuring robust infrastructure and security.

Economic Impact and AVAX Revenue

The economic implications of ACP-77 are also noteworthy. By introducing a continuous fee mechanism for subnet validators, the proposal suggests a move away from upfront financial commitments towards a usage-based fee structure. This mechanism would adjust fees based on the operational demands placed on the network by each subnet, potentially leading to more efficient resource utilization and cost distribution. This change could attract a new class of developers and enterprises looking for a more scalable and cost-effective blockchain solution.

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Supply and Issuance

The AVAX token has a total supply of 720 million. At the mainnet launch in September 2020, 360 million were released, with most locked in vesting periods of 1-10 years. The remaining 360 million AVAX will be released to staking validators over time. 

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The reward rate, governed by the protocol, allows token holders to control how fast the total supply reaches its cap. Unlike Bitcoin’s halvings, AVAX’s reward rate decreases more gradually as the supply approaches the cap. The objective of AVAX’s emissions function is to reach a capped supply in a similar fashion to Bitcoin’s emissions curve yet maintain the ability to govern the rate at which the system reaches the said limit.

AVAX is unique among capped-supply tokens in that it adapts to changing economic conditions. As of 2024, AVAX’s inflation rate is around 10-15% depending on unlock schedules. 

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Unlike Ethereum, all AVAX fees are burned, which creates long-term deflationary pressure. Another key difference from Ethereum's model is that Avalanche uses a transaction tier model with two types of transaction-processing mechanisms. All accounts with positive balances can immediately interact with the platform, where fees are based on an allotment mechanism similar to tiered payment models in cloud computing. Each transaction specifies a sender address (invoker) checked for its current invocation allotment. If the sender still has free invocations, no fees are required. Beyond a certain number of calls, the sender must attach fees based on the computational resources used. Fees can also be paid via computation. Future developments will support frequency-limited transactions that do not require coin fees but instead rely on pre-computation.

Supply Cap and Burn Mechanics

The AVAX token supply is capped at 720 million tokens and self-regulates the supply with a burn mechanism. Avalanche's burn mechanism resembles Ethereum's EIP-1559 fee structure with key distinctions. Users pay two fees for transactions: a base fee, determined by network demand for block space, and a tip that influences transaction order within a block. Fees across all three Avalanche chains are paid in AVAX and are subsequently burned, reducing the circulating supply and helping to counterbalance the high inflation rate of AVAX.

Despite growing adoption, the burning of fees could slow if subnet growth outpaces demand. An illustration of this phenomenon occurred in 2022, highlighting the dampening effect subnets have on average daily transaction fees. While total daily transactions increased four to five times from Q2 2022, the revenue generated from these transactions plummeted. The average cost of an AVAX transaction in USD decreased by approximately 85% over the course of 2022, contributing to a 94% year-over-year decrease in AVAX income. Since Avalanche burns all transaction fees, this reduction in fees has also led to a decreased burn rate of AVAX.

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Unless more subnets gain traction to counterbalance the reduction in fees, the protocol may face long-term sustainability issues. This is a common challenge for most blockchain networks, including Bitcoin and Ethereum. Lower transaction fees benefit users but represent a temporary net negative for investors and holders (HODLers) as there is less AVAX burning to offset net token issuance. However, some help could be on the way if ACP-77 is approved. The new burn mechanics introduced in ACP-77 and the “pay-as-you-go” model for subnets could help increase the overall amount of AVAX burned, especially if the subnet ecosystem ultimately grows into the thousands. 

Additionally, transaction fees on the Avalanche network vary depending on the type of transaction. Simple AVAX payments incur minimal costs, while creating new subnets involves the highest fees. These fees operate on a sliding-cost function set by a globally verifiable fee mechanism rather than by the transaction's issuer. As network congestion increases, so do the fees. This fee function is recalculated periodically to accommodate natural increases in transaction volume across the network.

ACP-77 Security Considerations

From a security standpoint, while reducing financial barriers might raise concerns about network security, ACP-77 addresses these by empowering subnets to define their security protocols and policies. This approach allows for the development of new security models tailored to the unique characteristics and needs of each subnet. Consequently, subnet creators will bear the responsibility for securing their networks, as the primary network will not impose a universal security policy.

The implications for the Avalanche network are substantial. Simplified subnet creation and enhanced management options will likely lead to an increase in the number and diversity of subnets, catering to specific niches or the general market. This diversification will enhance the Avalanche ecosystem's value to developers, entrepreneurs, and users alike. By reducing the complexity and cost of subnet management, Avalanche is poised to become the premier platform for decentralized applications and enterprise blockchains.

