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Polkadot and Its Parachains

By July 13, 20217 minute read

This is written by an external blogger, the views and opinions expressed within the post belong solely to the author

In 2021, every other project in crypto is trying to solve some sort of “scalability problem” according to their whitepapers, but most projects don’t even have the users or the potential to have a scalability problem in the first place, so forgive me for taking a step back when a project touts this as their USP straight out of the gates. However, every now and then, some projects come up that are truly worthy of everyone’s interests. Polkadot is one of those projects. In this article, I will try and explain what Polkadot is and why you should be keeping an eye on it. 

The original Polkadot Whitepaper was released in 2016. Polkadot is the brainchild of Dr. Gavin Wood, a very important figure in Ethereum’s early history and one of crypto’s best-known faces. Dr. Gavin Wood was co-founder, initial CTO, and core developer of Ethereum. He coded the platform’s first implementation, wrote its formal specification, and invented the Solidity smart contract programming language that is still one of the most widely used coding languages for most new DeFi projects. While still at Ethereum, he founded Parity Technologies, the company that developed the Polkadot Network, the Substrate development framework, a multi-signature wallet, among other technologies. It’s fair to say, Dr. Wood is a bit of an overachiever. 

In the summer of 2017, Wood and Parity’s Peter Czaban co-founded the non-profit Web3 Foundation to support the research and development of decentralized web software protocols. In October of 2017, in the middle of the 2017 bull run, the Web3 foundation conducted the Polkadot public sale and raised an incredible $145 million, making it one of the largest ICOs at the time. Unsurprisingly, Parity Technologies was chosen as the company to develop the Polkadot network. Parity also made the multi-signature wallet mentioned above, which was the same wallet that was used to store Polkadot’s treasure chest of ICO funds. 

Just 10 days after the fundraiser, Parity was attacked for the second time in three months, and Web3 Foundation’s ICO wallet was affected the worst, with 2/3rds of their funds, or approximately $90 million at the time being permanently frozen. Other users lost access to their crypto too, and in total, 513,774 ETH, along with some other tokens, were frozen and lost. Despite this, Web3 announced that they still had enough funds to develop Polkadot, and they marched on. Polkadot ended up raising more funds from private investors in 2019 and 2020 on two different occasions. So why have public and private investors been throwing money at Polkadot even after losing a huge amount of funds? Let’s have a look.

According to their lightpaper, Polkadot defines itself as “a next-generation blockchain protocol that unites an entire network of purpose-built blockchains, allowing them to operate seamlessly together at scale.” That’s a bit of a mouthful, but in simple terms, it’s a multi-chain framework platform that’s designed to offer interoperability and scalability for the blockchains built on top of it. It’s a platform for blockchains. 

Polkadot is developed using the Substrate blockchain development framework, which means that Polkadot-based chains and applications are compatible with other Substrate based chains. It is one network built with a collection of several blockchains, or a sharded blockchain. It connects several blockchains to one main chain.The shards are all different nodes running different logic, so each one is its own platform. The shards are able to exchange messages and data, not just tokens like other platforms that offer interoperability. 

The network is made up of three main elements, namely – 

  1. The Relay Chain – this is the heart of the polkadot network which is responsible for security, its consensus mechanism, and the cross shard interoperability
  1. The Parachains – these are the sovereign blockchains in the network that will have their own token and will be optimised for their own use cases. 
  2. The Bridges – these are special blockchains that will allow the Parachains in the Polkadot ecosystem to communicate with external networks like Bitcoin and Ethereum.

Using the Parachain system also means that Polkadot can remove a large number of scalability bottlenecks that haunt a lot of current networks. In most other blockchains, the transactions happen in a sequence, thus creating a chain. With Polkadot’s shards, transactions can run in parallel with each other, without fear of collision.

Polkadot’s Consensus Mechanism

The foundations of Polkadot, with Dr. Gavin Wood leaving the Ethereum foundation due to disagreements about the direction Ethereum was going in only makes it absolutely clear how important the consensus mechanism is for a layer one solution. The most important aspect of a good consensus mechanism is the absolute finality of the decision the system reaches. 

