Key Insights
- Hedera is a low-cost, Proof-of-Stake (PoS) public ledger with quicker transaction speeds than existing Layer-1 (L1s).
- Hedera’s unique hashgraph consensus algorithm functions as a Directed Acyclic Graph (DAG), making it different from most traditional blockchains.
- Ethereum Virtual Machine (EVM)-compatible Smart Contracts 2.0 launched on mainnet as of Q1 2022, along with the open-sourcing of its hashgraph algorithm.
- Hedera is currently a permissioned network of 26 nodes governed by leading organizations around the globe such as Google and IBM.
- Anyone can use the tools offered by Hedera to build fast, customizable, and secure applications.
Introduction
Over the past decade, it has become more apparent that the future of trade, ownership, and the global economy is tokenized. Traditional server-based enterprise solutions lack the ability to make this future a reality. Hedera Hashgraph is a Proof-of-Stake (PoS) Layer-1 distributed ledger that aims to enable the next wave of crypto adoption.
Hedera was born out of Dr. Leemon Baird’s vision of enabling “Shared Worlds, where anyone can gather, collaborate, conduct commerce, and control their own online footprint.” His invention of the hashgraph algorithm would later serve as the foundation for this vision.
Unlike most DLTs, Hedera’s software is overseen by a group of leading enterprises from diverse industries around the world that comprise the Hedera Governing Council. With plans to eventually shift to a fully permissionless and decentralized network, Hedera is currently permissioned, where up to 39 Council members act as the initial node operators. Hedera claims to process transactions faster than most existing networks since decentralized applications (dApps) can be built leveraging the speed of the hashgraph base layer. Even though the network saw a monthly average of ~5 TPS in May 2022, Hedera reports that the network can handle tens of thousands of TPS.
Background
Computer scientists and former US Air Force Academy faculty Dr. Leemon Baird and Mance Harmon co-founded software company Swirlds to test the resiliency of Leemon’s hashgraph algorithm, created in 2015. Swirlds raised the funding to create what would become Hedera Hashgraph towards the end of 2017, and the Hedera mainnet launched one year later in August of 2018.
In just the past few months Hedera has checked off multiple items from its roadmap. It’s open sourced its entire codebase, upgraded the EVM-compatible smart contracts, welcomed its 26th Governance Council member, and passed a vote to enable proxy staking on the network.
Source: Hedera Hashgraph
On a blockchain, transaction data exists in a string of blocks validated by nodes on the network, where each recorded block is linked to the previous. Untrustworthy copies of the chain are discarded, forming a single largest trusted chain of transaction history. Conversely, Hedera functions as a Directed Acyclic Graph (DAG), where nodes communicate freely and randomly between each other, resulting in a graph or “tree” of transactions across time.
With Avalanche (AVAX), Fantom (FTM), and a few other chains in the mix, Hedera is not the only DAG-based network with aBFT security; but hashgraph is unique. Avalanche uses a multilayer approach with subnets, while Hedera uses a gossiped graph of transaction history. Fantom’s Lachesis consensus may have the most similar design and network properties to Hedera currently, yet has a bit more of a measurable user ecosystem.
Network Architecture
Overview
Hedera Hashgraph is a data structure and consensus algorithm. Hedera features two types of nodes that form the Hedera network: consensus and mirror nodes. The 26 Hedera Governing Council members currently run mainnet consensus nodes, while mirror nodes are permissionless and can be run by anyone. Mirror nodes are essentially “read-only.” Files and transaction data can be stored on the mirrornet, whereas hashgraph on the mainnet does not store historical data by design.
The protocol is aiming to be a Swiss Army knife of sorts, giving businesses, governments, and individuals a suite of tools to remain compliant with regulations, while building applications to suit their needs on Hedera. The Hedera SDK gives users the flexibility to incorporate KYC and AML into their systems without the need for a centralized entity to do so. Anyone can create an application that’s as permissionless and transparent, or private and permissioned as they’d like.
Source: Hedera Hashgraph
Consensus nodes form the foundation for Hedera Network, which seeks to provide fairly ordered timestamps, and fair access for submitted transactions. Different network services rest atop the Hedera network trust layer, on top of which applications can be built using Hedera’s Software Development Kits (SDKs).
Hashgraph
The hashgraph consensus algorithm is the core engine that powers Hedera. Hashgraph leverages two novel consensus components: its gossip protocol and virtual voting. Together these components help to achieve its high TPS rate and fair ordering of transactions. The algorithm removes the reliance on fee-based auctions for transaction inclusion, eliminating higher levels of Maximal Extractable Value (MEV). Hashgraph is Asynchronous Byzantine Fault Tolerant (aBFT), meaning consensus can still be achieved while protecting against network slow downs, forking, and various network attacks.
