Subnets Potential for Banks & Institutions

Application-specific blockchains (ASBCs) are quickly increasing in popularity. From Cosmos’ ASB Hubs, to Polkadot’s Parachains, there is an ever growing demand for a project to build on an ASBC. Even ecosystems such as BNB Chain,Polygon, and Optimism are developing their own ASBC versions. And while many of these ASBCs offer teams and projects unique features, customizations, and flexibility, Avalanche’s subnetworks (subnets) are primed for massive adoption from traditional finance (TradFi) institutions.

A brief overview of subnets is required before we can delineate the reasons as to why subnets are uniquely fitted for TradFi institutions.

What are Subnets?

According to Ava Labs’ own Developer Documentation1;

“A Subnet is a sovereign network which defines its own rules regarding its membership and token economics. It is composed of a dynamic [set] of Avalanche validators working together to achieve consensus on the state of one or more blockchains. Each blockchain is validated by exactly one Subnet, and a Subnet can have many blockchains. A validator may be a member of many Subnets.”

Sovereignty

Subnets are sovereign networks, meaning they are independent from Avalanche’s other chains (Exchange Chain (X-Chain; Primary Network), Platform Chain (P-Chain), and Contract Chain (C-Chain)). Subnets have their own execution logic, determine their own fee regime, maintain their own state, facilitate their own networking, and provide their own security. They do not share execution threads, storage, or networking with other Subnets including the Primary Network, effectively allowing the network to scale up easily while enabling lower latency, higher transactions per second (TPS), and typically lower transaction costs.

This means that should the Avalanche Primary Network were to ever go down, so long as their validators continue to be active, subnets would be completely immune from this and would continue to function.

Independent tokenomics

As part of their sovereignty, projects on a subnet are also able to create their own independent tokenomics. This means a project’s native token(s), including their own governance token, can be circulated within its own ecosystem. Moreover, projects have the added flexibility to set customized use-cases for their native tokens, including the token that users will use as gas to pay for transactions, the emission rate, and supply.

Consensus Mechanism

Projects will also have the responsibility to set up their own consensus mechanism. Moreover, the mechanism is not confined to a type of Proof-of-Stake (PoS) consensus; even a Proof-of-Work (PoW) consensus could be implemented, depending on a project’s requirements.

Securing a Subnet

Subnets are relatively easy to create and deploy.

Unlike in Cosmos, projects on subnets have readily available validators and resources they can easily bootstrap into their network. Subnets can only bootstrap validators who are already staked on and securing Avalanche’s X-Chain. Projects that wish to bootstrap their own nodes will still have to meet the validator requirements of staking at least 2,000 AVAX on the X-Chain, as well as have the necessary hardware requirements to establish their validator nodes.

Although Avalanche validators can be incentivized by subnet owners to validate their subnet, they are not required to do so.

Additionally, unlike in Polkadot, projects on subnets have the customization feature to set up conditions and requirements for validators to meet before they can join their network2.

On October 18, 2022 Avalanche successfully activated its much anticipated Banff upgrade3. This upgrade now allows subnet owners to activate their own PoS validation and uptime-based rewards using their own token on their own subnet, thus enabling them to become Elastic Subnets.

Permissionless vs Permissioned Networks

Before proceeding, we must first briefly define what these terms mean.

A permissionless or open network is a network in which anyone can interact and participate. Although a permissionless network can typically be decentralized, that is not always the case4. Participants of permissionless networks tend to be largely anonymous as there are no requirements to release personal information. This also allows permissionless networks to be typically public. This means that any person or group can view a network’s transactions and information about its activities, making it transparent.

By contrast, a permissioned network is one where the entry is restricted to certain individuals or groups. They can also be decentralized, although they are often less so than permissionless ones due to the increased requirements and restrictions on participation. Furthermore, the identity of participants in the permissioned network are typically not kept hidden. KYC/AML procedures are often a requirement for individuals to go through before being allowed to interact with a network. Permissioned networks are typically private, whereby transactions and content are kept private from public view or at the very least, allow only a certain group of people to view them5.

Due to the unique customizability of subnets, subnets can be set up to be permissioned or permissionless, public, or private. As mentioned, subnet owners can establish predefined conditions and requirements for validators to meet before securing its network. These same conditions and requirements can be set up for users as well, including passing KYC/AMC checks, revealing the location of residence, or holding a certain license, among others.

