18 min read

💻 The Programmable Tangle: Implications of Layer 1 Smart Contracts on IOTA

[ - by @DigitalSoul.x]

Introduction

In light of the recent bombshell announcements from the IOTA Foundation, I think it’s important that we take a step back and really consider why these decisions have been made. After all, such steps were surely not taken lightly, and since the IOTA Foundation has come to this consensus they must be fully convinced that this is the best (if not only?) path to success.

Now, I will quickly concede that these decisions came as a shock to me when I first learned about them. They sounded drastic and hasty, and considering some of the questionable actions of the IOTA Foundation of the past, it felt like maybe they hadn’t really learned from past mistakes. Why hadn’t the community been solicited for input and advice here? Were they afraid that the community wouldn’t agree with the decisions? Did they see these steps as their only option? These were some of the thoughts that immediately occurred to me.

After taking a step back and trying to see the situation with a bird’s eye view, it became clear that these decisions each fall into place like logical dominoes, and there really isn’t another viable path, in my opinion. In the end I believe that there is no other course of action if we are to give IOTA / Shimmer the best chance of success, even if we must endure another period of pain as holders. Luckily this isn’t new to us. If nothing else, we are all united by our utopic vision of the future and our herculean pain tolerance, bordering on masochism. At least let me share my thought process with you in the hopes that it will ease your mind a bit as it has mine.

Silas from The Da Vinci Code

Where We Are Now: ShimmerEVM Layer 2 Programmability

With the launch of ShimmerEVM imminent, we will finally have smart contract functionality available on Shimmer. And as you probably know, ShimmerEVM represents a Layer 2 solution, a blockchain built on top of Shimmer that periodically anchors into the tangle for security and finality:

These L2 blockchains do offer certain advantages. First of all, they promote higher protocol scalability since the transactions are batched outside of the tangle and only occasionally require L1 throughput. Also, L2 smart contracts help to preserve privacy since individual transactions are batched and then anchored as a set on the tangle rather than each interaction being immutable. Another advantage is that L2 solutions reduce bloat on the core protocol and reduce the burden on node operators.

The bottom line is that ShimmerEVM already represents a huge step in the evolution of IOTA. It offers the ability for practically limitless new projects to build on top of the tangle, to leverage its unique combination of fast, feeless, and ultra-secure transactions. We are only just beginning to comprehend the full implications of this new functionality.

Where We Are Going: Layer 1 Tangle Programmability

So, if Layer 2 smart contracts offer clear advantages, why do we need Layer 1 smart contracts? Well, as is the case with most solutions, there are pros and cons to each approach. As it relates to IOTA / Shimmer, there happen to be some really great reasons we would want programmability on L1, but before getting into tangle-specifics let’s touch on the basics. The primary reasons for choosing to deploy smart contracts directly on the base layer are increased security, increased decentralization, and lower trust threshold. As the IOTA Foundation pursues its vision of “Digital Autonomy for Everyone”, it follows that they would embrace these core tenets of crypto through L1 smart contracts.

Increased Security
As mentioned earlier, smart contract chains built on top of base protocols (aka L2s) only occasionally anchor to Layer 1, and all other transactions occur in a silo. In contrast, those chains executed on the base layer inherit the full security and immutability offered by the underlying consensus mechanism. In the case of IOTA / Shimmer, this refers to Proof of Authority (PoA) for Stardust and Proof of Stake (PoS) for IOTA 2.0. These consensus mechanisms are time-tested and highly resistant to attacks, offering much more peace-of-mind to high-value and security-critical use cases.

Increased Decentralization
By their very nature, Layer 1 networks are much larger and widespread than the Layer 2 networks built on top of them. This means that they are naturally more decentralized, with many more nodes executing the smart contracts and validating transactions. This, in turn, reduces the chance that a single point of failure could bring down the chain. It also promotes an open, inclusive, and permissionless environment that fulfills one of the core principles of crypto.

Lower Trust Threshold
When smart contracts are offered as L2 solutions on top of the core protocol, there are a limited number of validators responsible for processing these transactions. Users of these smart contract chains must trust that these validators will act in good faith, and this can be a leap in crypto where most people are anonymous. In contrast, programmability built into the core protocol draws upon a much larger pool of nodes to validate the transactions. This means that users can utilize the contracts without relying on more centralized actors, and it also ensures that the programs have predictable operation. This fulfills another core principle of blockchain tech.