Gossip Protocol
Not only do network participants share or ‘gossip’ transactions with each other at random, but they also share information about a node’s previous gossip history. This behavior, termed “gossip about gossip,” enables faster transaction spread.
Virtual Voting
In contrast to earlier consensus algorithms, hashgraph saves on network bandwidth consumption with virtual voting. Consensus nodes do not need to remember the entire network transaction history and can achieve guaranteed order of transactions without actually performing any votes.
Virtual voting aims to provide for a fairer consensus voting system. In earlier PoW voting algorithms, whoever mines the next block gets to decide which transactions are added and recorded on the blockchain, where other nodes can have their transactions processed before others by paying higher fees. With hashgraph, nodes can “predict” how a certain node ought to have voted, by applying the virtual voting algorithm to their own copies of the hashgraph. Votes are weighted proportional to a node’s stake of HBAR, Hedera’s native token.
Network Services
Hedera currently offers five core open-source network services for its users. Anyone can make use of the consensus, token, smart contract, cryptocurrency (for native HBAR transfers), and file services on the network to power dApps. Hedera regularly reports on the network’s TPS performance broken down by service. In its V0.24 update, Hedera summarizes more than 10,000 TPS capability at different levels of network demand.
Source: Hedera Hashgraph
Hedera’s Smart Contract Service, although slower than native layer services by design, clocks in at around 350 TPS.
Hedera Consensus Service
An application using the Hedera Consensus Service (HCS) is harder to build than a smart contract, but it allows applications to reach down and make use of the native speed of the core hashgraph consensus algorithm. Synchronizing the fair and unbiased ordering of messages with HCS can power use cases such as supply chain asset tracking or decentralized ordering services.
Source: Hedera Hashgraph
HCS transactions are stored on mirror nodes. Application users can submit transactions directly to HCS, which are then ordered by timestamp and returned to the application and its users with the trust of Hedera’s state proofs.
HCS scales Hedera’s distributed ledger in a way that’s different from using traditional sharding or side ledgers. The best of both worlds is captured with HCS, where users can have the trust of the main ledger and the privacy of their own private application ledger.
Ledger Scaling Approach Comparison
HCS users can define confidentiality and access controls that cater to their dApp-specific use case. Immutable and verifiable audit logs of messages can be generated, while application state and data are persisted off-chain.
Hedera’s Smart Contract Service gives developers more advanced token customizability and user privilege tools. With this year’s launch of EVM-compatible Smart Contracts 2.0, Hedera interfaces with Hyperledger Besu (an EVM client for enterprises) and claims to achieve similar functionality to what Ethereum produces for a single block, in one second. All Hedera services, including the Hedera Token Service (HTS), Cryptocurrency Service, and file storage, inherit hashgraph’s aBFT security and fair transaction ordering properties.
HBAR Tokenomics
Hedera’s native token HBAR powers the Hedera economy and is the payment method for using Hedera’s network services.
Distribution and Supply Dynamics
The Hedera network has a total supply of 50 billion HBAR, which were minted at the network launch and moved into the Hedera Treasury on August 24, 2018. The supply can be increased beyond this amount, however the council must unanimously agree to do so. No more than 50.60% of the total HBAR is expected to be released until the end of 2025. Roughly 41% of the total HBAR supply (20.74 billion HBAR) is currently in circulation. An overview of Hedera’s liquid supply activity and funding history can be found in their Treasury Management Report.
An aggregate of 17.4% of the total HBAR supply is issued to Simple Agreements for Future Tokens (SAFT) investors during initial funding. Mance and Leemon collectively own 9.9% of the total supply as the founders. Because network consensus is a coin-weighted process, Hedera Hashgraph, LLC implements a 15-year token release schedule from its treasury account, to mitigate the risk of an attacker assuming control of one third of the network stake.
Governance
The Hedera Governing Council (HGC) will initially consist of up to 39 term-limited leading organizations and enterprises across multiple industry sectors, including aerospace, telecommunications, and energy. Council members are committed to running consensus nodes and governing decisions around software changes, network fees, and the staking and sale of tokens from the Hedera treasury account. A member’s maximum term is three years and can serve up to two consecutive terms. In the future, when the Council deems it difficult enough for an entity to amass one third of the total HBAR supply, mainnet nodes are to become increasingly permissionless.
Source: Hedera Hashgraph
The first 25 Council members were selected by original member Swirlds. As stated in Hedera’s LLC agreement, all Governing Members as of April 2022 will be nominated by the Membership Committee (one of four Hedera committees) and elected by Council Members. Applicants must meet membership criteria and have at least $10 billion in market capitalization before requesting membership.
