How Does Polkadot Capture Value with the Economic Model?
Background
Even if the craze for public chains abates, some continue to stake their claim to the market.
In retrospect of the enthusiasm last year, all public chains took incentive measures to attract funding for its growth. Ideas like giving red packets to get people engaged in the building of the public chain ecosystem proved effective and productive. As a result, the total value locked in some public chains such as Avalanche and Polygon soon surpassed one billion dollars.
As these campaigns go on, we also see the sound performance of the tokens carried by the public chain ecosystem. Other public chain followed by appealing to users in similar ways. Against this backdrop, as a mainstream public chain, Polkadot seems to be missing in this race.
The reasons are multifold. Polkadot is still in its infancy. More importantly, its special architecture and positioning entail a different development path. Naturally, Polkadot captures value in a way different from others. How should we then determine the value hosted by Polkadot? Will ideas like giving red packets work on Polkadot?
How does Ethereum get its value?
As DeFi and NFT stay hot, Ethereum has now become the largest blockchain platform, with its market cap surging accordingly and getting closer to Bitcoin’s.
The strong momentum is a result of not only Ethereum’s prosperous ecosystem, but also its well-designed economic model.
The Ethereum network supports the transfer of its native currency ETH and tokens of Ethereum-based projects. However, a gas fee must be paid in ETH for each transfer of these tokens. Likewise, many public chains have adopted a similar approach to Ethereum’s which is its secret to easy value capture.
After a long start, Ethereum has gradually structured its own ecosystem. Most importantly, as applications of DeFi and NFT progress, a large number of projects and participants have emerged on Ethereum, and developers are also constantly using the platform. It is now a gigantic pool of resources including talents, users and money, which is testimony to Ethereum’s network effect.
A gas fee must be paid in ETH in order to perform any function in this resource pool. As most users choose to stick to Ethereum, this becomes a continuous need. Besides, new projects gravitated towards the users and resources on the platform will likely generate new demands and a sizable market.
Such an economic model as Ethereum’s, therefore, can be regarded as a “taxation model”. Anyone who wants to use the super computer of Ethereum must pay the gas fee in ETH for the use of any project on the platform.
The logic behind this way of value capture is that when there are quite a few mature applications in the ecosystem which are usually accompanied by early dividends, there will be needs to use these applications. As the demand increases, a larger amount of ETH will be paid as the tax. Hence, greater demand and higher value for ETH.
In this economic model, even users of successful applications on Ethereum have to pay. Such a design will certainly enhance the value of the token. The whole blockchian ecosystem of the project, however, could be heavily burdened. In a nutshell, speculators win, users lose.
What is the value of Polkadot?
Unlike most public chains, the architecture of Polkadot is different from ordinary projects. Not surprisingly, its economic model is designed in a distinct way.
Other public chains will refer to the economic model of Ethereum in their design, because they believe that many designs of Ethereum are mature, tested and feasible.
Polkadot, however, is different. Gavin, the creator of Polkadot, knows best about Ethereum and its problems only too well. Holding that a tax design like Ethereum’s is irrational, he abandoned this idea when designing Polkadot.
When using the project in the ecosystem on public chains like Ethereum, users pay not only the token for services and functions, but also ETH to the network.
In Polkadot, however, projects exist independently in the ecosystem, and the economic model can be tailor-made. Any user of Polkadot ecological projects can perform the function without paying any gas fee to the network. The only payment they need to make is the token for the economic design of ecological projects. It is just one payment, and the transaction fee could even be reduced to zero. This will encourage wider use of the platform.
Why the difference in the design between Ethereum and Polkadot? Created on top of Bitcoin, Ethetheum is essentially intended to make money programmable. Its introduction of ETH is only for transaction fee payment to prevent spam transactions. In other words, it is just an anti-spam technique.
Thus, Ethereum was originally designed on top on Bitcoin and followed its footsteps. It is an innovation based upon Bitcoin to make blockchain technology easier. Nevertheless, similar problems come with similar designs. In spite of its successful innovation in smart contracts, the economic model of Ethereum is designed in a way that makes users pay high gas fees, which is an extremely unpleasant experience.