Tangle-Specific Benefit of L1 Programmability

With IOTA 2.0, our entire consensus mechanism is changing. We will be moving from PoA to PoS via On Tangle Voting (OTV) with Mana enabling throughput on the network. By allowing for L1 smart contracts, asset tokenization, and IOTA Chains anchoring, there will naturally be more demand for the IOTA token, and when demand exceeds supply (including inflation), the price will rise. And as the value and reputation of the network rises, the security of the network increases, as well as the demand for throughput (Mana). These mechanisms complement each other organically to support the value and security of the entire network.

Projects Possibly Requiring L1 Smart Contracts

So what types of projects might choose to deploy on L1 rather than L2? Well, we’ve already discussed above that projects requiring increased security, increased decentralization, and a lower trust threshold would likely choose to deploy on the base layer. There is also much more extensive documentation and developer support available to those building on Layer 1, which may be crucial to some projects. Let’s list some specific applications that might benefit from L1 smart contract programmability:

  • Decentralized Finance (DeFi) Protocols: While DeFi projects could also choose to use L2 scaling solutions, many core DeFi protocols (e.g. lending platforms, decentralized exchanges (DEXs), stablecoin issuers, etc.) are better suited for Layer 1. This is because these applications have significant Total Value Locked (TVL) and often require the highest level of security and decentralization.
  • Security Tokens: Security tokens are assets that represent real-world tangible goods (e.g. stocks, real estate, bonds, etc.) on the blockchain. These tokens must comply with local regulatory requirements, and so security is also of the utmost concern. For this reason, L1 is a preferred choice to ensure legal compliance and investor protection.
  • Initial Coin Offerings (ICOs): ICOs raise funds by issuing tokens to investors. These token sales often involve large sums of money and require a high level of security and trustlessness. To handle these transactions properly and provide peace of mind to the investors, the ICO should be hosted on L1 for the highest level of security and decentralization.
  • Non-Fungible Tokens (NFTs): NFTs are tokens that represent unique digital assets like digital art, collectibles, memberships and more. L1 smart contracts are often utilized for NFT minting as well as associated marketplaces due to their security and the assurance of true ownership. The immutability of the base layer is key here. Also, NFTs can be very valuable assets that demand the added security of L1 programmability.
  • Critical Infrastructure: Crypto-based identity systems, supply chain management, and voting systems are examples of critical infrastructure applications. These may be overseen by local governmental or regulatory bodies. Because of this, these applications demand the highest security and trustlessness. L1 solutions are recommended to ensure the integrity of these systems.
  • Governance and DAOs: Decentralized Autonomous Organizations (DAOs) and other governance mechanisms often depend on L1 smart contracts. In many cases, this is the best way to ensure the security and transparency of the decision-making processes, and to record them in an immutable way.
  • Legal Contracts and Agreements: There may be smart contracts used for legal purposes, such as notarization of documents or the execution of legal agreements. They are also frequently hosted on L1 to ensure the legal validity and security of these contracts.

As you can see, the projects listed above are big-time: Enterprise level, Governmental, Regulatory, etc. They require L1 smart contract support in most cases. While there are clear advantages to hosting smart contracts on L1 or L2, individual projects will need to weigh factors such as security, scalability, transaction costs, decentralization, developer support, interoperability, etc. when deciding on which layer to deploy. Layer 2 is commonly used for everyday transactions and applications that require high scalability or increased privacy. Layer 1 is better-suited for high-value transactions, security-critical applications, and programmability with the highest level of decentralization. The key takeaway here is:

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A complete range of solutions can only be offered to any project if smart contracts are offered on both L1 and L2, and the projects with the greatest chance of mass, real-world adoption will likely choose to deploy on L1.

IOTA L1 Smart Contracts and Assembly

We’ve now come to the conclusion that L1 smart contract functionality is key to the future growth of the IOTA / Shimmer ecosystem. Until recently this functionality was not considered possible. How would such functionality affect the Assembly network? Well, the Assembly network was proposed to be a network to organize the validators of the L2 chains connected to the Tangle. But, with L1 smart contracts there will be a seamless integration between L2 chains and the Tangle, so Assembly is defunct. Also, there has been plenty of speculation (notably from Hans even), that Assembly would take value AWAY from IOTA, as another token / network would only serve to fragment the ecosystem further. Apparently this criticism was well-founded.