Scalability

As subnets are structured to be easily scalable and live solely in their own network, subnet owners do not need to worry about network congestion. This creates space for a project or TradFi institution to be easily scalable without having to compete with other dApps for resources and securing their transactions.

How Financial Institutions can benefit using Subnets

On March 8, 2022, Avalanche launched an up to $290 million incentive program to accelerate growth on subnets6. This incentive program was not just aimed at decentralized applications (dApps), but also at institutions for the massive adoption of DeFi.

Ava Labs is collaborating with Aave Companies, Golden Tree Asset Management, Wintermute, Jump Crypto, Valkyrie, Securitize and others to build the first horizontally-integrated blockchain. Upon launch, Ava Labs will help regulated TradFi institutions to leverage the power of subnets to access DeFi primitives at a much larger scale, but with native KYC functionality to ensure regulatory compliance.

Apart from this large incentive program and developing infrastructure, there are a number of benefits for TradFi institutions to build on a subnet.

Subnets enable anyone to easily create powerful, reliable, and secure permissioned or permissionless networks with custom implementations. This includes features not available on other chains, like selecting which validators secure their Subnet activity, which token is used for gas fees, custom economic models and consensus mechanisms, and more.

Crucially, subnets remain natively integrated with the broader Avalanche ecosystem, do not compete with other projects for network resources, and are available in an unlimited supply. This empowers Web3 applications to customize their subnet based on user experience as they never had before.

With subnets, TradFi institutions can fully customize their own sovereign Avalanche blockchain to their application’s needs and build DeFi products scalable to millions of users. Crucially, the variety of network types, from fully permissionless to permissioned, subnets can enable these institutions to encode who can access the subnet, who secures it, and various other regulatory mandates so compliance is natively built into its very foundation, all while allowing heavily regulated institutions to participate fully in DeFi.

Moreover, because subnets have a low cost, are easy to deploy, have a relatively high throughput, and the ability to be isolated from other networks, including the Primary Network, they are the perfect infrastructure for any TradFi institution to build and customize their subnet in a way that meets their regulatory requirements.

In addition, given TradFi’s recent loss of trust and reputation, subnets could prove to be a valuable structural tool to help them regain trust through transparency. For example, an institution can choose to set up their subnet to be public, allowing any person to visually see and track all of its transactions. By having a publicly viewable blockchain, TradFi institutions can be more transparent about their ecosystem. Another more concrete example would be for TradFi institutions to ensure any tokens created on their subnet passes the Howey Test as defined by the American Supreme Court and Securities and Exchange Commission (SEC).

Finally, subnets allow TradFi institutions to create their own token and tokenomics, specifically designed to be regulatory compliant. This ensures that any minted token within their ecosystem will meet local securities law and can allow regulatory bodies to properly assess it and its tokenomics.

Although there has yet to be any formal announcements by TradFi institutions indicating their intention of building on a subnet, several have already formed strategic partnerships with Ava Labs and have begun to leverage Avalanche’s security, high transaction speed and eco-friendliness. Such well known names are Deloitte, Lemonade and Togg7.

Due to the customizable, flexible technology behind subnets, they are uniquely positioned to onboard and support TradFi institutions’ needs, products, services and regulatory requirements. Moreover, Ava Labs and the Avalanche ecosystem as a whole is prepared to not only offer them the tools and resources, but also an incentive program to assist in the transition of TradFi institutions to subnets, helping them meet their goals to integrate into DeFi on-chain.

Sources:

  1. https://docs.avax.network/subnets
  2. Ibid.
  3. https://medium.com/avalancheavax/banff-elastic-subnets-44042f41e34c
  4. https://www.techtarget.com/searchcio/tip/Permissioned-vs-permissionless-blockchains-Key-differences
  5. https://www.e-zigurat.com/innovation-school/blog/public-vs-private-blockchain-whats-the-difference/
  6. https://medium.com/avalancheavax/avalanche-foundation-launches-multiverse-an-up-to-290m-incentive-program-to-accelerate-growth-of-c815ac5692c7
  7. https://medium.com/avalancheavax/institutions-are-building-the-future-with-avalanche-4daf8062ad1

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Decentralized staking protocol building for Avalanche Subnets.