While Council members have collective governance rights over the direction and function of Hedera Hashgraph, LLC, the members do not have economic nor equity rights. Members of the Council have equal ownership of Hedera Hashgraph, LLC, but do not own the coins in Hedera’s treasury account and do not receive any shares of the LLC’s profits or assets. Given the size of the companies on the Governing Council, the monetary incentive to run a node is trivial. It seems those running consensus nodes wish to contribute to the growth of the network and benefit long-term as a user even after their term on the Council has ended.
Staking & Fees
A given node’s influence over the Hedera network is weighted only by their stake in HBAR. All Governing Council nodes earn HBAR rewards proportional to their designated stake every 24 hours for validating transactions and offering other computational resources to the network. Users pay fees in HBAR to consensus nodes for processing and timestamping transactions, and for any subsequent maintenance, such as storing a file or token balances. Network service fees are denominated in USD but charged in HBAR, allowing application users to estimate more predictable operational costs as opposed to paying fees with a more volatile token.
Source: Hedera whitepaper
Staking on Hedera mainnet, recently accepted in HIP-406, is pending implementation this quarter. As part of this upgrade, proxy staking will finally allow those who do not run consensus nodes to earn smaller payments in HBARs by contributing the weight of their HBAR to a node of their choice via proxy. The proxy stake to consensus nodes is capped, and those who proxy stake are incentivized to select reliable nodes.
Current State and Ecosystem
Current State
Although Hedera is a permissioned distributed network in its current state, the public ledger aims to become increasingly permissionless and decentralized over time. Hedera open sourced the hashgraph consensus algorithm in a December 2021 HIP, and Hedera now claims that it is taking steps towards decentralized governance.
Hedera’s 6-week Hedera22 Smart Contracts Hackathon, and their largest yet, concluded on May 16, with the HBAR Foundation offering over $400,000 in HBAR and other prizes to the winning teams. Deal Designer, a platform which incentivizes giving back to charity through customizable product offers, was awarded first place. Other winning projects consisted of self-executing legal agreements on Hedera leveraging IPFS, NFT royalty distribution, and a variety of other initiatives in sustainability, enterprise DeFi, storage, payments, and onramps.
Up until Q4 2021, Hedera’s fully diluted market cap saw relatively stable growth alongside an increase of circulating supply from 7 billion to 15 billion HBAR. Since November 2021, the fully diluted market valuation of HBAR has trended down with the intermittent release of tokens into circulation, with a current circulating supply of just over 20 billion.
Current average network TPS is less than 5 at the time of writing. Hedera attributes the low TPS to the lack of network demand, considering that it is outfitted to handle thousands of TPS when needed. At nearly 1 million total accounts, 84% of the total 2.37 billion transactions recorded on Hedera’s network are the result of requests sent from applications to the Hedera Consensus Service, with native HBAR Token transfers and account creations making up the remaining 16%.
Use Cases and Applications
Although Hedera is operated and governed by enterprises, Hedera’s ecosystem partners and users continue to grow, featuring projects such as social media dApp Calaxy which just secured $26 million in funding through the HBAR Foundation, and digital asset bridge Hashport, used for bridging wrapped HBAR to Ethereum (HBAR[eth]) and Polygon (HBAR[0x]). Earlier applications announced at Mainnet Open Access consist of AdsDax, which seeks to prevent ad fraud, and hash-hash.info, a Hedera network explorer, amongst others in the realms of music streaming, micropayments, and food traceability. Newest Council Member Ubisoft is focused on Web3 gaming, and DLA Piper on its own tokenization platform, TOKO as well.
Open Source
Hedera Hashgraph, LLC will be a wholly Council member-driven organization focused on governing the ledger. Founding member Swirlds will be focused on providing the engineering, marketing, and product resources needed to ensure the continued growth of the Hedera ecosystem.
In a recent push for increased decentralization, the Hedera team summarized the December 2021 vote for the Hedera Governing Council to purchase the intellectual property rights of the hashgraph consensus algorithm and open source its software. In addition to open sourcing Hedera’s full-stack technology, the Council’s vote consisted of the reorganizing of offices at Hedera Hashgraph, LLC, increasing council member engagement, and enacting member-approved treasury management.
Upgrades & Traction
Both EVM-compatible Smart Contracts 2.0 and Stader Labs’ staking contract on Hedera have gone live. Enabling staking capabilities with HIP-406 is still under review. Stader Labs, a staking platform also partnered with Terra 2.0 and Polygon, is bootstrapping the demand side of staking on Hedera. Staking rewards are primarily funded by the HBAR foundation, but they will transition fully to the network’s staking system once the bootstrapping period is complete.