According to the IOTA Foundation, rapid, recent technological developments in the crypto-space have opened new, exciting opportunities that actually could allow for L1 IOTA smart contracts. With these advances, why support another network (Assembly) that would cannibalize value from the IOTA? Now that there does seem to be a way to offer L1 programmability on IOTA, wouldn’t you prefer it this way? Let’s make IOTA ubiquitous in the space! Let’s make the Tangle the Swiss Army knife of crypto that it should be! This just simplifies everything and puts the focus back where it belongs: on IOTA. Personally, it makes sense to me that if IOTA can perform the original intended function of Assembly, then Assembly can be abandoned. This logically follows if smart contracts can indeed be deployed on the Tangle.

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But I staked my IOTAs for 2 years, collecting Assembly tokens, what about those?”

I feel your pain. Yes, IOTA stakers deserve something for their dedication and belief in the project. After all, we chose to stake because we were offered tokens in return, even if we were unsure of the future value of those tokens. To abort the Assembly network before it is born is just unfair to the staunchest supporters of the network.

Data from the Assembly announcements at the completion of each staking period on Twitter.

How could we reconcile this? Simply abandoning all of those staked tokens is unacceptable, because we gave up something in return for those promised tokens: the ability to use our tokens for other purposes, otherwise known as opportunity cost. After all, IOTA was trading around $0.75 per MIOTA back in early April of 2022. We all know where we’re at today. If I hadn’t been staking, would I have sold? I don’t know… probably not, to be honest. But the point is, I would have considered the option more strongly for sure.

Plus, it’s not only the IOTA stakers who need to be considered, remember the millions of dollars pledged by early Assembly partner supporters?

Well, these partners are large, influential corporations, capable of really pushing the ecosystem forward. And clearly they would be interested in supporting L1 smart contracts on IOTA since this is the same purpose and vision promised by Assembly. And let’s be honest, we can only assume that any funds already provided by these organizations have already been spent on development up to this point (speculation). We can’t leave these entities high and dry, since we will need their clout and resources to push our ecosystem forward. With Assembly scrapped, let’s bring them to IOTA! But what can we offer?

IOTA: One Token to Rule Them All

The only way to reward stakers and entice partners, if not with Assembly tokens, is with other ecosystem tokens: IOTAs or SMRs. And the only one of these that really makes sense is IOTA tokens, because the IOTA network will be performing the function of the proposed Assembly network. The problem is that the IOTA Foundation is already operating on a shoestring budget — there is no possible way they could attempt to make stakers whole and partners satisfied with the tokens they have on hand, it’s just not possible. “You can’t get blood from a stone!”

The Reluctant Solution: Mint New IOTA Tokens

“Blasphemy!” “Heresy!” “Sacrilege!” But wait, don’t kill the messenger…

Many of us have proudly boasted about IOTA’s non-inflationary model. I count myself as one. The entire token supply was minted and sold completely fairly, with none being pre-sold to VCs, none gifted to founders and early devs, none minted epoch after epoch, diluting the holdings of the most faithful, long term supporters. One IOTA is one IOTA, no matter the rate of inflation of my local currency. And yes, this sounds great on paper, just like many other initial lofty IOTA principles that wound up being unfeasible and are beyond the scope of this article.

And where did it get us? The IOTA Foundation has never had the budget to really compete with the largest, most well-funded crypto ecosystems. This last year has seen the IF tightening its belt to depression-level rations to survive. Many working groups have been spun off, and this prolonged bear market has added fuel to the fire. Sure, the IF is a bit hamstrung by the constraints placed upon them by their non-profit foundation status, but the recent formation of the Tangle Ecosystem Association in Switzerland offers a host of new opportunities. We just need FUNDING.

Suppose, just suppose, we begin minting new IOTA tokens. How might they be used?

