Fantom — What is it? How does it work? What are the risks to investing?

15 min readApr 5, 2022

What is Fantom
Asset Design
Project Developers
Asset Uses
Risks of sanctions
Risks of money laundering
Risks to consumers/investors

Note — this was written in February 2022 and there are some developments that have occurred since:

Solidly exchange was launched reaching a TVL of $2.3b before falling to around $350m (as of April 5 2022)
Andre Cronje unexpectedly left Fantom in March. I gave this a low risk rating and discuss below why I did not think it was likely. I have left it in for completeness.

1. What is Fantom

Fantom is a Layer 1 smart contract platform like Avalanche, Solana & Luna, which have all been gaining adoption in the last year as alternatives to Ethereum due to their faster and cheaper transactions.

What these projects are all competing to solve is the blockchain trilemma — the problem of having to sacrifice one of scalability, security or decentralisation in order to maximise the other two.

Fantom has maximised scalability and security at the cost of decentralisation.

2. Asset Design

Scalability

Fantom uses Lachesis — a Proof-of-Stake (PoS) Asynchronous Byzantine Fault-Tolerant (aBFT) consensus algorithm with Directed Acyclic Graphs (DAGs) to maximise scalability:

Proof-of-Stake (POS) — securing the network via locking up FTM tokens.
Byzantine fault tolerant — nodes can still reach an agreement on an ordering of events and verify transactions even if up to 1/3 of Fantom nodes turn malicious or go offline.
Asynchronous — Nodes don’t all have to reach agreement at the same time.
DAGs — Directed Acyclic Graphs. A more complex structure than a typical blockchain. The simplest generalisation for a DAG is a family tree. Directed as the order moves in one direction only. Acyclical in that you cannot go back in time. A graph in that you can read data from looking at the information flow from the ancestors / Fantom nodes.

Fantom being asynchronous and DAG-based, differs from synchronous blockchains such as Ethereum and Bitcoin, where transactions are appended into blocks, one at a time. This means that branched chains can occur if two miners produce a block at the same time. So block times are needed to give the network time to verify which branch of the chain is correct.

Fantom nodes, being asynchronous, can reach consensus independently by focusing on syncing the events between nodes. The nodes do this by periodically exchanging the events and transactions they have observed with nodes around them, instead of exchanging finalised blocks. This means they do not require a full record of the data to be saved on every single node, like in a blockchain. DAGs essentially combine blocks and transactions, which allows transactions to be processed faster in parallel rather than in a single block.

As there is no need to wait for block confirmations. This gives scalability and speed gains, with near-instant finality for transactions. Bitcoin generates a new block roughly every 10 minutes. Ethereum is on average 13 seconds. Fantom’s is around 1 second.

Since Fantom also does not have miners they also have cheaper transaction fees because they do not have to pay miners to validate blocks.

Security

Fantom is leaderless: there is no selected group of nodes that can decide the order and validity of transactions (like in Ethereum). All nodes are equal.

One risk of having leaders is they can fall victim to a DDoS attack, where a malicious agent can flood the blockchain with spam transactions, so that validators get overwhelmed and the network freezes. Fantom removing block leaders reduces the risk of a DDoS attack which increases network security.

Decentralisation

Fantom has a low number of validator nodes compared to other layer 1 smart contract platforms. This centralisation increases the risk of network outage.

In February 2021, the two largest validator nodes holding over 33% of FTMs total supply were unable to keep up with the other validators which caused the entire network to go down.

Fantom only had 39 validator nodes in February 2021 as 1,000,000 FTM was needed as a minimum stake to run a node. This high barrier of entry meant only a small number of nodes were able to run, which increased the risk of centralisation of FTM holdings and therefore a network outage.

Andre Cronje, DeFi Architect at Fantom, stated in Jan 2022 that the reason why Fantom initially had this high barrier to entry was to have a personal relationship with their validators. Having a small number of validators was important in the early stages of Fantom as they were able to communicate easily to organise fast updates in the event of network errors.

Since the 2021 network outage, Fantom reduced the requirement needed to become a validator from 1,000,000 FTM to 500,000 FTM and have since onboarded additional validator nodes, running a total of 57 active validators (as of 10th February 2022).

