Below is the full report by Messari Research on Harmony’s token economics and ecosystem. It covers the scalability of its sharding protocol, the security of its cross-chain bridges, and the innovation of its keyless wallets.

By Rasheed Saleuddin

The following report was written by Messari Hub Analyst(s) and commissioned by Harmony, a member of Messari Hub. For additional information, please see the disclaimers following the article. [The report is inlined in full below with permission from Messari.]

Ethereum fees are once again out of control but, unlike previous spikes, there are now many alternative chains ready and willing to pick up the priced-out traffic coming from the dominant DeFi and NFT chain.

With much lower fees and faster transaction times, Solana and Terra have grown the quickest, outpacing the earlier challenger, Binance Smart Chain. All three have eaten into Ethereum’s market share since the beginning of 2021.

It’s also, finally, a belated Layer 2 summer. Optimistic rollup platforms and DApp-specific ZK rollups offer lower fees while inheriting Ethereum’s security. It’s too early to tell how successful layer 2s will become, but there is every reason to believe that many low-value, high-frequency transactions currently uneconomic on Ethereum mainnet could migrate to rollup scaling solutions. Currently, about $2.5 billion in value is locked in Ethereum scaling solutions. While this is only a small fraction of the value locked in Ethereum’s mainnet, L2 TVL has grown 3x in one month.

Source: l2beat.com

Judging from the growing value locked in the challenger chains, the recent rally in L1s appears rational: Ethereum will end up ceding market share, no matter how successful its L2 scaling solutions are. Ethereum dominance in DeFi is now two-thirds, down from 100% a year ago.

Messari’s recent Mainnet conference marked the mass adoption of the multi-chain view of crypto, with Do Kwon stating: "Maybe it's a bad idea to stick all the applications into one global computer. Maybe it just makes sense to have a multi-chain future."

As the multi-chain future becomes the present, the narrative is shifting towards determining who the winners will be. By measuring the ratio of TVL to a project’s market cap, we can begin to see which platforms the market expects to grow next. With a 4,000+ % increase YTD in price with minimal TVL locked, it’s clear that the market is expecting serious development from the Harmony network.

Harmony is the latest EVM-compatible smart contract platform to play the liquidity incentive game that proved very effective for Polygon and, more recently, Avalanche in their quest to attract both developers and users. Even with incentives, it won’t be easy for new L1s to challenge Ethereum and the two other leading DeFi chains, Terra and Solana. Fantom has now entered the fray, with $600 million in incentives, while Ethereum’s L2 scaling solutions are also coming online.

Harmony’s ONE token has been one of the best performers among the smart contract platforms over the last year, gaining roughly 4,285% year to date in dollar terms. Despite its appreciation, and having a complete L1 platform, its ecosystem is still in development. A recently announced rewards program in which Harmony will be spending $300 million from its treasury is intended for developers to build on its platform and bolster its emerging ecosystem.

The question still remains: if they build it, will users come? That is, in a multi-chain world how will a challenger L1 stand out? There are two likely possibilities: (1) a platform provides technological improvements and/or (2) focuses ecosystem development on one (or more) underserved communities. Harmony claims to have both.

Harmony was founded in 2018 by Stephen Tse and launched in 2019 as an EVM-compatible, sharded Proof of Stake smart contract blockchain. Harmony’s Fast Byzantine Fault Tolerant (FBFT) consensus protocol, combined with random state sharding and Boneh–Lynn–Shacham (BLS) constant-sized signatures allows Harmony to achieve finality in one block or roughly two seconds – compared to optimisitic finality in Solana or Avalanche, or 6 seconds for Cosmos, or 60 seconds for Polkadot. A normal transfer costs only about 0.000021 ONE. Harmony was the first sharding-based L1 on a mainnet. It has solved the trilemma of decentralization-security-scalability by uniformly scaling with shards.

A sharded blockchain requires a large number of validators. To motivate the delegation of stakes across a larger number of validators, Harmony uses a novel Effective Proof of Stake (EPoS) mechanism. In many blockchains, the right to propose and confirm blocks is randomly determined but weighted by the amount staked (e.g. Cosmos) or by delegating to elected validators (EOS). Harmony’s EPoS is based on the amount staked (the first option) for each epoch (~ 1 day), but block rewards are based on the median staked by all validators. This discourages an over-concentration of tokens with any one node or group of nodes, increasing decentralization and preventing single-shard attack.

