Cardano: Slow and Steady Scales the Chain

Key Insights

  • Cardano is one of the largest smart contract networks, with billions in market cap and millions of holders.
  • Following the Alonzo hard fork, smart contract development has increased and produced a variety of new DeFi protocols.
  • The eUTXO accounting model enables native token transfers, scalability, and decentralization.
  • Sidechains and Layer-2s such as Hydra aim to scale the network even further.
  • Cardano has stayed true to its methodical, deliberate, and sometimes slow approach to development, prioritizing sustainability over speed.

Cardano was conceived with the goal of solving security, scalability, and sustainability problems. The project is an early adopter of two of today’s popular architecture choices: Proof-of-Stake and modularity. Cardano developed Ouroboros Classic as its first PoS consensus mechanism and split the functions of computation and settlement into separate layers. Combined with an unspent transaction output (UTXO) model for a planned smart contract network, Cardano considers itself to be a “third generation” blockchain — with Bitcoin being the first generation and Ethereum being the second generation.

Cardano takes a calculated approach to development, putting functionalities through rigorous academic peer review before production. While Cardano’s initial roadmap is still in progress, its “completed” roadmap items continue to be improved. Cardano’s PoS mechanism, Ouroboros, has already been through several different versions with several more iterations planned.

Cardano has a large and passionate fanbase on social media, from Twitter (1.3 million followers) to Reddit (670,000 members) to YouTube, with conviction in the chain, driven by the leadership of founder Charles Hoskinson.

Background

Cardano is an open-source, smart-contract-enabled blockchain originating from peer-reviewed academic research. Development on Cardano began in 2015 by founders Charles Hoskinson and Jeremy Wood, as well as the team at Input Output Hong Kong (IOHK), now Input Output Global (IOG). Hoskinson and Wood previously worked on Ethereum before starting Cardano. Cardano and the ADA token launched in September 2017 after a multi-stage ICO.

Progress on the project has been deliberate and heavily tested along the way. All functionalities and protocols are peer-reviewed before being implemented, which in some cases delays the path to production. For example, smart contracts were not enabled until the Alonzo hard fork in September of 2021 — a full four years after the network launched.

Cardano is supported by three entities:

  • Input Output Global (IOG) — A blockchain research and development company founded by Charles Hoskinson and Jeremy Wood. This is the development arm.
  • The Cardano Foundation — A non-profit organization focused on core development and ecosystem growth. It owns the Cardano brand and drives adoption.
  • EMURGO — A venture capital firm that is the for-profit arm of Cardano. EMURGO facilitates integrations for Web2 business partners and incubates business opportunities.

Roadmap

Cardano’s roadmap consists of five phases: Byron, Shelley, Goguen, Basho, and Voltaire. These phases do not necessarily occur in series, with some continuing to be iterated on long after launch.

  • Byron – Foundation
    • The Byron era arrived in September 2017 with the mainnet launch of the Cardano blockchain. During this phase, the chain operated as a federated network that only supported ADA transactions.
  • Shelley – Decentralization
    • Shelley launched in July 2020, bringing Cardano’s proposed Ouroboros Proas Proof-of-Stake (PoS) protocol to life.
  • Goguen – Smart Contracts
    • Goguen added support for smart contracts in September 2021. The Plutus programming language was released and welcomed dapps, NFTs, and a DeFi ecosystem.
  • Basho – Scaling
    • The Basho era is currently in progress and aims to improve scalability by adding sidechains and L2s to the ecosystem.
  • Voltaire – Governance
    • Voltaire is concurrently in progress with Basho and will take the final steps toward self-sustainability. Voltaire is responsible for the treasury system and a voting system for Cardano Improvement Proposals (CIPs). After completion, the community will control hard forks and the treasury rather than IOG, Cardano Foundation, and EMURGO which currently hold all seven governance keys.

Technology

CSL and CCL

Cardano has a modular design and operates on two separate layers — the Cardano Settlement Layer (CSL) which is optimized for the transfer of value and the Cardano Computing Layer (CCL), optimized for the storage of data.

The CSL acts as a ledger for accounts to transfer value. It is also the layer where consensus is executed. On the other hand, the CCL handles the execution of smart contracts and arbitrary logic. Because the CCL carries the complications of Turing completeness for smart contracts, the CSL is the more secure, efficient, and flexible layer.

Both layers can be updated independently, which contributes to sustainable development.