  1. Offer IOTA rewards to IOTA stakers expecting Assembly tokens. Since there are no Assembly tokens to give, and we’ve already discussed that the only fair thing to do is to offer IOTA stakers something, why not give them tokens of the network that will replace Assembly, namely IOTA?
  2. Offer IOTA tokens to the partners that Assembly had procured. These partners had already pledged funding to support the development of a new smart contract network in the IOTA ecosystem. Does it really matter that this ‘new’ network is actually an old, O.G. network getting some shiny new upgrades? And no need to be concerned about stability or security, all upgrades can be tested on the existing sister network, Shimmer. Offering these partners IOTA tokens keeps them in our ecosystem and helps to further bootstrap the new and improved IOTA.
  3. Establish a proper war chest for the IOTA Foundation. This will allow them to further fund their research and innovation, helping to maintain the cutting-edge tech needed for tomorrow’s use cases. I’m talking ZK Rollups, sharding, etc.
  4. Establish the funding needed for a dedicated Ecosystem Fund. Let’s really get the word out about IOTA. Let’s reward our content creators who tirelessly attempt to promote the protocol, for little more than love of the tech. Let’s give IOTA the chance to succeed that it never had.

The IOTA Foundation is hoping that this inflation will have a limited effect on the price of the token, all other things being equal. This is because the newly minted tokens won’t be dumped on the market, but will be distributed to stakers over a period of 2 years and also be held in the IF’s war chest. But some people will not like this inflationary model and may sell, and some tokens will need to be sold to support the IF’s mission. In the grand scheme of things, 12% inflation per year is not terrible if it’s partially counteracted by airdropped tokens and the resulting war chest increases the value of the network substantially from an outsider’s point of view. The ecosystem fund will bring many new opportunities, and this will help to take some of the sting out of the inflation.

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Let’s be clear: even if the dilution does not result in a clear drop in price, minting new tokens at a rate of 12% per year will reduce our personal ownership stake in the protocol. By decreasing our personal allocation of the total amount of IOTA tokens, this effectively reduces our individual access to blockspace, even at constant IOTA price.

You must ask yourself: can the IF leverage the 12% inflation to generate even more value through strategic investments? This is key to deciding if you can live with the decision.

Moving from 2.78 Billion tokens today to 4.6 Billion tokens in 4 years will mean that your total percentage ownership of the protocol today would decrease by 40% in 4 years, not including your airdrop in place of Assembly tokens. This is just the hard truth of the matter. But let’s look at the math to see how the IOTA airdrop could counteract the 12% inflation.

I’ve already shown in the previous Assembly chart that 12.29 Billion ASMB tokens have been promised. But these numbers were taken from the Assembly Twitter announcements for each staking period, and apparently aren’t 100% correct. Reading through the recent blog post, the IF states that 12.38 Billion ASMB tokens are due, so let’s use this more accurate number. As you can see above, 161M IOTA tokens have been allocated to compensate these stakers. [Note that 1 IOTA after the hard fork will be equal to what we previously called 1 MIOTA.] This tells us that we will receive 0.0130 IOTAs (new notation) for every ASMB we have earned through Firefly. Simply open your Firefly wallet or input your address in the list found here to check for your total ASMB rewards and multiply this number by 0.013 to see how many IOTAs you will receive in the airdrop.

It’s also important to note that 10% of the total IOTAs to which you are entitled will be airdropped and unlocked immediately. The other 90% of your IOTA tokens will airdropped bi-weekly over a period of 2 years.

The following is a bit of personal observation to give you all a bigger picture of the impact of these airdropped tokens. I had an amount locked up in cold storage, collecting ASMB since the beginning. The math for me worked out as follows:

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If we consider that there will be a 40% decrease in our individual ownership stake in the network over the next 2 years, and if you had staked a constant amount of IOTA tokens over the entire staking period, you would likely experience ~35% decrease in ownership stake after the airdrop has completed rather than the full 40%.

Criticisms

Just because I can understand the reasons that the IF made the decisions it has, doesn’t mean I am in complete agreement with the way that these decisions are implemented. My biggest criticism of this entire process is the way that the IOTA Foundation announced it in such a unilateral, this-is-how-it’s-going-to-be manner. I understand that there are a few reasons that the IF decided not to solicit community feedback: 1) it would take many months to utilize the governance framework to approve these measures, which the IF didn’t believe they had, 2) the IF truly believes that this is the ONLY way forward, and if these measures aren’t enacted the IF will need to close their doors, and 3) Dom himself has said recently that community governance and DAOs are still in their infancy, and one token, one vote is not fair for this type of decision, since whales would have outsized influence.