Sharding allows transactions to be confirmed in parallel, accelerating transaction validation speeds. Harmony’s random state sharding exists in three dimensions: state, network and transaction. Sharding requires a method of assigning nodes to different shards. There are currently four shards live on Harmony’s mainnet. Though nodes can be assigned randomly, sorted by location, or centrally selected, random sharding has been recognized as the most secure solution.

Harmony’s distributed randomness protocol (DRG) incorporates both a Verifiable Random Function (VRF), based on the validator’s private key (as in Algorand), and a Verifiable Delay Function (VDF) that delays the revelation of the randomness. This means that a malicious block proposer cannot know in advance what the random number will be, and therefore can’t propose a malicious block. The final result is unbiasable and unpredictable shard membership. VRF is also provided as an on-chain precompile providing true randomness to any dApp on Harmony.

The network is currently secured by 122 independent validators with 1,000 slots staking 4.7 billion ONE, worth close to $1 billion. The validator network runs 800 nodes across four shards. Staked tokens are locked for 7 epochs (~ 5.25 days). Harmony punishes undesired validator behavior in two ways. For validators that sign on conflicting blocks, a slashing penalty is issued on their stake. The validator is then permanently banned from the network. At the end of each epoch, validators that were unavailable for over 1/3rd of the time are considered “Inactive” and are ruled out from the next election. This helps to remove stale validators from clogging the network.

As with other L1s, Harmony’s native ONE token is used:

Annual issuance is set at 441 million ONE tokens, declining to zero over time, offering predictable and simple tokenomics for holders.

What sets Harmony apart from many other layer 1s is that all ONE tokens earned through transaction fees are burnt. High network usage should lead to zero token inflation. Like with EIP-1559, issue-and-burn tokenomics rewards a growing network by reducing inflation thereby increasing the intrinsic value of the ONE token.

Delegated tokens currently earn about 10% after fees based on the current staking ratio. This is in the mid-range of staking returns among competing L1s. With consistent returns and predictable inflation that declines as network usage increases, staking is popular, with 42% of outstanding ONE staked.

The next way Harmony differentiates itself from other L1s is with its native bridge - a key requirement for a multi-chain world.

Source: 1kx

Many access points to non-Ethereum layer 1s are fraught with difficulty – assets are easily lost, and fees can skyrocket quickly with less fatal errors. Additionally, some bridges are far from trustless. Polygon’s, for example, is controlled by a 3-of-5 multisig. Three unidentified powers can seize assets very easily. Avalanche also relies on a multi-sig for transfer back to Ethereum. Four “trusted” wardens have complete control over bridged assets.

Harmony’s Horizon bridge currently transfers assets to Ethereum and BSC, while Terra’s shuttle bridge has already transferred over $1 million UST. A Polkadot bridge is on testnet, and it is quite easy to adapt the bridge to other EVM-compatible chains. The Ethereum bridge has been running for a year, with a full audit and no security issues. Though the current bridge uses trusted validators, Harmony’s upcoming upgraded bridge is both gas-efficient and trustless: Smart contracts that exist both on Ethereum (or BSC) and Harmony are the only custodians of each chain’s respective native asset.

On Harmony’s end of the bridge, costs are near zero, so the BSC bridge fees are overall very low. On the Ethereum side, bridging to Harmony costs approximately 100,000 gas: around $20 at 65 gwei. A return to Ethereum requires multi-sig confirmation by Harmony validators, at an approximate cost of 400,000 gas. Finality back to Ethereum is achieved within 6 minutes, comparing favorably to L2s and side chains.

Source: Harmony’s Technical Overview

The ease of bridging has attracted an influx of assets to Harmony. The bridge has locked almost $1 billion in ERC-20 token volume to date.

Wrapped Bitcoin and stablecoins dominate the bridged assets:

Once bridged, what will users find on Harmony, now and in the future?