Identified Potential Risks

• Possibly decreasing the demand for AVAX: ACP-77 changes the economics for Avalanche subnet validators. It will reduce the cost of becoming a subnet validator, decreasing this “revenue stream” for the protocol. However, each additional validator means consistent RAM usage on the P-Chain with a continuous fee mechanism to meter that resource usage.
• Inactive Validators: The continuous fee mechanism in ACP-77 doesn’t apply to inactive subnet validators because they’re not stored in memory. Instead, they’re stored on disk and contribute to P-Chain state growth.

Ecosystem Developments

Chain Abstraction via Particle Network

Particle Network, a leading chain abstraction protocol, is building on the Avalanche ecosystem by introducing Universal Accounts. Universal Accounts will allow users to interact with any dApp on Avalanche using tokens from various networks. Particle Network’s tagline of "one account, one balance, any chain" appropriately demonstrates the significant UX changes it hopes to usher in on the Avalanche network.

Initially, Particle Network emerged as an account abstraction service provider, facilitating the creation of smart contract wallets linked to Web2 social accounts for seamless integration within dApp-embedded interfaces. With the launch of a modular Layer 1 (L1) blockchain based on the Cosmos SDK, Particle aims to provide a high-performance, Ethereum Virtual Machine (EVM)-compatible execution environment. The protocol’s vision has since expanded to encompass a broader chain abstraction strategy, encompassing wallet services, liquidity, and gas abstraction on its L1 blockchain.

At the core of Particle’s offering are Universal Accounts (UAs), functioning as smart accounts attached to an externally owned address (EOA). These accounts aggregate token balances across multiple chains into a single address, facilitating atomic cross-chain transactions. This capability allows users to manage assets across different blockchain environments as if they resided on a single chain. 

Particle’s L1 blockchain acts as a coordination and settlement layer for all cross-chain transactions, storing account settings to maintain a synchronized state across UAs. This central source of truth ensures consistent cross-chain messaging, facilitating the deployment or updating of account instances as needed.

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Universal Liquidity represents another critical component of Particle’s chain abstraction services. This functionality allows for the automatic execution of transactional requests, thereby unifying balances across different networks. Universal Liquidity eliminates barriers to entry, such as the need for native gas tokens and the creation of native wallets for new networks.

For instance, if a user wants to purchase an asset on an unfamiliar blockchain without existing funds, the necessary liquidity is sourced automatically from their balances on other chains. This process relies on Particle’s Decentralized Messaging Network (DMN), where specialized Relayer Nodes monitor external chain events and settle state events. 

New Launches

Salvor, a new player in the NFT lending space, is joining the Avalanche Rush program to boost their high volume peer-to-peer (P2P) NFT lending protocol. This allows users to use NFTs and community coins as collateral to borrow AVAX and increase liquidity in the Avalanche ecosystem. Furthermore, Salvor allows users to earn points by creating loan offers, borrowing, listing, bidding, and trading. Points can be redeemed for rewards in AVAX or Salvor’s native ART token to encourage active usage of the platform.

Another notable launch this quarter is BitNote, a dApp for encrypted notes on the C-chain. BitNote enables users to store and share confidential information on-chain, such as passwords, seed phrases, private keys, and other sensitive data, with end-to-end encryption. By bringing a Web2 product on-chain, BitNote eliminates the need for a centralized database and hosted front end. This means encrypted personal data is stored on the Avalanche blockchain forever and can be accessed from any device with a browser for more security and convenience.

Re, a platform for tokenizing real-world assets (RWA), has launched its first open-ended reinsurance fund on Avalanche. The redeemable Tokenized Reinsurance Fund by Re aims to bring transparency and on-chain settlement to the reinsurance industry and open up this $1 trillion market to more people. In addition to the fund, Re is also building its own subnet, signaling its long-term support of the Avalanche ecosystem. 

Conclusion

ACP-77 marks a pivotal shift in the Avalanche blockchain's architecture, aiming to lower entry barriers and enhance the autonomy of subnets. By removing the substantial AVAX staking requirement and redefining the relationship between the P-Chain and subnets, ACP-77 paves the way for a more diverse and accessible ecosystem. The proposal's focus on economic efficiency, security, and scalability highlights its potential to attract a new wave of developers and enterprises to the Avalanche network. While the changes introduce new risks and challenges, the overall direction points towards a more flexible, decentralized, and sovereign blockchain platform capable of onboarding new projects like Particle, BitNote, and others.

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Disclaimer: This report was commissioned by Ava Labs. This research report is exactly that — a research report. It is not intended to serve as financial advice, nor should you blindly assume that any of the information is accurate without confirming through your own research. Bitcoin, cryptocurrencies, and other digital assets are incredibly risky and nothing in this report should be considered an endorsement to buy or sell any asset. Never invest more than you are willing to lose and understand the risk that you are taking. Do your own research. All information in this report is for educational purposes only and should not be the basis for any investment decisions that you make.