Avalanche

The Avalanche network is a novel Proof of Stake (PoS) smart contract blockchain designed to outpace Ethereum's transactional throughput, reduce operational costs, and enhance overall system performance. Launched in 2020, the network's structure is uniquely compartmentalized into three interoperable blockchains known as the P-, X-, and C-chains. This tripartite framework operates synergistically with subnetworks, or subnets, serving as the network’s primary scalability solution. Within this system, the AVAX token serves multiple purposes, including staking, transaction fees, launching and securing subnets, and facilitating governance through participatory voting.

Blockchain Architecture

Avalanche distinguishes itself from other L1 blockchains as a "platform of platforms," an architectural design choice that integrates a Primary Network with a myriad of specialized subnets to create a singular, cohesive, interoperable ecosystem. The overarching goal is to address the pervasive "blockchain trilemma," which posits achieving scalability, security, and decentralization in one network is (practically) impossible. Due to its design, the entire Avalanche network functions as an asynchronous and heterogeneous network. This means Avalanche developers have the freedom to build an array of tailored blockchains, each harnessing distinct virtual machines, tokens, and/or other parameters. These purpose-built blockchains maintain interoperability through a common foundational chain, not unlike Cosmos or Polkadot.

The Avalanche blockchain represents an innovative approach to decentralized network architecture. Its core structure, which encompasses a Primary Network comprised of a three-chain system, is engineered to segregate processing duties. This segregation is critical, as it ensures that activity on one chain does not impede the performance of others, thus optimizing the network's capacity to process transactions concurrently. 

The Avalanche Primary Network provides security across this multi-chain framework and functions as the linchpin of the Avalanche protocol:

• The Platform Chain (P-Chain) orchestrates the critical aspects of staking, validator coordination, and overarching protocol governance. This chain is integral to the network's consensus and facilitates the creation and coordination of subnets.
• The Exchange Chain (X-Chain), which operates on the Avalanche Virtual Machine (AVM), is responsible for asset creation and exchange. It adopts the Unspent Transaction Output (UTXO) model, akin to Bitcoin's, but it advances beyond with a Directed Acyclic Graph (DAG)-based structure, enabling programmability and the minting of digital assets such as NFTs and utility tokens.
• The Contract Chain (C-Chain) ensures compatibility with the Ethereum Virtual Machine (EVM), thereby providing a seamless transition for developers from Ethereum's dapp environment to Avalanche. This chain is responsible for the management and execution of smart contracts, boasting a high transaction throughput and swift finality times.

Subnets

As previously mentioned, the Avalanche blockchain extends beyond the Primary Network, offering developers the capability to build custom blockchains, termed subnets, within its ecosystem. These subnets are scaling solutions akin to the layer-2 solutions implemented by Bitcoin and Ethereum but possess distinct differences in their design and performance. These subnets afford developers complete control over the programmability of their networks. This includes the customization of tokens, fee structures, and rules, aligning with specific project requirements or regulatory compliance. 

Each subnet on Avalanche is a dynamic collection of validators that work in unison to reach consensus on their respective blockchains. The structure ensures that while a single subnet exclusively validates a blockchain, a subnet can oversee multiple blockchains, enhancing the efficiency of the network. This P-Chain operates as a specialized subnet within Avalanche's ecosystem, overseeing the validation process across the network. Such a design provides developers with unprecedented flexibility, enabling them to tailor blockchains to specific applications, whether permissioned or permissionless, and ensuring interoperability within the same subnet.

Putting all these together, the benefits of Avalanche's design are multifarious. One of the most beneficial advantages of this design is network isolation, which shields users on one chain from network congestion and high fees during spouts of heightened network activity on another. Perhaps most beneficial for projects planning a global user base, Avalanche supports subnet-specific validator configurations. This feature empowers projects to tailor validator protocols to comply with pertinent regulatory frameworks, exemplified by the General Data Protection Regulation (GDPR) within the European Union or Know Your Customer (KYC) regulations in the U.S. Traditional Finance space. Additionally, it offers the flexibility to modify the prerequisites for becoming a validator, including the technical specifications of the requisite hardware, thereby aligning with the distinct needs and regulations of various jurisdictions.