Like all L1s, Harmony has a complete ecosystem planned. Early priorities include:

The focus continues to be on wallets and bridging, but now both native and cross-chain dapps are beginning to emerge. EVM-compatibility is a key competitive advantage for Harmony; to migrate a DApp from Ethereum to Harmony, only minor code edits are required and all the infrastructure and support tooling needed to deploy an Ethereum DApp is readily available.

The tools are there, now. When dapps such as SushiSwap land on Harmony, they find:

1. Subgraphs for analytics

2. Gnosis multi-sig for rewarder contracts

3. Horizon to bridge initial liquidity

4. An Etherscan-like explorer

5. Metamask, web3.js, ether.js support

Source: Harmony Newsletter

Decentralized Finance

For now, SushiSwap is the dominant DEX on Harmony (82% of total DeFI TVL), followed by DeFi Kingdoms. Harmony is Sushiswap’s third largest chain as measured by TVL, and this with very little incentives or marketing.

The chain has yet to host a dominant money market or yield farm protocol, with three DEXs in the top 5 DeFi dapps, and yield aggregator Beefy Finance at only $2 million TVL:

Source: DeFi Llama

Incentives will drive new deployments. Cross-chain dapps such as Curve and Aave are approved and arriving soon.

Metaverse/NFTs

Harmony’s metaverse is also growing. NFTs can be minted and traded on daVinci. High gas fees on Ethereum are driving artists and minters to lower-cost chains. The mid-September spike has also driven many artists to Harmony. According to the platform, several hundred artists switched to daVinci over the seven days ending September 15th. Almost 500 creators joined, bringing the total on daVinci to over 5,000.

DeFi Kingdoms is a game, DEX, liquidity pool, and marketplace for NFTs, with a front-end resembling old school fantasy pixel art. It’s already live with $1-2 million in daily volume, and is the second highest valued project on Harmony.

It’s projects like these that have the potential to help Harmony stand out from the crowd.

Source: DeFi Kingdoms

Liquidity

The challenge for every chain is to attract users, and that requires a critical mass of liquidity. Developers will build where the users are. This chicken-and-egg problem can be addressed by partnering with liquidity providers ahead of launches. Hashkey Capital, for example, has committed to provide $10 million in funds to bootstrap DeFi and NFT liquidity.

Oracles

Price provider and random number generator Chainlink is expected to be live on Harmony imminently.

Harmony’s mobile 1Wallet is intended to make interacting with the chain feel more like a mobile Web2 experience. Mobile wallets that don’t require crypto-native levels of knowledge are needed for blockchains to go mainstream, especially in Asia, and China in particular, where users are already accustomed to a simplified mobile wallet experience.

Instead of seed phrases, Harmony’s 1Wallet uses Google Authenticator, and backup access is obtained through social recovery. Based on a close collaboration and the research paper SmartOTP, 1Wallet advances smart contract wallets beyond Argent and Loopring. In particular, 1Wallet does not require secure enclave hardware or linking with your email identity. Of course, users can also transact with traditional wallets, including MetaMask and Gnosis Safe, easily with Harmony. 1Wallet is a smart contract based wallet with upgradability.

Fiat onboarding is another key to mainstreaming crypto adoption. Harmony is focused on connecting to existing FinTechs and TradFi businesses, especially in Asia and Africa. NowPayments allows users to transact in the real world with ONE, while Crypto Bank Africa converts ONE to spot fiat currencies. Crypto can be used as a store of value on-chain in countries with weak currencies, but can be easily converted to the local means of payment when actually needed.

While it will be a multi chain world, how will the challengers differentiate? How many SushiSwaps and Curve clones does crypto need? How many NFT marketplaces?

Recent history has revealed a few key requirements for on-chain L1 growth:

Harmony may not have the big-name sponsors of Solana and BSC, but it does tick the other three boxes. Of course Harmony is EVM compatible and its bridging is seamless and is transitioning towards a trustless nature. Incentives have arrived as well.

Ever since Polygon used incentives to grow its TVL from near zero at year end to $12 billion just six months later, native token reward programs have been popular with competing smart contract platforms. Rewards can go to users, developers, and validators. Some chains use a combination of incentives: Polygon has used MATIC to entice users, compensate validators, purchase rivals (Hermez) and incentivize developers. Lately the focus has been on incentivizing ecosystem development: Fantom, Celo and Near together are providing almost $2 billion for developers to build on their respective platforms. Avalanche, on the other hand, has focused on onboarding DeFi users, to the tune of $180 million.

