Tokenomics 101: Qredo

Not your keys, not your coins, describes the fact that if you don’t own the private keys to your wallet, the coins you own, are not really yours either. It’s a scary statement, but it’s true. If something happens to the exchange holding the private keys to your coins, you might lose your coins. This is important for anyone. Nobody wants to lose money. 

On the other side, there are a bunch of stories, where people have lost access to their wallets by losing their keys. A large risk not only for individuals but also for funds holding billions of dollars in tokens. Understandably, large funds would like to pass the management of that risk to a centralized authority like coinbase custody.

It’s a dilemma; hold your own keys and risk losing them but don’t rely on an institution OR put your funds in custody and trust an institution and don’t worry about keys.

Qredo tries to solve this problem with decentralized custody (more on how this works later). But to really compete with a centralized exchange like Coinbase, Qredo needs to offer more than just custody options. Institutions also want to have a place to exchange tokens.

The vast ecosystem of blockchains and tokens complicates fund operations in a decentralised setting. Centralised exchanges easily solve this problem by holding many different tokens and allowing trading of them on a database, only settling to the blockchain when funds are withdrawn. 

Doing this decentralised is much more complicated, but decentralised custody, synthetic assets and a blockchain to keep track of token ownership offers a way of providing exchange services for institutions. With this Qredo positions itself somewhere at the cross section between Thorchain (a cross-chain exchange - I wrote about it here) and Fireblocks (an MPC custody service):

Qredo basics

Qredo’s own words, ‘the network is the vault’, describe best what they aim to achieve.

Broken down from from the official website there are three main components:

Blockchain interoperability. The problem with exchanging tokens across multiple blockchains is something Qredo approaches in a similar way to how centralised exchanges do this. Just decentralised. A layer 2 proof of stake blockchain is used to record ownership of tokens from various layer 1 blockchains. The assets are represented by a synthetic version that is backed by the real token. BTC becomes qBTC. This enables trading of tokens among Qredo users and Qredo market makers without immediate settlement on the layer 1 blockchain. Like a centralised exchange a user only actually receives tokens into his own wallet when withdrawing the tokens from the exchange. 

The ownership of tokens here is secured by Qredo’s blockchain. The terminology of layer 2 can be a bit confusing as it’s not like an Ethereum layer 2, which uses the consensus of the layer 1 blockchain. Qredo has its own consensus mechanism, so technically it’s more like a sidechain. 

Lightning-fast settlement. Synthetic assets are mirrored versions of the actual assets owned on layer 1. To transfer the synthetic assets only a transaction on Qredo’s layer 2 blockchain is required, enabling much faster and cheaper trading. 

Secure decentralized custody. To enable institutions to self custody tokens on layer 1 generally requires some kind of multi-sig arrangement, where multiple users own a key required to sign a transaction and a majority vote of keys (e.g., 3 out of 5) is needed to sign a transaction. This adds the risk of users losing their keys.

Qredo utilizes multi party computation (MPC), which uses advanced cryptography to distribute parts of a key among different nodes. Meaning no one party actually has ownership of the full key. Only the combination of all parties will enable usage of the full key to sign a transaction of layer 1 assets.

Qredo combines MPC with the consensus mechanism of its own blockchain (read about the details here). The diagram below describes how multiple users initiate a transaction of a layer 1 asset like bitcoin and how this transaction gets executed by MPC.

1. Users sign up to Qredo and form groups to jointly manage wallets. Every user owns a Qredo private key and can sign Qredo transactions.

2. The Qredo layer 2 blockchain tracks the asset ownership of wallets. Wallets can hold tokens from different chains.

3. A transaction is initiated by a majority of users of a wallet signing the transaction.

4. The MPC nodes then validate the asset ownership as recorded on layer 2.

5. MPC nodes jointly sign the transaction to execute the transfer of assets on layer 1.

MPC is required when transferring assets on layer 1 adding decentralised security to the process. Transfers of assets can also be executed synthetically on layer 2 relying on the consensus of the Qredo layer 2 blockchain without settling on layer 1.

Qredo token

Qredo has four main users playing a role in tokenomics (there are two more, but they don’t seem to play a major role at the moment). Custody users, traders, market makers and validators. An interactive, fullscreen version of the diagram can be found here.

Qredo Protocol

• Qredo has a token $QRDO with a supply of 2 billion, distributed as follows:

• The first 1 billion is issued (partially vested) over the course of two years. A second billion $QRDO tokens will be distributed to network users via inflation over a runtime of 50 years to incentivise network usage.