Gavin thought of this and managed to address the root cause in his design of Polkadot. He adopted another mechanism to deal with the spam. For example, with the ID system connected to the oracle, we no longer need to set so many fixed elements. Consequently, there is no setting of account or currency on Polkadot. Users no longer need to worry about gas fees or pay DOT for any function they use.
Polkadot was originally designed to be more universal, flexible and customizable. It reimagines the blockchain technology from bottom up. What comes from the original aspiration of a creation might in the end be the real key to the problem.
Fortunately, Gavin is such an idealist and practitioner, just as Elon Musk and Steve Jobs.
Thanks to his design, users in the Polkadot ecosystem can use the applications in an easier and less expensive way, but this adds little value to Polkadot itself. Compared to the economic model of Ethereum, Polkadot makes users win and speculators lose.
That being said, there is no need to be over-concerned. This logic does not completely apply to Polkadot since its architecture and design are more complex. For this reason, its way to gain value is less explicit. This might be why many Polkadot participants are long confused about how it gets value.
How does Polkadot capture its value?
1. Proof of interoperability
The story of how Polkadot captures value all begins with its main function: interoperability, also know as crosschain composability.
Polkadot consists of relay chains and parachains. Parachains exchange information through the slot on the relay chain. Public chains with a non-parachain structure could only realize the crosschain composability through reconnecting to the relay chain using the bridge. Therefore, a slot on the relay chain gives access to the crosschain composability of Polkadot.
Slots are assigned by parachain slot auctions in which projects need to bid by staking DOT. Auction winners can use the parachain slot for a period of 24 weeks to 96 weeks. When the slot lease expires, the bonded DOT are released back to the original owners, and the slot is then ready for another auction.
When leasing the slot with DOT, participants are in fact paying the opportunity cost of the bonded DOT in exchange for the token of their favored parachain project. Parathreads, on the other hand, adopt a “pay-as-you-go” approach for crosschain information exchange, which means that participants make actual payments in DOT.
The two models above are part of how Polkadot gets value. Namely, projects or individuals need to use DOT to realize the crosschain composability. This suggests that well-developed parachains can encourage wider participation from developers in the Polkadot ecosystem and drive more quality projects. A significantly greater demand for DOT as these projects develop will help Polkadot gain more value.
2. Sufficient demand for crosschain composability
Once the need for crosschain composability is proven to be a huge market, some cryto assets with extensive consensus such as BTC and ETH or stablecoins such as USDT and USDC will cross-chain to the Polkadot ecosystem via the bridge, engaging in various applications. This will also drive the demand for crosschain composability, which then creates stronger demands for DOT. Hence, more value for Polkadot.
3. DOT usage scenarios of common good parachains
Another approach for Polkadot to capture value in the future is through the common good parachain. Since such parachains do not seek to have its own native token, DOT can be used for circulation or the design of the economic model.
Take the Statemint which issues assets such as CBDC, tokens, stablecoins and NFT as an example. The wellbeing of the Polkadot ecosystem will increase the volume of assets issued by Statemint, which then creates a tremendous demand for DOT and helps DOT capture massive value.
4. Important endorsement assets in the Polkadot ecosystem
In addition, as the most credible asset in the Polkadot ecosystem, DOT is becoming the asset for endorsement for many projects on parachains, similar to the role of ETH to DeFi on Ethereum.
It’s like the fact that in addition to its industrial use value, gold has added a new attribute as a trusted asset, so that its financial value has been increased, and its price has improved qualitatively. And this is why ETH will rise with the DeFi boom.
As the Polkadot ecosystem gradually develops, the need for DOT will catch up. The value of DOT will be closely related to the prosperity of the ecosystem.
But the most important thing is that, in general, the ecosystem of one public chain is only empowering one coin. Since Polkadot is Layer 0, it has many parachains which are Layer 1. If the DeFi on each parachain has a demand for trusted assets for DOT, then there will be 100 parachains jointly empower DOT, and the empowerment brought by Polkadot ecosystem to DOT will be at least several times the effect brought by a single chain.
Summary
Polkadot captures value in a more long-term way which least burdens the ecosystem, whereas the design of public chains like Ethereum directly enhances the value but undermines the ecosystem. Things should become cheaper, faster and easier as the they evolve.
