The Settlers of Canto

Key Insights

• Canto is a general-purpose Proof-of-Stake blockchain that embeds a decentralized exchange, lending market, and overcollateralized currency into the network.
• These three core DeFi primitives are offered to users as Free Public Infrastructure — public utilities that are free to use in perpetuity.
• Canto’s design choices represent a radically different approach to building blockchain applications that could catalyze an organic wave of developer adoption. However, a concentrated token distribution and reliance on liquidity mining could hinder the network’s long-term growth.

Two important trends are occurring across crypto right now:

1. Blue-chip DeFi application business models are converging. Rather than offering a single service in isolation, protocols are beginning to package exchange, lending, and stablecoin services together in one unified stack.
2. Applications are choosing to leave generalized smart contract networks to create their own application-specific blockchains. While this approach forces applications to bootstrap their own network security, it allows for greater customizability and control over network incentives.

Canto is an experimental smart contract network that combines both of these ideas together. Built on the Cosmos SDK, Canto is a general-purpose Proof-of-Stake (PoS) blockchain that embeds a decentralized exchange (DEX), lending market, and overcollateralized currency into the network. Canto views these three core DeFi primitives as public goods that should be offered to users for free. Altogether, Canto provides a unique approach to both application and network design that is aligned with the permissionless ethos of public blockchains.

The Canto Experiment

Most new Layer-1 blockchains claim a unique tech stack or consensus algorithm to separate themselves from competing networks. However, Canto is merely a copy-paste fork of EVMOS, a generalized smart contract network that brings EVM compatibility to the Cosmos ecosystem. Instead, Canto differentiates itself by offering its set of core DeFi primitives as “Free Public Infrastructure” to its users.

Historically, DeFi applications have been built as businesses with decentralized ownership structures. Under this structure, protocols extract value from users and redistribute (or intend to one day redistribute) it to owners of the protocol’s governance token. Rather than employing a similar pay-to-use model, Canto’s Free Public Infrastructure offers DeFi services as free-to-use public utilities built upon three core tenets:

1. Rent Extraction Resistant: Canto’s foundational DeFi services lack governance tokens and cannot be altered to extract rent (charge fees) in the future.
2. Minimal Viable User Capture: Canto seeks to avoid front-end ownership of its users. For example, the Canto DEX offers no swapping interface. Instead, all trades must go through third-party aggregators or community-built graphic user interfaces (GUIs). This approach is intended to center competition around the end-user experience and facilitate greater user acquisition for new protocols.
3. Liquidity as a Free Public Good: Canto views liquidity as a public good that should be freely available for any user, arbitrageur, or protocol on the network. Specifically, the Canto DEX charges no fees on trades leaving liquidity mining and public goods funding as the only incentive to provide liquidity on the network.

These principles are grounded in a grassroots spirit of decentralization. Canto has no foundation or venture backers, and its genesis launch featured no token presale or vesting. Scott Lewis, one of Canto’s original creators, expressed his intentions for Canto in the community Discord shortly after launch in August:

Network Genesis and CANTO Distribution

Canto launched its public testnet on July 15, 2022. Over the next 30 days, early testers that used the network and provided feedback became known as the Settlers of Canto. On Aug. 15, 2022, the network went live and airdropped eligible Settlers 2% of the initial 1 billion total CANTO supply. A total of 13% of the CANTO supply was distributed to contributors with no vesting. The remaining 85% of CANTO tokens were sent to a community pool for future grants (5%), short to medium-term liquidity mining (35%), and long-term liquidity mining (45%).

The CANTO token serves four purposes within the Canto network:

1. Network security via staking.
2. The native form of payment for block space.
3. A tool to incentivize DEX liquidity.
4. A governance tool for the Canto Lending Market (CLM), $NOTE, and the broader network.

CANTO follows an inflationary supply schedule with an exponential decay rate. This helps to incentivize early stakers to bootstrap the network’s security before quickly easing off rewards to a sustainable level. Network governance has the ability to adjust both of these parameters. At genesis, the network started with a ~20% annualized inflation rate and produced ~16 million new CANTO for stakers which quickly doubled the network’s circulating supply. Following Canto’s first epoch (30 day periods), the DAO voted to reduce inflation emissions by 70%, bringing the annualized inflation rate down to ~5% for stakers. Liquidity mining incentives were also reduced by 50%, resulting in a net ~54% decrease for CANTO issuance.

Components of Canto’s Free Public Infrastructure

Canto DEX

The Canto DEX is a forked implementation of the Solidly protocol. The DEX supports both standard constant product liquidity pools for uncorrelated asset pairs and concentrated liquidity pools for correlated assets. While the DEX borrows the majority of its codebase from Solidly, its creators removed the protocol’s governance token, fee mechanisms, and any ability to upgrade the protocol’s core logic. This architecture is intended to provide a neutral platform for exchange while protecting against rent-seeking behaviors.

Since there are no fee mechanisms built into the DEX, liquidity providers receive no revenue from traders. Instead, the network relies on liquidity mining rewards as the only incentive to provide liquidity on the DEX. This is a critically important design choice. As the network matures, the protocol will one day run out of CANTO allocated for liquidity mining rewards. Without any fees, there will be no incentive for LPs to provide liquidity and expose themselves to impermanent loss. Additionally, the exponentially decaying inflation schedule will leave the network without any emissions to direct to liquidity providers. As such, CANTO holders will likely be forced to change the network’s inflation schedule to incentivize liquidity on the DEX when liquidity mining rewards run out.

Finally, there is no native front-end GUI for the Canto DEX. Users must rely on third-party aggregators like Slingshot to access the enshrined DEX. Despite this limitation, Canto has consistently produced ~$5 million in daily volumes since genesis.