Potential Complications with Subnets

Security

Avalanche’s subnet structure bears some resemblance to the side chains of Ethereum and the zones/hubs of Cosmos, yet there are critical distinctions. In Cosmos, for instance, each zone/hub maintains its own set of validators. Conversely, a subnet in Avalanche can validate multiple blockchains with a singular validator set. Developers are empowered to configure their subnets with a variety of parameters, including but not limited to:

• Chosen virtual machines (VMs)
• Programming languages
• Designated tokens
• Fee structures
• Validator set specifications
• Uptime requirements
• Security protocols, including optional shared security features

However, it's important to note the security implications of this independence. Unlike Polkadot's shared security model or the integrated security seen in Ethereum and its rollups, Avalanche's subnets function as standalone chains. They must independently establish their consensus network, handle data availability, and manage execution. While this promotes autonomy and flexibility, it also implies that the security of these subnets is not as robust as that of the primary Avalanche network.

Minimum Staked AVAX 

Validators of custom subnets are required to be part of the primary network, necessitating a stake of 2,000 AVAX. This means new projects looking to build in the Avalanche ecosystem need to set aside $40,000 to $200,000+ before anything else to purchase AVAX tokens. This is a meaningful expense to any new project and could be cost-prohibitive for many new dapps. However, initiatives like Benqi’s Ignite and others are trying to create solutions to help offset this cost.

Validator Hardware Requirements

Additionally, Avalanche's design permits validators to secure the primary Avalanche chains without the obligation to validate additional subnets. This selective validation may lead to a spectrum of security levels across the ecosystem, potentially making some subnets more vulnerable than others. Because the C-chain has seen the most usage and transactions to date, it may require advanced hardware for validators, which could present a hurdle for some subnets seeking to maintain performance and security on a budget.

Interoperability

As the network matures and the tapestry of subnets expands, interoperability will become increasingly paramount. Originally, the unique configuration of Avalanche's blockchains yielded complex bridging mechanisms between subnets. Cross-chain transfers are facilitated through bridges, allowing for the movement of assets and data between subnets, circumventing the need to engage the X-Chain. However, the interaction between subnets and the primary network is unidirectional in terms of validation responsibilities. Validators on each subnet are mandated to validate the three primary chains, which requires the staking of 2000 AVAX. Yet they are not compelled to validate other subnets, underscoring a unique aspect of Avalanche's network design.

Avalanche Warp Messaging (AWM)

To address the interoperability issues between subnets, Avalanche announced a pivotal enhancement to its platform in 2023: the introduction of Avalanche Warp Messaging (AWM) as part of the Banff 5 update. AWM enables subnets to interact seamlessly among themselves and with the C-Chain, negating the need for a trusted third party. 

Validators must register a Boneh-Lynn-Shacham (BLS) key to engage in AWM, ensuring that a subnet can create BLS Multi-Signatures representing a consensus among stakeholders. This cryptographic innovation underpins the authentication process for inter-subnet messages, encompassing asset transfers and contract data. Once a message is signed with this multi-signature scheme, its authenticity can be recognized and verified by any other subnet within the Avalanche ecosystem. Additionally, subnets have the ability to whitelist other subnets with which they interact, providing another example of subnet customization. 

One of the most notable implications of this update is the reduction of overhead for subnets in terms of cross-communication and updates regarding validator set changes, which were previously necessary for message validation. By mitigating these requirements, AWM significantly simplifies the mechanics of inter-subnet interactions, thereby enhancing the overall efficiency of the network. 

Astra Proposal

Ava Labs has recently put forward a proposal for an upgrade to its subnets, dubbed the Astra Upgrade, to remove some of the pre-existing frictions involved with launching and securing a subnet. 

The initial phase concentrates on streamlining the responsibilities of subnet validators. It alleviates the prerequisite for subnet validators to concurrently validate the entire Avalanche Primary Network. With the implementation of this upgrade, validators can dedicate their resources to solely managing a subnet and maintaining the P-Chain, which is responsible for staking AVAX and disbursing rewards. This shift is poised to reduce the computational burden and the associated costs of running a subnet, thereby easing the entry barriers for validators.

This change primarily benefits subnet validators by eliminating the need to validate the main network, which in turn eliminates the need to initialize and synchronize with the C-Chain and X-Chain. Validators will only need to synchronize with the P-Chain, which tracks validator set changes and facilitates communication across subnets.

Looking ahead to other phases, Ava Labs intends to transition the subnet validation mechanism from a staking model to a rent-based model. This move replaces the current staking requirement with a variable "pay-as-you-go" fee system in AVAX, which adjusts based on the number of validators in a subnet. This dynamic pricing model eliminates the need to commit substantial amounts of AVAX upfront.