Despite its gigantic size, the value capturing of Ethereum feeds on the entire ecosystem, which is against the law of development. The history of Internet bears testimony to this. If every user needed to pay Amazon a transaction fee when buying products from the retailer on the platform, Amazon would not be where it is today.
The value capture method of Polkadot transfers the pressure to the project itself, and this is why parachain slots are acquired through auctions for a maximum lease of only two years. What Gavin has been trying to do here is to use this mechanism to test the project. If the project progresses smoothly, it can renew the lease. If that’s not the case, the project will have to return the slot and switch to parathreads. Challenging as it is, it drives the survival of the fittest, in particular, eliminating projects which just want to maliciously seize money after the first auction. As a result, only quality projects can stay in the Polkadot ecosystem.
Polkadot through a different lens
That said, the value capture of Polkadot can be viewed from another perspective similar to the valuation model of the Internet platform. For instance, some Internet platforms have increasingly higher valuation and keep receiving funding even if they are not making money. This is because that they do valuable things and have network effect. Their potential grows as the Internet grows in the long-term.
Similarly, what Polkadot does is to link all blockchains as a major infrastructure of the industry. As it benefits the long-term wellbeing of the blockchain industry, what it does becomes highly valuable, and the value it captures grows as its ecosystem develops. In the vast Polkadot ecosystem, in addition to plentiful parachain projects, each parachain can grow its own ecosystem. Therefore, Polkadot will foster an ecological cluster with a size far beyond the scale of other public chain ecosystems. Hence, extraordinary network effect.
Such network effect will influence the new entrants. When there are sufficient parachains, applications, users and money in the Polkadot ecosystem, teams of new projects prefer to release projects directly in the ecosystem, or link to this immense network via the bridge. As a consequence, the network effect of Polkadot gets continuously enhanced in this virtuous cycle.
At present, dozens of parachain projects are running on Kusama, some of which have already developed early stage ecosystems. This promising progress on Kusama reaffirms the confidence in the Polkadot ecosystem. Allowed time to develop, Polkadot will strike those who only care about the price instead of the potential of the ecological projects. When that day comes, Polkadot will be brought into the spotlight of an increasing number of people who will have higher expectations for it, just like what happened to Amazon.
Polkadot ecosystem is speeding up
The Polkadot team is acutely aware that Polkadot can only grow with the projects in the ecosystem. So, they are also taking various measures to support the Polkadot ecological projects.
For example, a new version of Grants with the cap removed, more hackathons to encourage and promote projects, and intensive promotion of “Builders For Builders”. The last example is an initiative that shares best practices of the Substrate Builders Program with parachain teams to support their projects, and empower them to develop their own ecosystems and thriving community of builders. This will enrich the Polkadot ecosystem as a whole.
Polkadot is constantly evolving
The discussion above is only a review of current observations in aspects such as the crosschain composability and common good parachains of Polkadot. More possibilities await with regard to the scalability of Polkadot, new value of the interaction between parachains and its own functions. For example, the advanced architecture of Polkadot itself brings more possibilities to its NFT ecosystem.
Polkadot’s native NFT standard such as RMRK has more powerful functions than ERC721 and ERC1155 do. Such advanced standards will support better NFT or blockchain games, and therefore boast tremendous potential. Projects evolve, so does Polkadot.
Afterword
As the Polkadot parachain formally kicked off at the end of last year, we embraced a key function for Polkadot, the interoperability (also known as crosschain composability). As discussed above, the prosperity of projects on parachains will contribute to the sound development of the Polkadot ecosystem as it mirrors the important value of Polkadot.
Of course, we will continue to follow closely the development of projects in the Polkadot system, how Polkadot combines with existing mature public chains, and the use cases of crosschain empowerment between them which constitute an important link in the value capture process of Polkadot.
As the famous playwright, Ke Ling wrote in Xiangxuehai (Sea of Fragrant Snow), “ Time, the old man, always takes the same steps. Yet, its significance and value varies.” Time goes by in the same way for Polkadot and other public chains. However, the value and results vary widely. Whether the means matches the end remains a decision of the later generations.
About Us
Polkadot Ecology Research Institute focuses on the research and analysis of Polkadot’s ecological development which was founded in 2020. While delivering professional and in-depth content to users, we’ll keep exploring the value of Polkadot’s ecology.
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