Consensus Mechanism

Ouroboros is Cardano’s Proof-of-Stake (PoS) consensus mechanism. In this system, users can delegate their ADA to a stake pool operator and earn rewards while still retaining ownership of their tokens. Cardano was one of the first cryptocurrencies to adopt the PoS consensus mechanism, specifically using a variant called Delegated-Proof-of-Stake (DPoS).

Ouroboros divides time into epochs of five days and further divides each epoch into 21,600 slots of an average of 20 seconds each. Each node uses a verifiable random function (VRF) to generate a random number. If the VRF number is under a certain threshold, that node gets to be the slot leader and proposes a block. If multiple nodes achieve this, they all produce blocks and the next selected slot leader builds upon the lowest VRF number of the bunch. The threshold depends on the amount of ADA, favoring larger staking pools.

There have been many versions of Ouroboros since it was first developed for the network, and it is still being iterated. Ouroboros Classic was the first version that went live at launch in 2017. Ouroboros Genesis came in 2018 and solved the bootstrap problem analytically.

Ouroboros Praos is the current consensus mechanism in place. In Praos, stake pool operators / validators are aware of which slots they lead ahead of time, but other validators are not. Additionally, no users know in advance how many slot leaders each slot will have. This adds a layer of security as it prevents DDOS attacks on slot leaders. In previous versions of Ouroboros, slot leaders were known publicly ahead of time, and only a single slot leader corresponded to a single slot.

Since its launch over five years ago, Cardano has never skipped a block or had to reboot. There have also been no network shutdowns during upgrades. Other networks, such as Polkadot and Mina, have chosen to adopt Ouroboros and adapt it to their needs.

Accounting Models

In the UTXO accounting model, assets are stored on the ledger as a directed acyclic graph (DAG) between addresses. In a transaction, those unspent outputs are consumed to create new outputs.

By contrast, the account-based model adds and subtracts transactions from addresses stored in a database of network states. Ethereum, Solana, all EVM-based chains, and many other smart contract networks use an account-based model.

Classic UTXO

Cardano, like Bitcoin and unlike Ethereum, uses a UTXO model. Transactions can include one or more UTXOs as inputs and one or more UTXOs as outputs — all of arbitrary sizes — to meet the needs of the transfer.

For example, if Alice has a UTXO worth 5 ADA and wants to pay Bob 2 ADA — the UTXO will be split into a 2 ADA UTXO to Bob, a 0.2 ADA UTXO for a fee, and a 2.8 ADA UTXO back to Alice as “change,” just like with cash. That original UTXO will no longer be a UTXO as it has now been consumed, and it can never be spent again.

Extended UTXO

Cardano uses a novel version of UTXO called the extended UTXO (eUTXO). eUTXOs include a datum and a script, allowing for arbitrary logic and metadata to be attached to each individual transaction.

eUTXO includes two features over the classic UTXO:

  • Scripts: Arbitrary logic that references the eUTXO itself and its data to determine if it can be used as an input for a new transaction.
  • Datums: Metadata or a smart contract in Plutus. It gives instructions to the transaction builder on what to do with the eUTXO.

eUTXO in Practice

Compared to the account-based model, the eUTXO model:

  • Has cheaper transaction verification — no fees are needed for the memory cost of tracking the accumulated chain state.
  • Has lower node requirements in terms of data storage — a state tree of all account balances does not need to be kept as it does with an account-based model (same reasoning as above).
  • Is deterministic — transaction outputs rely on outputs from previous transactions, forcing a level of atomicity. The cost and validity of transactions can be predicted prior to execution. Fees can also be predicted as there is no arbitrary ordering based on a gas variable.
  • Is scalable — transactions can be processed in parallel.
  • Is less familiar for developers — the majority of Web3 developers are accustomed to account-based transactions.
  • Has concurrency risks — dapp developers must find ways to batch transactions to allow simultaneous UTXO interactions within the same block.

Dapps on Cardano must account for the eUTXO model and structure themselves to avoid concurrency problems. Given that each UTXO can only be spent once, protocols cannot make a user’s UTXO available to multiple users at the same time. Developers must approach Cardano DeFi differently than they do on Ethereum, Solana, or other account-based protocols and create their unique solutions to concurrency issues.

Many of these solutions allow community members to get involved and capture value by providing batching services. These different strategies make the Cardano DeFi ecosystem function similarly to app-specific multichain environments where protocols have heterogeneous and optimized strategies rather than a general-purpose fix.

Native Tokens

On blockchains with account-based transaction models (e.g., EVM chains), the blockchain’s sole native token (e.g., Ether on Ethereum) has different functionalities from all other tokens (fungible and non-fungible).