From these validators:

9 (15%) nodes are run by the Fantom Foundation. This presents a low risk to central control of the network.
19 (33%) nodes are unknown. This presents a risk of the Fantom Foundation, or other current node validators running additional nodes to gain increased control over the network. The Fantom Foundation has addressed the anonymity of these nodes for security reasons in their documentation, stating “validators are anonymous to make the network decentralized and resilient to attacks from the outside.”

Despite onboarding additional validators since the network outage in 2021, the Nakamoto coefficient was last measured at 3 in December 2021, meaning if three major validators were to go offline, the entire network would go down again.

Fantom’s minimum stake of 500,000 FTM costs $1.1 million (from a FTM price of $2.20 on February 10th 2022), so a high barrier to entry remains. However, validator requirements are proposed to be further reduced, likely to 100,000 FTM (worth around $200,000) which will increase decentralisation and therefore network stability.

Finally, Fantom has announced close ties with Amazon Web Services (AWS) and Fantom validator requirements advise the use of AWS hardware. This risks a central point of failure from an Amazon Web Services outage, which may also cause validator nodes running AWS to go offline. AWS suffered four outages in 2021; however, these were localised to certain geographical regions and it is not clear how many validator nodes actually use AWS.

Tokenomics

Allocations for early investors finished vesting in November 2020, so there is no risk of token dumps from vesting.

There is a low impact of price dilution as there is an inflation rate of 14% from staking emissions, 80% of total supply is already issued and there is a hard capped maximum supply of 3.175 billion.

However 57% of FTM tokens are held by 12 whales (addresses with more than 1% of the circulating supply). This presents risks of price manipulation, large token sell-offs and disproportionate control of governance (discussed in more detail later in Section 7).

3. Project Developers

Looking at how many developers are building on Fantom helps to give an understanding of how much activity is happening to improve its technology.

The Electric Capital Crypto Developer Report, published in January 2022, shows the number of Fantom developers at around 90 as of December 2021. This places Fantom amongst the lowest number of developers compared to the other layer 1 smart contract platforms. Therefore, there is a risk that development speed will not be able to match that of its competitors.

However, the report also shows Fantom has the fastest growing ecosystem of 2021, with total monthly developers increasing by 389% between December 2020 and December 2021.

There are three factors which can cause Fantom’s developer base to continue its growth in 2022, but which also have associated risks:

Andre Cronje

Globally influential developer Andre Cronje is a proven success with Yearn Finance. Having notable names like Andre building on Fantom with a pedigree of influence can help attract more developers to also build on Fantom.

There is a risk that Andre leaves Fantom, if he does it would be damaging as he is one of their lead DeFi architects. However there is a low risk of him leaving, as he has supported Fantom since 2018 and recently referred to it as his “child”.

370 million FTM Incentive Program

Announced in August 2021, the Fantom Foundation committed 370,000,000 FTM to incentivise developers to build in the ecosystem. As of January 2022, 21 teams have received more than 22 million FTM as incentive rewards.

There is a risk that developers may move away once this incentive program ends. However there is no specified date for ending and around 94% of FTM rewards are still remaining. Around 6% of rewards have been given out in 4 months, if this distribution were to continue at the same rate, the Program could be expected to end some time in 2027.

Opera

Opera is an Ethereum Virtual Machine (EVM) compatible application development layer for Fantom.

The advantage of Fantom being EVM compatible is developers can build smart contracts on Solidity, the most common blockchain programming language with the most support available. This makes Fantom better able to bring in new developers compared to non-EVM compatible projects.

However, Fantom is dependent on EVM since it does not have it’s own proprietary virtual machine. Fantom Virtual Machine (FVM) is in development but there is no clarity on when it will be available.

Until FVM is complete, Fantom can only be seen as complementary to Ethereum and not a true alternative (unlike competitors such as Avalanche which has AVM). This poses the risk of competition from other chains which are also complementary to Ethereum, such as layer 2 scaling solutions Polygon and Arbitrum.

These are also developing rapidly in 2022 and if launched successfully, they can bring significant market share back to Ethereum since they benefit from it’s strong base of security and decentralisation. There is a risk therefore that Fantom may lose market share and no longer be necessary.

4. Asset Uses

The FTM token has a number of use cases within the Fantom ecosystem: running a validator node, staking, peer-to-peer payments, voting in governance, paying for network fees, and as collateral in the Fantom DeFi suite.