For now, incentives appear to have motivated TVL increases on layer 1 challengers Avalanche and Fantom, while L2s, primarily Arbitrum, have grown exponentially over the past month without any native incentives.

Harmony recently launched its own grants and bounties program to build out an ecosystem.

Source: Harmony's Open Development – Budgets & Allocations

Of the $300 million set to be spent over four years, Harmony will fund 100 DAOs with up to $50 million and improve tooling and target bug fixes with another $30 million. Recently announced, Curve has deployed on Harmony, and the launch will be bootstrapped by Harmony with a $2 million incentive program.

Recognizing the importance of seamless bridging and transacting, $20 million in grants are focused on improving the 1Wallet UX. NFT platforms and DeFi protocols, new and old (e.g. Curve), will also be prioritized. Finally, Web2 and fiat onboarding partnerships will also receive funding. As its DApp ecosystem grows, Harmony has plans to improve developer and user experiences in the medium term.

Using its incentives warchest, Harmony is focusing on the following targets for the next six months:

Source: Harmony

Onboarding - 20% Yields and Cross-Chain Partnerships

In a multi-chain world, cross chain partnerships will be crucial, and Harmony has partnered with one of the most successful challengers, Terra. The two L1s will cooperate on hackathons and developer support to bring Terra’s DeFi infrastructure to Harmony. Terra and Harmony have agreed to accommodate Terra’s UST as Harmony’s native stablecoin accessed through the Terra bridge and enabling Anchor-type yields of 18-20% in the ONEAnchor borrowing and lending protocol. This yield will be accessible directly in 1Wallet.

Onboarding - Enhanced and Additional Bridging

A native Bitcoin bridge and further refinements to the trustless Ethereum bridge are due in Q4 2021. Terra and Polkadot bridges are in testnet. A Cosmos bridge, a version of the Ethereum-Cosmos Gravity Bridge, is expected in Q1 2022.

Harmony is also working to incorporate cross-chain bridges for NFTs as well as allowing them to be self-custodied in 1Wallet.

A Bitcoin bridge is also on testnet. Harmony is adopting Interlay’s BTC/DOT bridge to support wrapped Bitcoin. In the long term, Harmony plans to bridge native Bitcoin, and then expand to other Bitcoin-based assets such as USDT.

Technological Innovation

Harmony is focusing on a cross-chain API as a way of adding seamlessness to the cross-chain experience. By Q1 2022, using a single API, users will be able add liquidity to, or trade non-Harmony tokens on, DEXs such as SushiSwap and Viper.

While development on Harmony continues apace, the improvement of the chain itself has been prioritized, with the goal of one second finality and even more secure sharding.

Incentives

Catching up to challenger L1s will require a full commitment to ecosystem development. Incentives using native treasury tokens are needed to build wallets, developer tools, and new smart contract code. While rewards are necessary, they are not independently sufficient to bring success. A unique approach is required to differentiate a chain from its myriad of competitors in this fast-growing multi-chain world.

Mobile-first and FinTech Access

Harmony’s incentive program reveals its focus on Asia and other developing economies. These communities are mobile-first and less likely to be crypto-native. Seamless and secure entry and exit between other chains, along with FinTech and fiat currency integration, are all long-term conditions needed for a successful crypto ecosystem. Offering crypto yields with secure wallet front ends is Harmony’s near-term plan for mass adoption.

Trustless Bridges

Harmony has the potential to compete with both L1s and L2s using its low fee, fast, and trustless bridge. Competitors’ bridges are far from trustless. Do you want to put your crypto assets in the hands of three or four individuals?

The focus is on onboarding and bridging, from other chains and from TradFi. Ecosystem development should proceed apace with competitive incentives for developers. Incentives have worked wonders for Avalanche, Polygon and now Fantom. Is Harmony the next ONE?

This report was written by Messari Hub Analyst(s) and commissioned by Harmony, a member of Messari Hub. All content was produced independently by the author(s) and does not necessarily reflect the opinions of Messari, Inc. or the organization that requested the report. Paid membership in the Hub does not influence editorial decision or content. Author(s) may hold cryptocurrencies named in this report.

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