Regarding point 1), I would argue that the IF could have solicited community feedback if they really have been discussing this internally for as long as they say they have been. In a way it feels like the IF doesn’t trust the community to make decisions that are in the best interest of the protocol. But I think we would surprise them if given the chance. Why have we been developing this governance framework anyway? If our goal is to develop a truly fair, decentralized protocol, the IF must relinquish control and let the community take the reins. I believe that we all want this protocol to succeed, and we will do what’s necessary to help make that happen. If it came down to a Firefly vote that barely passed, I think the community would accept that, even a good number of those that would have voted against it. And if the vote failed, I think the community would have come forward to propose other creative ideas to solve the problems at hand.

Regarding point 2), this feels like the IOTA Foundation is acting to preserve their existence at all costs. And while I would fully agree that we need the IF to continue research and development on the network even after IOTA 2.0 (ZK rollups, sharding, etc.), I also question the amounts of inflation and the entities that are being formed. Do we really need so much for the UAE Foundation? And these Ecosystem / Contributor Funds feel like money is being taken from the community, only to slowly give it back to those who are willing to contribute. And while I am a longtime contributor and hope to be able to recoup some of those funds through future contributions, not everyone can or will contribute, so it still doesn’t feel quite right.

Regarding point 3), yes, DAOs may have a long way to go, but I personally don’t think they have “failed”. The governance structure that we have developed for use with the Shimmer Treasury is sheer proof of that. One could even argue that one token, one vote might be appropriate for just this situation, because whales will lose more access to the network after the token inflation than small holders, so it might actually make sense here. And even if the community doesn’t agree that one token, one vote is fair in this case, this isn’t the only voting mechanism. How about quadratic voting or some other creative mechanism?

There is also one last piece of criticism I’ll share. The way I understand it, some of the newly-minted tokens will be made available to institutional and accredited investors at a nice discount. It seems that they will be able to buy these tokens at 20–30% less than market prices at that time. And while this practice is somewhat common in the investing world, it doesn’t seem right that this discount would apply to newly-minted tokens. Perhaps we should assemble like-minded community members who are willing to offer funds to a multi-sig wallet so that we can form a community institutional entity, to buy tokens at discount to recoup some of the dilution we are facing. I’d be interested in forming such an entity, and I know several others who would be as well …

For even further discussion about criticisms against these actions by the IF, I would recommend the following very well-articulated and thoughtful piece by IOTA co-founder David Sønstebø: Can lightning serve as a silver lining?

Wrapping It All Up

Listen, I get it, inflation is hard to take. IOTA has already felt like the black sheep of the crypto community for years. And now there may be more pain ahead. But to be fair, I’m no soothsayer. Strange things happen in the market, and maybe this is just the type of news that will entice large outside entities to invest in the protocol, seeing the new opportunities that these plans enable. I’ve definitely seen stranger things happen in terms of price action with IOTA in the many years I’ve been here. I would have expected a sharp reaction in the IOTA price already, and instead there has been a dump in Shimmer while IOTA has remained more stable. Who would have guessed?

Let’s face it: this is make-or-break time. Either this works, and we wind up back in the top 10 on CMC where we belong, or it’s over. At least we’ll know one way or the other and we gave it our best shot. I’m going to stick around for the ride, if for nothing other than principle alone. The virtues of feeless crypto transactions make too much sense for me to be able to fully support another crypto network while IOTA has a chance.

At the same time, there are many exciting opportunities on the horizon that were never possible before. The implications of Layer 1 smart contracts on a feeless DAG are truly breathtaking — this is what we really need for EBSI, complete Digital Identity, DeFi, etc. Demand will begin building for the IOTA token as well as Mana. The IF will have the war chest they have always needed to properly compete in this market. If they have accomplished what they have over the years on a shoestring budget, imagine what they will be able to do with this scale of funding! And the entire ecosystem will get a boost as well, so that those who want to contribute to the success of the protocol can be properly compensated for doing so.

Despite the relatively harsh way that the IOTA Foundation’s plans have initially come across, I hope I have shown above that the steps they have proposed are a natural, logical progression from the first realization that smart contracts could be deployed on the Tangle. There really isn’t a better solution that I can see, I just wish that these plans had been accomplished through more community involvement. As a community we need to rise up and become more involved in the decisions that shape the future of IOTA, anf the IF needs to welcome this. I hope you agree and decide to stand firm as we hold on for the ride. It’s gonna be a wild one.