Research series
The state of Polkadot
This is the ninth post in our research series. In this series, we publish data-driven analysis on specific blockchains, dapps, and market segments. Let’s dig in!
Topic: Polkadot, a security and interoperability protocol for blockchains and dapps.
Polkadot is a network of blockchains that aims to provide a scalable, interoperable and secure backbone to the decentralized web. The network’s core blockchain was launched in May 2020. Currently, the network is growing as more blockchains are being rolled out.
This article provides an overview of the project and looks at its historical performance using Token Terminal’s data.
Purpose
Polkadot’s goal is to make blockchain technologies scalable. It aims to achieve this by building a network of application-specific blockchains and giving developers the required tools for building applications on them. By performing computation in parallel across independent blockchains, it scales significantly better than individual blockchains like Ethereum.
Problem
The total crypto asset market capitalization has grown to over a trillion USD over recent years. However, blockchains have struggled to efficiently scale to meet the increased demand, greatly hindering the growth of the industry. Modern blockchains can not efficiently process tens of thousands of transactions per second to serve millions of users across a diverse ecosystem of interconnected applications.
Solution
Polkadot is a network of two kinds of blockchains: the relay chain and parachains.
The relay chain is the core of the network. It is a nominated proof-of-stake blockchain responsible for providing security to the network and coordinating its functionality as a whole. The relay chain has minimal functionality by design and does not support smart contracts.
Parachains are application-specific blockchains that connect to the relay chain. They can be customized to serve the needs of the applications running on them. The only requirement is that the parachain must be able to generate a proof of its state in the required format. Parachains are able to process transactions in parallel, hence the name.
External blockchains, such as Ethereum, can connect to the network by using parachains that function as bridges.
The relay chain’s native token is DOT. It is used to pay for transaction fees on the relay chain, its holders can participate in the governance of the network, and it needs to be locked to connect a parachain to the relay chain.
Why now
Interest in blockchain technologies has grown exponentially over recent years. Decentralized finance (DeFi), non-fungible tokens (NFTs), and other blockchain applications have grown from fringe movements to multi-billion dollar industries. The demand for scalable blockchains and decentralized applications (dapps) is higher than ever before and investors are willing to fund teams building scalable blockchain technologies.
Market
Polkadot is a network of blockchains on which dapps can be deployed. Ethereum, launched in 2015, was the first blockchain to support dapps. Since then, many other blockchains supporting dapps have been launched, especially over the previous two years. Ethereum continues to be by far the largest one, containing over 60% of the total value locked. The sector’s valuation grew rapidly until the bear market of 2022.
Competition
Polkadot competes with other blockchains and networks of blockchains. Its closest competitors include relatively new blockchains that have higher throughput than Ethereum, such as Solana, Avalanche, and Fantom. Cosmos is an example of another project that aims to build a network of interoperable application-specific blockchains. Ethereum’s future upgrade will also introduce sharding (i.e., parallel processing of transactions across separate blockchains known as shards) to make it more scalable.
Product
Polkadot is a network of parachains that connect to the relay chain to leverage its security, consensus mechanisms, transaction settlement functions, and connections to other parachains. In addition to Polkadot, there is also Kusama which is a Polkadot’s early release that functions as a live testnet and stand-alone blockchain network. So far, 19 blockchains have secured a parachain slot on Polkadot and 31 on Kusama.
Currently, the relay chain has approximately 100 parachain slots. Auctions are held to determine which projects get a slot. In the future, the relay chain will also support parathreads that are conceptually similar to parachains. However, unlike parachains that are connected to the relay chain continuously, a parathread can be used to connect to the relay chain for a short amount of time using a “pay as you go” model.
To facilitate the development of parachains, the company behind Polkadot has developed Substrate, a modular software framework for building blockchains.
Currently, Polkadot is still in its launch phase which will be considered to have been completed once the parachains on the auctioned parachain slots are live. After launch, the project’s main focus will be on growing the network.
Business model
Polkadot generates revenue by charging fees for transactions on the relay chain. After the launch of parathreads, Polkadot will also generate revenue by charging fees for connecting to the relay chain on a block-by-block basis.
Team
Polkadot was founded in 2016 by the computer scientist Gavin Wood who was also one of the co-founders of Ethereum and the inventor of the smart contract programming language Solidity. Research and development of Polkadot is coordinated by the Web3 Foundation. The development of Polkadot is managed by a London-based company Parity Technologies.
Polkadot is very well funded and supported by well-known crypto investors. In the initial public sale of DOT, the Web3 Foundation raised 145 million USD worth of ETH. However, in an exploit targeting the multi-signature wallet of Parity Technologies, nearly 100 million USD worth of ETH was lost. In June 2019, the Web3 Foundation sold another 50 million DOT to private investors.
Financials
The initial total supply of DOT was 10 million. However, in a community vote, the total supply was increased to 1 billion and DOT holders’ account balances were increased by 10x. DOT does not have a maximum supply. The inflation rate (currently around 10%) depends on how much DOT has been staked. The figure below shows the circulating market capitalization of DOT.
The figures below show transaction volume on the relay chain in USD and DOT. The changes in transaction volume have mainly been driven by changes in the price of DOT.
The figures below show transaction fees on the relay chain. 20% of the transaction fees are paid to the block producers (i.e., supply-side participants) and 80% are deposited in the Polkadot treasury that is governed by DOT holders.
The success of Polkadot will ultimately depend on the whole network of blockchains. Therefore, developer interest in the tools they provide is crucial. To get a rough estimate of developer interest in creating parachains, we can use the number of times Substrate has been starred (i.e., bookmarked) on GitHub, shown in the figure below.
Conclusion
Polkadot aims to build a network of efficient application-specific blockchains to enable blockchain innovation and mass adoption. Given its technology and funding, Polkadot is in a good position to become a major hub in the multi-chain future.
Check out previous posts on Centrifuge, Lido, Arweave, Euler, Ribbon, Cosmos, Ethereum Name Service, and Optimism.
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This newsletter is meant for informational purposes only. It is not meant to serve as investment advice. Please consult with your investment, tax, or legal advisor before making any investment decisions.
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