Details

As previously discussed, to qualify as a Subnet Validator, one must initially commit to being a Primary Network Validator, which entails staking a minimum of 2,000 AVAX. Today, subnets typically launch with a group of ~eight validators, equating to 16,000 AVAX staked. Furthermore, as part of their validation duties, these validators must run and maintain substantial computational resources, including 8 virtual CPUs, 16 GB of RAM, and 1 TB of storage, to facilitate synchronization with the entire Primary Network and to actively participate in its consensus.

This current model presents challenges for small, cash-strapped projects and big, regulated entities alike. Regulated, TradFI-type entities that face restrictions on validating permissionless, smart contract-capable blockchains like the C-Chain have no options in the current subnet design. Due to the mandate for Primary Network Validation, such entities are barred from launching their subnets, obstructing a potentially significant influx of Real World Asset (RWA) issuers from contributing to the Avalanche ecosystem.

To rectify these issues, the new proposal would make the following changes:

• Create an entirely new entity known as a Subnet-only Validator (SOV)
• Remove the up-front 2000 AVAX cost and replace it with a refundable 500 AVAX deposit
• Create a new transaction type that is required for SOVs to register with the P-chain 

Implications for Avalanche and AVAX

Security

Should this new proposal be implemented, security across the subnet ecosystem will be much more complex and nuanced than compared to its peers. While exceptions certainly apply, the ease of explaining “rollups inherit the security of the Ethereum L1” or “Polkadot utilizes a shared security model” is good marketing and easily grokked by the end user. Subnet security will exist on a spectrum depending on a multitude of factors, including the total number of validators but also the total number of each type of validator, and the economic security behind them. Currently, the C-chain, the EVM-compatible chain that has garnered the most traction, is secured by ~1500 validators. In contrast, most subnets today are also running the EVM but are only secured by 5-10 validators. This begs the question, where does the cost-to-security tradeoff lie? And how does an EVM subnet with reduced security compare to an Ethereum rollup or L3?

However, as many subnets are catering to gaming, where security is not the priority, and institutional/enterprise-type use cases where KYC is expected, these issues become less relevant. 

Economics

In the long term, Avalanche is counting on the proliferation of hundreds/thousands of subnets to scale the network and prevent any one subnet from reaching maximum capacity. Avalanche borrows from Ethereum's EIP-1559 fee structure with some important differences. Users pay two fees for transactions: 1) a base fee set by the network based on block space demand and 2) a tip to determine how their transaction is ordered in a block.

Transaction fees for all three Avalanche chains, as well as future subnet subscription fees, are paid in AVAX and ultimately burned. This eliminates AVAX from the circulating supply, helping to somewhat offset the current high inflation rate.

In the current subnet model, the average subnet would require ~16,000 AVAX (as previously discussed) to launch, creating demand for the AVAX token. Therefore, there was a clear correlation between the proliferation of subnets and AVAX demand. With this new model, that correlation is no longer as clear. The rent-as-you-go model is far more variable and always runs the risk of subnets leaving for new solutions (or their chain, dydx style) should they grow large enough and the fees get too unpalatable.

Additionally, one of the primary benefits of a subnet is that it can use its native gas token. This means that with this proposal, Avalanche’s primary solution to scaling and adoption essentially removes the need for AVAX almost entirely. This raises questions about the token’s value and value accrual mechanism, not unlike ATOM in the Cosmos ecosystem.

Growth

Should this proposal pass, it will inarguably reduce the barrier of entry for many projects to launch their subnet. The removal of the high up-front cost that resembled a Polkadot Parachain auction would enable smaller teams to build on Avalanche, leading to greater experimentation and use cases. Additionally, the removal of validating the entire Primary Network is one less objection for TradFi and RWA projects to build via a subnet. Overall, this proposal makes it easier than ever for a new team to build on Avalanche, especially the enterprise solutions that Avalanche seems to be targeting this cycle, like with its Evergreen subnet.

Conclusion

Avalanche's latest developments reflect a conscious effort to refine its unique "platform of platforms" model, addressing key components of the blockchain trilemma—scalability, security, and decentralization. With the introduction of the Astra Upgrade and the prospect of transitioning to a rent-based model, Avalanche is streamlining the process of launching and securing subnets. These enhancements aim to lower the barriers to entry for new projects and validators by reducing the current financial and computational requirements. The potential for growth and diversification within the Avalanche ecosystem is significant, as these changes could attract a wider array of developers and institutional entities. By allowing greater freedom and flexibility for subnets while maintaining a robust primary network, Avalanche is poised to cultivate an even more vibrant and dynamic blockchain environment. These strategic shifts indicate a forward-thinking approach, positioning Avalanche to effectively compete in the evolving landscape of blockchain technology.

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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.

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