The state of the Polkadot network is decided by four distinct elements, namely –

  1. Nominators – they are basically tasked with securing the relay chain by trustworthy validators. They will have to stake DOT tokens in order to be a nominator.
  2. Validators – the validators are nodes that are also tasked with securing the relay-chain by staking DOT, validating proofs from collators, and participating in consensus with other validators.
  3. Collators – these elements are tasked with maintaining the transactional states in the individual shards, or Parachains. They would then forward this with proof on to validators.
  4. Fishermen – the last set of components are the fishermen. They are tasked with monitoring the network and reporting bad behaviour to validators. Collators and any parachain full node can perform this function. 

Polkadot has opted for a unique, hybrid proof-of-stake system when it comes to the actual consensus mechanism used. The system consists of two parts, GHOST-based Recursive ANcestor Deriving Prefix Agreement, or GRANDPA, and Blind Assignment for Blockchain Extension, or BABE. By combining these two mechanisms, Polkadot allows for blocks to be rapidly produced. The slower finality mechanism runs in a separate process to finalize blocks without risking slower transaction processing or stalling.

Polkadot also has a very advanced governance system. Traditionally, when there are updates that are required to be made to a blockchain, a Fork is required. The new blockchain with the updates needs to be forked away from the old blockchain and all of the nodes have to agree to run with the new code. If they don’t agree, the blockchain has to split into two separate chains, like the Ethereum hard fork which split the network into the current Ethereum blockchain and Ethereum Classic. Polkadot, however, has developed a system that’s able to completely bypass forks, and the blockchains can update themselves without the need for any human intervention. They have a system of on-chain voting mechanisms built into the main relay chain. At the same time, each of the individual Parachains have the ability to come up with their own governance system according to their needs. The native token, DOT, is used to participate in governance decisions.

The DOT Token And its Economics

The native currency of the Polkadot network, DOT, is used for three main purposes, staking, fee payment, and bonding and governance. 
In their staking system, game theory incentivises token holders to behave in an honest way by rewarding the good actors and punishing the bad ones. Their fees system is used to pay the transaction fees. Users need to pay DOT to the Validators in order to ferry messages to the other parachains. The third use-case for DOT tokens is to act as a bond. If you want to create a new Parachain, you have to tie up some DOT tokens in a bond. When some Parachains become outdated or aren’t used anymore, they’re removed from the network by withdrawing those bonded tokens. Finally, we have the governance component. DOT tokens are used to control the network through on-chain governance. Those who hold the tokens would vote on important proposals like network fees, Parachain auctions, protocol and schedules, and even upgrades and fixes.

When DOT was initially sold in 2017, the total supply was 10 million. However, on August 21, 2020, after one of their first on-chain governance votes, the DOT token was redenominated by a factor of 100, which means the supply was increased from 10 million DOT to 1 billion DOT.  The total supply for DOT is not capped, which means any amount of tokens can be minted. Polkadot says they currently target an annual inflation rate of 10%. A portion of the newly minted tokens goes to the Validators of the network, and the rest goes to the Polkadot treasury, which can be used for future developments voted on by the community. 

Now, basic economics dictates that if the supply is constantly increasing, there would be sell pressure and the price would go down. However, there are some counter-forces on the supply side that help solve this problem. Like we saw in the token use cases, both the Validators and the Parachain operators need to lock up their DOT in the form of staking and bonding. This takes out a considerable amount of tokens from the circulating supply. On the other end of the equation, the demand for DOT tokens increases when the network gains more participants that need to buy DOT to pay network fees. In most cases, reduced supply and increased demand is going to result in positive price action long term. 

In conclusion, Polkadot is a project meant to solve problems long-term, and even after the few initial hiccups with Parity, they’ve come out on top. It’s run by some of the smartest people in the business, and they have got more than enough funding to make things happen. They’re not the only ones in the space, however. They have some serious competition from projects like Ethereum, Internet Computer, Cardano, etc. If they could capture enough network effects to come out on top of everyone, it would be an interesting race to witness.

About Guest Blogger (Parv)

Parv is a blockchain and cryptocurrency researcher, investor, and entrepreneur. He is the founder of Estate Protocol, a marketplace that would have real estate-backed NFTs. When he isn’t occupied with crypto, he enjoys reading, traveling the world, and meeting new people. You can check out his LinkedIn profile here
Disclaimer: Cryptocurrency is not a legal tender and is currently unregulated. Kindly ensure that you undertake sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section doesn't represent any investment advice or WazirX's official position. WazirX reserves the right in its sole discretion to amend or change this blog post at any time and for any reasons without prior notice.
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