Canto Lending Market (CLM) and NOTE

The Canto DEX is complimented by the Canto Lending Market (CLM), a fork of Compound V2 that creates a pooled debt market for the Canto network. Unlike the Canto DEX, the CLM is not entirely free from fees. Borrowers must still pay interest to lenders to compensate them for the risk they are taking when lending out their assets.

The borrowing and lending process requires governance oversight to conduct risk management and prevent the protocol from taking on bad debt. To adhere to its Free Public Infrastructure philosophy, the network delegates CLM governance powers to CANTO stakers that secure the broader network. Since these stakeholders are interested in growing the network’s overall usage and development, they should not be incentivized to extract rent from the application layer.

The CLM is home to $NOTE, Canto’s shared unit of account. $NOTE functions as an overcollateralized currency that only enters circulation when users borrow it from the CLM. This design is reminiscent of the soon-to-be-released GHO stablecoin from Aave.

While $NOTE isn’t pegged to the U.S. dollar, the CLM uses a dynamic interest rate to influence its price. When $NOTE trades under $1, the interest rate rises to strengthen the incentive for buying and lending $NOTE. If $NOTE trades above $1, the interest rate is lowered to incentivize users to borrow and sell $NOTE for other assets. The interest charged during this process is collected by the protocol and used to fund public goods for the network. In the future, the DAO could choose to recycle these funds as liquidity incentives for the Canto DEX, thereby creating its own solution to the aforementioned liquidity problem the network faces in the long-term.

The CLM has successfully bootstrapped over $50 million worth of TVL from thousands of daily transactions. However, the protocol’s borrowing usage is underwhelming – the CLM has averaged less than 14 borrow transactions per day since launch. This can be expected given the network’s immaturity, but it will be an important data point to track going forward to monitor its level of adoption.

Catalysts and Concerns

Catalysts

Enhanced Bridging Services

While many users have grown accustomed to quick and simple bridging processes, transferring assets into Canto is currently a headache. New migrants can expect to spend close to an hour sourcing CANTO from the community Discord for wallet initialization, awaiting hundreds of block confirmations, and wrapping assets to be used in the Canto EVM. Still, Canto has managed to dominate volumes on the Ethereum-to-Cosmos Gravity Bridge since it went live in mid-August.

Enhanced bridging capabilities are expected to arrive to Canto in the near future. Synapse has been rumored to be building support for Canto multiple times in recent weeks. As a top 10 bridge provider in terms of monthly volumes, a Synapse integration would greatly expand Canto’s potential userbase and solve the clunky user experience issues when migrating to the network.

Contract Secured Revenue (CSR) and Canto Hackathons

Canto contributors recently introduced a proposal to begin developing a new mechanism for smart contract developers to profit from their work: Contract Secured Revenue (CSR).

CSR will provide an opt-in fee splitting model that shares a portion of transaction fees with the developers responsible for the smart contracts used in a given transaction. When complete, this should function similarly to NEAR’s shared fee structure.

For Canto, CSR will encourage applications to refrain from extracting revenue from their users and instead place a tax on the network’s stakers. The long-term effects of this design choice are unclear, but it should incentivize builders to experiment with the free-to-use public utility model in the short-term.

Speaking of builders experimenting on Canto, the network’s first public hackathon recently awarded builders a total of 300,000 CANTO for their creations. The hackathon produced a handful of NFT projects (Magnet, Canto Long Necks, and Prompt), an alternative DEX (CantoSwap), the Canto Name Service, an auto-compounding yield protocol (Y2R), and a Pokémon themed slot machine game (Kanto Game). The community’s second official hackathon is currently running until November 20 and will again offer 300,000 CANTO in prizes.

A Grassroots Narrative

A final catalyst for Canto presents itself in the form of a narrative. Grassroots crypto projects with highly aligned communities have a history of catalyzing application and network growth. Yearn, Sushi, and Juno are just a few examples of projects that were recently propelled to top 100 prominence by community-driven narratives. The novelty of Canto’s Free Public Infrastructure has already convinced notable Ethereum developers Joseph Delong and Foobar to take on roles in Canto’s early ecosystem. Perhaps more organic growth will follow in the footsteps of these early adopters.

Concerns

Token Distribution

According to ByBit, roughly 129 million of the 130 million CANTO reserved for early contributors was distributed to only 29 addresses after the Settlers of Canto event took place. Since there was no vesting at launch, this concentrated a large amount of voting power, staking influence, and sell pressure into very few hands. Although Canto advertises itself as “a distributed community of DeFi advocates for free public infrastructure,” the marginal developer may see the concentrated token supply and choose to build elsewhere.

Liquidity Mining Has a Bad Track Record

To make liquidity freely accessible for its users, Canto doesn’t allow any fees on its DEX. This idea is nice in theory, but there still needs to be a way to incentivize LPs to provide the liquidity to begin with. Without swap fees, Canto can only incentivize liquidity using its governance token. As we learned during 2020’s DeFi Summer, liquidity mining is a highly reflexive strategy that quickly spelled disaster for a large number of DeFi applications.

Even if Canto manages to safely depart the liquidity mining roller coaster, there still needs to be a sustainable plan for when the reserves dry up. $NOTE interest redistribution provides some semblance of hope, but it’s unclear whether these revenues will be significant enough to retain the necessary levels of liquidity.

Parting Thoughts

As blockchains mature, we’re beginning to understand the crucial role they will play in the future of funding, building, and maintaining public goods. Vitalik has been on the record for years now, advocating for builders to create more experiments in this space. Canto is a perfect example of builders answering this call to action. Whether or not Canto survives the test of time, its bold attempt to offer DeFi services as public utilities will serve as a case study for future public goods designers to draw upon for years to come.