With Cardano’s multi-asset support, this isn’t the case. All fungible tokens (FTs) and non-fungible tokens (NFTs) are native tokens and share almost all the functionality that ADA has. The main differences are that gas fees are still always paid in ADA and that only native tokens can be created and destroyed.

Tokens on Cardano don’t need to be deployed via smart contracts. As such, they are not vulnerable to exploits to the same degree as ERC-20s or ERC-721s and do not require a smart contract execution to be transferred. Because they are not created with heterogeneous smart contracts, dapp developers can integrate all Cardano native tokens in the same way. Additionally, the eUTXO model allows for multiple tokens of different types to be transferred together in a single transaction.

Minting policies are written into a script attached to the token address. These policies handle authorization for transactions to use the mint field and create more of an asset.

Cardano Improvement Proposal 25 (CIP25) declared the metadatum label for Cardano NFTs to be the same as Ethereum’s ERC-721.

Staking

ADA holders delegate their ADA tokens to a stake pool operator (validator) to receive a share of block rewards while still retaining ownership of the ADA. They can use or withdraw their ADA at any time.

Transaction fees are pooled over the course of an epoch and evenly distributed to all pools that produced blocks for each slot in the given epoch; this distribution remains equitable with varying numbers of slot leaders per slot. Rather than relying on the operator for distribution, the blockchain guarantees that every delegator receives rewards.

Stake becomes active after two epochs, and the distribution of rewards begins after the third. Any changes to operator pool parameters take two epochs to take effect, protecting delegators from sudden changes.

A fixed 20% of transaction fees goes into the treasury rather than being fully distributed to stakers. This treasury share can be adjusted through the governance process and is used to support sustainable development.

Staking rewards are optimal when all staked ADA is uniformly distributed amongst an arbitrary amount of staking pools. The K parameter refers to the desired number of pools: originally 250 before being updated to 500, with talk of increasing to 1000 for more decentralization.

Pools with too much stake experience diminishing returns to incentivize decentralization between more pools. Saturation is determined by the circulating supply divided by the K parameter. Cardano does not require slashing thanks to the incentives in its reward-sharing scheme.

Haskell and Plutus

Cardano was built with Haskell, a statically typed functional programming language. Plutus, created by IOHK, is a language based on Haskell; it has additional features to support blockchain use cases and smart contracts.

The Vasil hard fork in September 2022 added new features with Plutus V2.

Tokenomics

The ADA Token

ADA, the native token on Cardano, is used for P2P transactions, security, and gas fees.

The max supply of ADA is 45 billion. About 31.2 billion ADA were minted during the Genesis Block Distribution with the remaining 13.8 billion ADA to be minted as block rewards. About 35 billion ADA (78%) is currently in supply.

The supply of ADA is inflating by roughly 0.3% per epoch. There is currently no burn mechanism. At this time, the treasury holds over 1 billion ADA to be used for ecosystem development.

The Genesis Block Distribution

The initial ~31.1 billion ADA tokens were distributed to ICO participants (~83%) and Cardano’s three main entities (~17%).

ICO participants purchased ~25.9 billion ADA token vouchers throughout four tranches between 2015 and 2017 for a value of ~109,000 BTC, or $63 million USD.

About 5.2 billion ADA was distributed to IOHK (now IOG), the Cardano Foundation, and EMURGO, as follows:

  • IOHK: 2.46 billion ADA
  • Cardano Foundation: 648 million ADA
  • EMURGO: 2.07 billion ADA

A Japanese company, Attain Corporation, facilitated the voucher sales/ICOs, and later the token distribution to the voucher holders when Cardano launched. A portion of Attain’s proceeds equaling 8,258 BTC was donated to the Cardano Foundation.

State of Cardano Ecosystem

Activity in 2022

Cardano experienced a surge in Q1 2022 in the form of DeFi activity. During the bear market, daily transactions took a decline through Q2 and settled out at about 60,000 in Q3. At this level of activity, Cardano averages roughly 0.75 transactions per second (TPS). It’s important to note that eUTXO TPS is not directly equivalent to account-based TPS, as multiple assets and multiple recipients are often involved in a single eUTXO transaction.

Nodes and Stakers

Initially, IOHK was the sole block producer, but now there are over 2,900 stake pool validators with 71% of all ADA delegated to them. As of March 2021, those stake pool operators have been exclusively responsible for block production. Full decentralization and community ownership are aided by infrastructure like the Daedalus wallet.

Daedalus is an open-source wallet supported by IOG. Aside from the normal functionalities of light wallets like Yoroi and Nami, the Daedalus wallet includes a full node with all the capabilities of a validating node. Due to how light the UTXO nodes are, Daedalus independently validates all transactions and does not need to rely on centralized servers.

DeFi

Cardano’s DeFi TVL was ~$78 million at the end of Q3 2022. With a market cap of ~$14.8 billion, that gave Cardano a Mcap/TVL ratio of ~190 — significantly higher than competitors Ethereum, Solana, and Binance with ratios of ~6, ~17, and ~10, respectively.

Despite being around for over five years, smart contract functionality is barely a year old. This late start follows the project’s ethos of building carefully and deliberately with extensive reviews, but this approach made Cardano lose out on any potential first-mover advantage. Slow growth can also be attributed to Web3 developers having to learn a new programming language (Haskell) and not just forking EVM protocols.

Despite the relatively late introduction to the DeFi game, Cardano’s TVL is ranked 30th. Cardano’s growing ecosystem includes DEXs, borrowing and lending protocols, decentralized stablecoin providers, and all other essential DeFi infrastructure. Minswap, WingRiders, and SundaeSwap are carrying the DeFi ecosystem with 52%, 20%, and 19% of market share dominance, respectively.

NFTs

Cardano hosts over 8,000 NFT projects and 15 marketplaces but only averages around $6.8 million in monthly volume — far from industry leader Ethereum with over $150 million in monthly volume. jpg.store is dominating marketplace volume with over 90% of the market share in Q3 2022. SpaceBudz, the top collection in the space, has done over 40 million ADA in volume.

Multichain Vision

Cardano aims to have multiple ways to scale, mainly through Layer-2s and sidechains. Overlay networks such as Mithril and Mamba are supported by a subset of Cardano stake pools and can solve specialized needs such as EVM compatibility.

IOG released the Cardano EVM Sidechain in alpha in June 2022, which allows Solidity developers to easily port applications into the Cardano ecosystem.

Hydra is a class of L2s based on isomorphic state channels and optimistic settlement. Ouroboros Hydra is a new version of Cardano’s consensus mechanism, being designed by IOG. It will help enable faster transaction speeds, increased throughput, and lower transaction costs for Hydra protocols. Hydra was announced years before smart contracts were enabled, and it is now quickly approaching V1.0, currently in beta V0.8. Hydra Heads is set to be the first Hydra protocol to launch.

Cardano is moving towards collaboration and interoperability in many directions; Charles Hoskinson has even suggested for Dogecoin to find a new home as a Cardano sidechain.

Digital Identity

Atala PRISM is a self-sovereign identity (SSI) platform on the Cardano blockchain providing digital infrastructure for banking, healthcare, education, and more. Nation states, universities, and industries traditionally in the Web2 space are making use of Atala’s identity infrastructure:

  • World Mobile Network is bringing internet connectivity to areas lacking it, starting with Zanzibar; subscribers to this network will be able to access Atala for digital services such as banking and healthcare. IOG owns a 10% stake in World Mobile.
  • Ethiopia’s education ministry is using Atala as a credential system for students.
  • IOG and Georgia have a technology partnership to improve data security and fintech.
  • Dish Network is using Atala for its identity and loyalty system.

Competitive Landscape

Every network is feeling the heat from the bear market; Cardano shared the same fate as most others with a 65% drop in market cap through Q3 this year. Even so, its market cap and decentralization are ahead of most competitors. However, Cardano’s ecosystem is still far behind the competition despite its growth this year. Cardano’s goal in the near future will be to catch up to established ecosystems and take some market share.

Conclusion

Smart contracts development is currently dominated by Solidity and the EVM. However, many L1s have different VMs, and some even use brand-new languages. For developers, languages and VMs are barriers but not dealbreakers.

Aside from tools, most smart contract developers are used to working with account-based transaction models, not UTXOs. At its worst, this model is another barrier to developer adoption, but at best, it is an opportunity for optimized, platform-specific solutions.

Cardano prioritizes market research and academic peer review over shipping features quickly. This strategy has the network behind its competitors in ecosystem adoption. With that said, Cardano remains a top 10 cryptocurrency by market cap, has a massive community of dedicated users, and has a particularly large presence on social media.

The final phase of Cardano’s roadmap is not too different from those of other L1s such as Ethereum’s or Polkadot’s: a scalable, secure, and decentralized multichain ecosystem centered around the main L1. The differences are the routes taken to get there and the partners/users focused on along the way — whether that be traditional Web3 dapp users or governments.

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