Roadmap/Strategy
From the initial minting of the total 50 billion HBAR supply in 2018 until now, Hedera Hashgraph has made steps in the direction of increased developer tooling and decentralization. Looking towards Hedera’s roadmap, the protocol’s initiatives on the horizon for 2022 include the launch of proxy staking in Q2, permissioned community nodes, and overall increased scalability.
We are currently in phase 1 of Hedera’s three-phase network evolution. Once the 39 spots on the Hedera Governing Council have been filled, and hundreds of permissioned consensus nodes are live on mainnet, Hedera will enter its final phase of its network evolution on the road to decentralization. Co-founders and most staff, including developers, are moving from Hedera Hashgraph, LLC to Swirlds, and Leemon’s and Mance’s roles of CEO and CTO at Hedera have since been dissolved as of Q4 2021. Both will retain leadership roles at Swirlds, which has a permanent seat in the Council.
Source: Hedera Hashgraph, Decentralization of Consensus
Enabling and promoting open standards for inter-ledger integration is on Hedera’s radar on the longer-term time horizon. The public ledger seeks to build standardization around micropayments, social messaging, emails, and information exchange, all being managed by a living ecosystem of other shared applications. A topic of interest includes decentralized account recovery for example. Private keys would be stored in a way that doesn’t compromise security, which would prevent the average user who’s not as familiar with the blockchain from losing their keys.
Risks & Challenges
Adoption: Hedera launched around the same timeframe as other top L1s. From a quantitative perspective, however, it is difficult to build a clear picture of what entities are building on top of it, as well as the overall user traffic. Very early stage applications run across the gamut of familiar use cases, although they will need to focus efforts on increasing network adoption if they are to compete as the de facto public ledger. To put things in perspective, the entirety of Hedera’s over $40 million in TVL mainly comes from HBAR deposits in the Stader Labs stake pool at the time of writing, currently paying out over 40% APY. The Fantom ecosystem currently fosters $1.5 billion in TVL amongst 40 protocols. Hedera’s digital asset bridge Hashport has a reported over $3.5 million in volume and $3 million in TVL.
Hedera has development work ahead of itself in terms of continuing to build out community-based ledger explorers, APIs, and network activity dashboards for increased data visibility. Swirlds has recently added HashScan to the list of Hedera mainnet explorers; however, there is limited available data on transactions broken out by application.
Decentralization: The organic decentralization of nodes running global public ledger suitable for enterprise use does not happen overnight. The team has outlined its ambitions for extending from hundreds of permissioned nodes to a completely permissionless consensus engine over time. Until then, these 39 members of the Governing Council, including Swirlds, will continue to give the final say on proposals to modify Hedera’s codebase.
Performance & scalability: There have been disputes about Hedera’s reportedly 10,000 TPS performance, as well as critiques surrounding large market participants determining fair transaction history. Most notably in Hedera Technical Lead, Paul Madsen’s rebuttal to Eric Wall’s Hedera FUD post, followed up by Wall’s Counter-counter FUD. At current demand, the network is processing a monthly average of 5 TPS, with a max of 10 TPS, which is well below the 10,000 TPS mark.
Security: An attacker would need to gain control over 51% of the hashrate on a PoW network, or 51% of token stake on a PoS network in order to corrupt these systems. A malicious actor however, can corrupt a DAG by gaining control of 33% of the network stake. Leemon speaks on the likelihood of Sybil attacks here before the Swirlds algorithm became branded as Hedera Hashgraph.
Conclusion
Hedera has broken into the realms of DeFi, micropayment solutions, and entertainment as a distributed public ledger. Its potential to bring truth and reliability to Internet-of-Things (IoT) data and machine learning training models poses interesting network use cases. But if Hedera is to be adopted by mainstream markets, its leading edge will need to consist of more than just its unique hashgraph consensus algorithm. Hedera needs to increase user adoption and grow its application ecosystem if mass adoption of the protocol is to take place. The recent developments in its codebase, developer community, and decentralization efforts could catalyze Hedera’s progress towards this goal.
It will take time to observe the growth and sustainability of Hedera’s economy given the network’s 15-year token release schedule. It remains to be seen how useful hashgraph technology will be for the mainstream markets, with the continuing emergence of scalable platforms that specialize in providing one robust service as opposed to a conglomerate of services. If reputable corporations and markets are to integrate with immutable public ledger technology, then security, regulatory compliance, and cheap transaction providence will remain as top priorities in the solution of their choice. Time will tell if hashgraph will win over a multilayer approach when it comes to building an efficient distributed ledger.
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