Robonomics Parachain Auction Strategy Review
The overview of potential Robonomics Parachain Lease Offering on Kusama and the implications of illiquidity premium for PLO participants
Parachain Lease Offering in Polkadot and Kusama
Kusama Network, the wild cousin of Polkadot, will soon open its doors to projects competing for the parachain slots. The status of parachain will give a project several advantages including shared security, ability to seamlessly communicate with other connected parachains and use established elements of infrastructure. All of it maintaining the integral computational qualities of one’s own blockchain.
In order to lease a Kusama parachain slot projects need to bond a certain amount of KSM tokens for the duration of the lease (from 6 months up to 2 years). The size of the bond will be determined through a candle auction. At the end of the lease period KSM tokens are returned to their rightful owners. If a project cannot afford to cover the parachain costs on its own, it is offered to participate in the Parachain Lease Offering (PLO) using Substrate crowdfunding module, where KSM holders are proposed to loan their tokens in return for some sort of remuneration. To learn more about obtaining the parachain slot and auction mechanics, you can check out Polkadot blog post and Polkadot wiki page.
Polkadot is pioneering a new economic model for deploying decentralized applications which will come with its own set of incentives and trade-offs. The holders of DOT/KSM will need to decide whether it is more beneficial for them to participate in staking and receive inflation rewards, or to contribute their tokens to projects via Parachain Lease Offering.
To determine a benchmark for DOT/KSM holders’ expected returns we need to look at the existing validation parameters of the network. Currently there is about 10 million of KSM and 1 billion of DOT in circulation, the target inflation rate is 10%. Validation rewards are automatically adjusted so that validators receive all the inflation if active staking amount is at the target 50% of circulating supply. Any deviation in staking amount from the 50% will send the proportional remainder of rewards to the treasury, thus compressing the returns of validators. This Polkadot wiki page covers the topic in more detail.
Using the given parameters, we arrive at 20% annual return in DOT/KSM as staking rewards. The staked tokens are subject to 7 days unbonding period in Kusama and 28 days unbonding period in Polkadot. During the unbonding period DOT/KSM holdings are illiquid and do not earn rewards.
Robonomics Parachain Lease Offering Approach
The first project that outlined its parachain auction strategy for Kusama is Robonomics. Robonomics team has been a longtime participant in the Polkadot ecosystem and expects to get one of the first available parachain slots in the Kusama Network. You can learn more about the Robonomics approach to Parachain Lease Offering in the following blog post.
Robonomics is planning to attract KSM holders to their PLO by allocating $720,000 worth of XRT, Robonomics.Network native token, for the 2-year lease period. To arrive at this figure the team uses the following assumptions:
- Current KSM circulating supply: 10,000,000
- Current KSM price: $30
- Target annual return for KSM holders: 20%
- Target rate of active staking: 50% (5,000,000 KSM)
- Target rate of parachain bonding: 40% (4,000,000 KSM)
- Total number of parachains: 100
- Extra premium for PLO participants: 50%
The calculation logic is straightforward. At $30 KSM price Kusama holders can expect to receive annually at least $24 million from participation in Parachain Lease Offering (the equivalent of staking rewards).
4,000,000 KSM (total target bond) × 30 USD (KSM price) × 20% (return from KSM staking) = 24,000,000 USD
As the total number of Kusama parachains will reach 100, the expected annual cost per parachain should be $240,000. Robonomics is planning to apply for the 2-year lease and provide additional 50% premium to PLO participants, which brings us to the aforementioned $720,000 worth of XRT.
Illiquidity Premium in Parachain Lease Offering
This approach is a good first step in the right direction. By providing the community with a concrete and transparent calculation logic Robonomics team raises a valid question on valuing a parachain slot that the community will have to answer in the nearest future. We see several important aspects in which this approach can further evolve.
Robonomics team decided to use the formula of simple interest in the calculation:
“We do not believe that the formula of compound interest of staking reward accumulation is worth using and is applicable at this time. Robonomics and other parachains will offer DOT and KSM blocking schemes, where the reward will be accumulated either in full at the beginning of the slot lease or in part during the entire lease period, whilst the funds themselves will be transferred to the address of the holder without restricting access to them. This means that making calculations based on simple interest is more realistic and more convenient.”
As staking rewards will always be used as a benchmark for parachain bonding costs, we believe that it will be important to integrate compound interest in the calculation. In a nutshell, returns for the PLO participants should follow a simple logic:
PLO returns = Staking returns (using compound interest) + illiquidity premium for DOT/KSM — liquidity discount for PLO rewards
The illiquidity premium is generally understood to be the increased return received for the additional risk of tying up capital in a less liquid asset. Illiquidity becomes a particular concern when markets start to fall, as investors may be forced to endure large price drops. In traditional markets the illiquidity premium can be illustrated by the shape of the normal yield curve, when long-term bonds provide higher interest rate than short-term bonds.
The illiquidity premium for DOT/KSM arises from prolonged illiquidity for PLO participants. In case of staking, the unbonding period is only 7 days for Kusama and 28 days for Polkadot, while for PLO the bonded amount will be locked for the whole duration of the lease.
The liquidity discount accounts for the immediate nature of the PLO reward. When staking, the rewards are gradually accrued during the whole period of active staking. In case of PLO, particularly in the Robonomics scheme, the rewards will be released immediately.
If we imagine that all 4,000,000 KSM, that are targeted for the parachain bonding, will participate in PLO for 100 parachains, then 40,000 KSM on average will be enough to secure a parachain slot. Switching gears back to Robonomics offering, the PLO participants will exchange their 40,000 of KSM (worth $1,200,000 at the current KSM price), that could grant them a steady 20% annual return, for $720,000 worth of liquid XRT tokens and the ability to receive 40,000 KSM back in 2 years.
If KSM holders would decide to go with staking, they can expect their holding to increase up to 57,600 KSM or $1,728,000 in a two-year period given the fixed KSM price, while benefiting from the asset liquidity. If they favor the Robonomics approach it will immediately grant them $720,000 worth of XRT tokens, that can in theory be converted into yield generating asset and accrue additional $316,800 over two years (using the same nominal return as in KSM). By the end of the 2-year lease period they will end up with $2,236,800 ($1,200,000 + $720,000 × (1.2)²), which is the equivalent of 36.5% annual interest rate.
Given that from the initial PLO allocation of $1,200,000 only $480,000 are becoming illiquid ($1,200,000 — $720,000), the annual interest rate for the illiquid part would equal 58%. This brings us to 38% annual illiquidity premium for participating in Robonomics Parachain Lease Offering, which is significant.
Final Thoughts
In this blog post we have outlined the logic on how we view the economic component of the Parachain Lease Offering. It is important to understand that our calculations are primarily based on hard assumptions involving stability of KSM price and perfect assets liquidity which is usually not the case. This blog post in not an investment advice, and potential PLO participants should consider other risk factors such as their view on the KSM and XRT market price action, and market liquidity for both assets.
Furthermore, as parachains on the Kusama Network will be released gradually over a few years, with no publicly available release schedule, it is impossible to predict the demand for early parachain slots. This alone can significantly alter the logic of the calculation.
We invite the Polkadot community to join the discussion. Fair guidelines for participating in the Parachain Lease Offering will be vital for the long-term sustainability of the Polkadot ecosystem.