A report by Crypto Consulting Institute describes the risk to Fantom from its strong competition of other layer 1 smart contract platforms:

“Ethereum being highly decentralized makes it stand out. Binance Smart Chain’s ease of onboarding users from the Binance exchange gives it an advantage in attracting new liquidity. Solana’s speed and finality set it apart. Avalanches subnets is a hive of innovation as anyone can create their own sub-blockchains for permissioned and permissionless environments. Terra is home to the most viable decentralized algorithmic stablecoin with a burgeoning ecosystem.

What we also notice is that despite their faults (ETH’s gas fees, Solanas network outages, Avalanches rocky start with scaling, $UST stablecoin peg being battle-tested) they still have made incredible gains and it is broadly accepted that their network effects make them a force of nature.”

This highlights a risk that Fantom may struggle to compete with it’s competition’s strong network effects from their niche use cases. Fantom could fail to find a niche that sets it apart from other blockchains. Fantom’s DAG technology is also not unique, it can be also used in Avalanche subnets to integrate payment functions.

Currently Fantom’s most popular dApps are DeFi protocols, so Fantom could be seen as cornering the DeFi niche.

However, these are either popular Ethereum dApps that have migrated over to Fantom (yearn.finance and Curve) or they are forks of popular Ethereum dApps — SpookySwap is a fork of Uniswap, SCREAM is a fork of Cream Finance and Geist is a fork of Aave. There have been few innovative projects building on Fantom and it is used primarily for its cheap transactions, which many other blockchains also offer.

However, Andrew Cronje has recently announced an upcoming project, Solidly, that will launch on Fantom and looks to innovate by combining the best features from Curve and Uniswap, whilst also utilising NFTs. When launched, this could attract investment into Fantom as it is the only protocol concept of its kind.

5. Sanctions

The most pertinent sanction for FTM is the risk of a class action lawsuit from the Securities and Exchange Commission (SEC) similar to Ripple (XRP).

In order to determine the risk of FTM being classified as a security, the Howey test must be performed. FTM will be deemed as a security if it is:

An investment of money
In a common enterprise
With the expectation of profit
To be derived from the efforts of others

In terms of criteria 1–3, FTM (along with most other digital assets) would likely fulfil the criteria. The contention lies in the fourth criteria. Any project with an Initial Coin Offering (ICO) is likely to fulfil the fourth criteria because most ICOs are not the project’s final form, roadmaps are usually published which implies a finished product is to come in the future.

Fantom’s ICO in 2019 published a roadmap which can therefore imply value will be derived from the efforts of the Fantom Foundation to add profit to FTM.

The likelihood of this risk occurring for FTM is dependent on the outcome of the XRP lawsuit. This is not a FTM-specific risk, Fantom’s competitor projects which launched via an ICO and offered a roadmap will also likely face this risk.

6. Money Laundering/Terrorist Financing

Chainalysis Report

According to a Chainalysis report from January 2022, $8.6 billion dollars were laundered in 2021. There was also a 1,964% year-over-year increase in total value received by DeFi protocols from illicit addresses, which increases the likelihood of government regulations in DeFi.

Fantom was not specifically named, but falls under the 68% altcoin share of total illicit value received in 2021.

As shown earlier, Fantom’s most popular dApps are DeFi protocols. So there is a high risk DeFi regulations could damage Fantom’s ecosystem. There is also a risk of attempted government sanctions on Fantom and it’s dApps to penalise illicit activity. But it remains to be seen how possible this is due to the decentralised and anonymous nature of Fantom’s node validators and autonomous design of many DeFi protocols.

The Financial Actions Task Force (FATF) anti-money laundering rules only covers centralised systems or virtual assets service providers such as cryptocurrency exchanges. Such exchanges must adhere to FATF’s “know your customer” requirements, where the platforms are expected to know the identity of parties transacting on them. But FATF requirements do not cover financial activities occurring on decentralised systems.

Central Bank Digital Currency (CBDC)

In 2021, the Fantom Foundation announced the “research and development of Central Bank Digital Currency (CBDC) solutions” on Fantom. A CBDC will combat money laundering and offer consumer protections, which can also cause governments and regulatory bodies to see Fantom in a more favourable light.

7. Risks to Consumers/Investors

Institutional Investors

Environmental, Social and Governance (ESG) factors have grown in importance to institutional investors, according to a survey of 100 UK-based institutional investors. Fantom has a highly favourable ESG profile which makes it an attractive proposition for investors.