• The MPC concept described above allows the protocol to safely hold custody of assets in layer 1 wallets. The assets are represented by synthetic versions on the Qredo layer 2 blockchain to keep track of who owns what.

• Transitioning to completely DAO based governance is planned. The DAO decides on the inflation distribution.

• The toolset based on the Qredo platform allows users to create accounts, connect with peers, create wallets for funds and form groups governing the funds.

• The Qredo protocol generally collects fees in layer assets and keeps them in dedicated wallets. Once a sufficient amount has accumulated, the protocol issues an RFQ (request for quotation) to all market makers to exchange the layer tokens for $QRDO tokens. The $QRDO tokens are then distributed as follows:

Custody User

• Custody users are the most basic function of Qredo. They typically hold layer 1 assets in a wallet protected by MPC. Wallets can be combined into funds which can be governed by multiple custody users to enable an additional level of protection.

• A monthly fee is paid by custody users in the layer 1 tokens they hold. The fee amounts to 0.75 basis points or 0.0075% and is stored in different protocol wallets until it is exchanged for $QRDO tokens.

• To incentivise custody users, protocol inflation distributes fresh tokens based on the amount of assets held in custody.

• Qredo currently supports BTC, ETH and a bunch of ERC20 tokens. It is planned to support more tokens going forward.

Trader

• A user holding tokens can aso trade them within Qredo. Trades can be executed via atomic swaps among trusted peers or with a market maker. Atomic swaps are a bit confusing here as they do not refer to the normal layer 1 to layer 1 atomic swap, but a swap synthetic assets.

• Traders pay a fee in layer 1 tokens of 0.5 basis points or 0.005% and might receive a cashback based on protocol inflation rewards.

Market maker

• Market makers enable trading, provide liquidity and don’t pay any fees.

• Market makers can charge their own fees for premium services they might provide.

• To become a market maker a minimum amount of assets needs to be deposited into a wallet and $QRDO tokens need to be staked.

• The protocol will issue an RFQ to all market makers to convert its layer 1 assets collected from fees into $QRDO tokens. The market maker winning the RFQ, gets to keep 20% of layer 1 tokens of the trade.

• Protocol inflation rewards market makers based on their transaction volume.

Validator

• Validators of the layer 2 Qredo delegated proof of stake blockchain need to stake $QRDO and are rewarded by ~80% of the collected fees from Qredo.

• Protocol inflation adds an additional reward based on the % staked.

User centric tokenomics

Qredo is taking a different approach to tokenomics than most layer 1 blockchains, where only miners / validators are rewarded for network participation. The protocol wants to incentivise network participants by rewarding all users via inflation rewards. The slow and steady distribution over the course of 50 years will help incentivising users of Qredo, but will also slowly introduce new tokens, potentially diluting the price of the token. 50 years however is a very long time frame and a good change to the usually much quicker issuance of new tokens other protocols pursue.

The main demand for tokens, aside from speculation and general value capture of the protocol, comes from market makers and validators who are required to stake $QRDO. Increasing amount usage and adoption on the platform will increase the amount staked and the amount held by the treasury. Once the protocol is fully decentralised, the treasury will presumably be used to fund new developments and improve the protocol.

Closing thoughts

The intersection of cross-chain exchanges and decentralised custody could be just what institutional investors or investments DAOs are waiting for. At least the ones that care about decentralisation. MPC is a concept that has been around for a while and others already offer similar services, but the combination with a blockchain to record asset ownership seems unique.

While Bitcoin and Ethereum are a good start, Qredo needs to support a greater variety of tokens to become really attractive for institutions. Partnering with exchanges could be one part of the solution here. The recent announcement of using Qredo as a custodian within Metamask Institutional is a good first step, giving users decentralized custody while having access to DeFi applications. While this doesn’t immediately add support for new tokens, Qredo is planning to build out support for more layer chains.

The project is still very early, the discord server kind of quiet, many of the features, like full decentralisation are still being worked on and the documentation can be a bit confusing. Nevertheless, this is a project with great potential and I’m excited to see how the tokenomics pan out with greater adoption.

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This post does not contain financial advice, only educational information. By reading this article, you agree and affirm the above, as well as that you are not being solicited to make a financial decision, and that you in no way are receiving any fiduciary projection, promise, or tacit inference of your ability to achieve financial gains.