Environmental

Fantom has been named the “most eco-friendly blockchain in the world”. The entire network has consumed less power in a year than the average American household.

This is due to the Lachesis consensus algorithm and DAG technology providing transaction finality, so nodes do not have to store the entire history of transaction data. Also the validation mechanism requires no miners or energy intensive mining equipment.

Social

Fantom and digital assets as a whole are speeding up the advance of financial inclusion. It is providing access to payment services for millions of people globally who are unbanked or who pay high fees for current financial services, e.g. remittance payments.

Governance

Decisions regarding the Fantom ecosystem development are made using transparent on-chain voting. Votes are weighted according to the amount of FTM held where 1 FTM equals 1 vote.

The benefit of this decentralised governance setup is that the community can provide collective decision-making. Being on-chain ensures transparency and no risk of third party interference.

However one risk is users with more holdings get more votes. As mentioned previously, 57% of FTM tokens are held by 12 whales, so there is a risk that governance can be controlled to suit the needs of a minority.

Also, the first two governance proposals for Fantom involved refunding slashed validators.

Both of these were passed which risks undermining network penalties in the future, as validators may deliberately exhibit malicious behaviour if they know they can recoup their slashed FTM. However, both proposals state the slashings were due to “unintentional incidence” which points towards protocol error rather than node misbehaviour. There has since been no governance proposals for refunds which further strengthens this point.

Retail Investors

Credibility

Credibility in a project is lost when a team is anonymous and lacks communication. However the Fantom team are public and frequently provide updates. Their Telegram and Discord pages are also active and core members respond to questions. I received a response directly from the CTO for a query when researching:

Their credibility is also improved by notable venture capital backing, such as investment from Alameda Research. The announcement states Alameda Research are “collaborating with the Fantom Core team integrating Solana, Serum, Raydium, and other cross-chain products.” Collaborating rather than competing with ‘rival’ chains increases the chance the project will succeed rather than get killed off in a zero sum contest.

However, there are two areas in which Fantom may risk losing credibility among investors.

Liquidity Locusts

The risks for retail investors centre around “liquidity locusts” who utilise new DeFi protocols with high-yields before quickly moving to other opportunities. This mercenary capital can bring liquidity to a network but also remove it just as fast. This means network activity figures could be short lived and not a true representation of the long-term value of the network.

For example, the main driver of an increase in the Total Value Locked (TVL) in October 2021 was driven by Geist, an inflationary DeFi protocol which offered high rewards from Geist token. This caused a sharp increase in TVL but was not sustainable growth due to the highly inflationary token.

Other more recent projects include Tomb Finance, a seigniorage protocol which initially offered 3000% APR. The rewards have since decreased to around 500% APR which has coincided with a decrease in Tomb’s TVL.

Additionally, as part of the Solidily launch it was announced that the top 20 Fantom DeFi protocols would be airdropped an NFT and tokens as initial distribution to kickstart the system. Following the announcement on January 10th, Fantoms TVL went from $6B to $13.6B on January 23rd when the snapshot was taken. Projects such as 0xDAO and veDAO were created purely to amass liquidity to be in the top 20 and receive the airdrop. Since the snapshot, both project’s TVL have fallen 95% and 99% respectively, and Fantoms TVL dropped 30% from $13.6B to $9B (as of February 12th 2022).

The risk for retail investors involves getting caught up in these hype cycles and losing money as liquidity leaves the projects and doesn’t come back. This then has a knock-on effect of Fantom gaining a reputation for “pump and dumps” and investors moving away.

Hacks / Exploits

Fantom DeFi projects have also been subject to exploits. The most prominent example is the Grim Finance exploit in December 2021 which lost over $30 million.

Public blockchain explorer FTMScan shows the hacker transferring the funds to the Spookyswap decentralised exchange (DEX). The hacker then used the privacy protocol Tornado Cash to obfuscate their digital trail. However, funds can still be traced from Tornado Cash and all stolen funds are still visible. Despite this, the funds are unable to be retrieved as the identity of the hacker remains anonymous. Anonymous identities and wallet addresses are a widely publicised problem in crypto, and this is also possible on the Fantom network.

The risk of another exploit happening also remains. Popular Fantom dApps, such as Spiritswap, have a poor DeFi Safety score: