Explained: Polkadot
Polkadot is a new generation blockchain secured by NPoS (Nominated Proof of Stake), a staking mechanism that allows for two types of network actors, validators and nominators, to secure the network.
The validators and nominators share the block rewards and slash penalties if misbehaving validators are detected. The staking design will be further explored in the Polkadot tokenomics section of this article.
The Polkadot blockchain was designed to facilitate cross-chain communication that allows for Substrate-based blockchains to scale independently.
Substrate is an open-source framework that lets you build entire, configurable blockchains in minimal time.
This design was created to support blockchains with specific features and use cases to coexist in an ecosystem that allows them to communicate efficiently.
This can power a network of applications that run on their own optimized blockchain but still allow the transfer of tokens between them.
Therefore the Polkadot multi-chain design provides the platform for blockchains using the open-source Substrate framework to easily connect to and benefit from the security of the larger system.
The components that make up the Polkadot blockchain system are:
Relay Chain
The main component of the system; The Relay Chain provides the shared consensus between the parachains and facilitates cross-chain interoperability. The Polkadot wallets, accounts, and governance are all structured in the Relay Chain framework.
Parachains
The individual Substrate-based blockchains that connect to the Polkadot platform via available “slots”.
The parachain’s team and community are then responsible for leasing the available slot using the DOT native token. We will explore slots more in the tokenomics section.
Parachains are free to use their own token in their platform for transaction fees, and other economic activity pertaining to their own blockchain.
XCMP (Cross-Chain Message Passing)
The common framework used in Substrate based blockchains to communicate with each other. The XCMP framework enables smart contracts in each individual chain to understand a standard logic for representing the unique assets and messages between them.
Collators
Collators facilitate the different parachains transactions by maintaining a full-node of the parachain blockchain and the Polkadot Relay Chain.
Collators must be incentivized by the individual parachain in order to be rewarded for the service provided to them. Parachains may reward collators with their own token or transaction fees.
The Polkadot system has no set rules on how collators are incentivized to work with the parachains and it’s up to the parachains to provide an economic incentive to attract enough collators to their blockchain.
Bridges
Blockchains that are not built on the Substrate framework, like Bitcoin and Ethereum, use specialized bridge contracts or modules to connect to Polkadot.
Parachains can host the setup of the bridge to allow for tokenized versions of the “bridged” chain to be represented on its Substrate blockchain and therefore be compatible with the larger Polkadot ecosystem.
Value Proposition
Blockchain Platform
Polkadot provides the blockchain ecosystem with a new blockchain framework to build decentralized applications with interoperability allowing builders to create specialized use cases that can scale independently.
The upcoming applications built on the Polkadot Substrate framework will be able to operate in the best blockchain environment for its use case and still benefit from the greater blockchain ecosystem.
Cryptocurrency Asset
The DOT token use case facilitates the security of the network and the more applications built on top of Polkadot the more DOT tokens are put to use in the platform for the leasing of parachain slots.
DOT token holders can, therefore, benefit from the Polkadot ecosystem's overall growth.
Blockchain Research
The Polkadot Substrate framework gives blockchain researchers a new framework to test concepts and applications.
Software developers familiar with the popular developer languages like WebAssembly (Wasm), and Rust can build smart contract applications, which makes it easier to experiment than Ethereum’s smart contract native language Solidity, which not many developers have experience with.
Use Cases
Smart Contract Applications
Polkadot was built from the ground up to be a smart contract first blockchain.
The Substrate framework currently supports EVM (Ethereum Virtual Machine) that allows developers to migrate their Ethereum Dapps instantly to the Polkadot platform.
More modern languages like WebAssembly (Wasm) and Rust are being integrated that will allow developers to build smart contracts faster because of the languages’ familiarity.
Cross-Chain Transactions
Blockchain interoperability is a key part of the Polkadot platform, allowing each application to be built on its specific blockchain but still allow interoperability.
Currently, the most popular blockchain applications are causing the Ethereum network to become congested, and those same applications on a platform like Polkadot would divide the stress between the different connected blockchains.
The specialized Substrate blockchains can reach 1000 TPS (transactions per second) according to a recent Gavin Wood presentation.
For example Tether (USDT) can live on its own blockchain and USDT token transactions between users can be independent of other token transactions.
When USDT users wish to trade on Uniswap a separate Blockchain they would then deposit to a cross-chain contract for its value to be credited on the Uniswap Blockchain.
The Uniswap blockchain would then be configured to handle its specialized transactions with the USDT token and other tokens sent over the same way.
Scaling Solutions
Parachains are free to configure the consensus model that affects its own blockchain security and speed allowing them to scale more easily since they are just an interoperable independent chain.
Specialized use cases like DEX’s and lending platforms would, therefore, be operating independently not affecting each other’s transaction load.
Staking Rewards
The native currency DOT is used to stake the different components of the Polkadot system that secures the web of interconnected Substrate blockchains.
The DOT token holders are then incentivized to stake and participate in the governance of the platform to be rewarded additional DOT tokens from the protocol block reward mechanism.
DOT Tokenomics
Staking
Nominated Proof of Stake (NPoS) is the consensus mechanism used to create and validate blocks in the Polkadot blockchain.
There are two staking roles in the system - Validators and Nominators, that together create a staking pool. Staking pools are then rewarded with the block rewards and transaction fees generated by the system.
Validators
The validator role verifies the blocks and provides consensus in the staking mechanism. Validators are required to run a “validator node” and “bond” DOT in order to be selected as a validator and participate in staking.
The DOT bonded by validators is locked for 28 days. The amount of DOT required for bonding to become a validator is dynamic and depends on the amount of “bond” being put behind other validators that wish to participate in staking as well.
Nominators
Nominators are DOT token holders that wish to participate in the staking mechanism but do not have the technical means or want to bear the responsibilities of maintaining a validator node.
Nominators can stake their DOT behind live validators.
The staked DOTS by Nominators are locked for the staking period and can be “unstaked” after a 24 hour wait period is completed.
Nominators can select up to 16 validators to “nominate” their stake too.
A nominator bears the same slashing risk as a validator, therefore it’s important for Nominators to choose their Validators carefully, more on slashing risk later down the article.
Staking Rewards
Validators and the Nominators backing together create a validator pool. The validator pools are rewarded from the Polkadot's new DOTs created on each block (10% inflation designed for the first year).
All active validators are equally distributed the block rewards, regardless of how much DOT the validator has bonded or staked to them by the Nominators.
Validators then set a “validator payment” parameter that divides the block rewards collected to the nominators backing them.
For example, a 20% validator payment allows the validator to keep 20% of the share and distribute the other 80% to the Nominators proportionally according to the amount of DOT staked in the validator pool.
In effect, this reward mechanism incentivizes Nominators to stake Validators that have a lesser amount of DOT staked to them since this allows the Nominators stake to collect a larger share of the Validators reward from the “validator payment” share.
The second benefit of this reward mechanism is that the system will avoid a concentration of power behind a single validator pool because the nominators can earn more with equally trustworthy validators that have fewer nominators backing them.
The Polkadot system will also award staking inefficiencies to the platform’s treasury fund. Staking inefficiencies happen when less than or more than 50% of the total circulating DOT is staked/not staked which in turn causes the deviated designed inflation to go to the treasury.
Slashing
When a validator misbehaves the validator and their nominators will get slashed by losing an equal percentage of their bonded/staked DOT.
There are 4 levels of security threats that can slash the staking pools from 0.1% to 100% according to the severity.
All slashed DOT is transferred to the treasury wallet where they can be used or transferred back to the staking pool in the case of a system error and the slash needs to be returned.
Transaction Fees
The Polkadot blockchain charges transaction fees in DOT for transactions performed on the Relay Chain. These transactions can pertain to DOT token transfers, staking actions, governance participation and the setting of on-chain identities.
Relay Chain transaction fees get distributed at 20% to block producers and 80% to the treasury fund pool.
Parachain transaction fees are not required to be denominated in DOT, and each parachain is able to set up their own transaction fee economic model.
Identity
Polkadot accounts can set up an on-chain identity that can store and display fields like legal name, display name, website, twitter handles, and more.
Identities serve as a way for validators to make their profiles public to nominators. The cost to create the identity requires DOT to remain locked and not spent.
The amount of DOT required is not yet clear and has to be first decided by the governance council.
Registrars
Registrars are private entities that can attest to the on-chain identities submitted by account holders.
Registrars can specialize in certain fields like business identifications and GPG keys.
The registrars can charge their own prices and build a reputation in the ecosystem for doing the right due diligence.
In order to become a registrar, a proposal must be submitted to the governance platform and be voted on by the community.
Treasury
The Polkadot blockchain platform has a treasury pool that collects funds from the transaction fees, slashing events, and staking inefficiencies.
The treasury funds can be spent by anyone in the community as long as their proposal of the use is approved by the council.
Users that submit a proposal have to deposit 5% of the requested amount, and if the amount is denied the deposit is burned or kept in the treasury according to governance rules at the time.
This burn proposal mechanism for how treasury funds can be used was made to avoid spam submissions and allow for real thought out proposals to be openly discussed in the community before being submitted.
Governance
The Polkadot system's main use case for DOT is to participate in the governance of the platform, where network participants vote on protocol fees, network upgrades, and the addition or removal of parachains.
Governance proposals that can be submitted by any DOT token holder or council member. A single proposal is then put up to a referendum that happens every 28 days that allows all DOT token holders to vote on the proposal options of “aye”, “nay”.
Each vote is weighted by stake and locking period. Voters that decide to lock their stake for longer are rewarded with additional voting power and voters that do not lock their stake have their votes counted by 0.1.
Lock periods are counted by 30 days with a maximum of 180 days, which stands for 6 periods, and each period allows for a multiplier in the voting power.
For example, a locking period of 2 would lock a voter’s stake on the proposal for 60 days and multiply its voting stake by 2. Therefore a staking balance of 50 DOT would count as 100 DOT.
In contrast, a voter with 50 DOT that did not lock their stake would only count as 5 (50 x 0.1).
DOTs that are bonded and locked in governance can still participate in further proposals and the locked period left is applied to the new votes staking power.
Locked DOTs in governance can also continue to participate in the staking mechanism and the tokens are only prevented from being transferred to another wallet.
Parachain Bonding
Parachain’s require DOT’s to be bonded in the Relay Chains “parachain slots” to prevent ghost chains with 0 economic value from spamming the Polkadot multi-chain platform.
The slots are auctioned off in 6-month increments with a maximum of 24 months, therefore 4 slots can be bid on in a single auction.
All of the Bonded DOT’s are returned when the lease period ends.
The bonded DOTs in a parachain’s lease will be locked for the time of the lease and will not be able to participate in the staking mechanism, account transactions, or other parachain leasing auctions.
Bonded DOTs are still capable of participating in governance voting.
Parachain Economics
Parachains in the Polkadot multi-chain system are free to set up their own token economics.
The parachains must have a big enough incentive to attract validators to take on the role of Collators to their chain.
Collators run full-nodes of the parachains and incur hosting and other technology costs.
Therefore parachains must have their own blockchains token with economic value to award Collators to provide consensus on their chain.
The Current Status of Polkadot
Polkadot reached its “transferability block” on August 18 that allows ICO participants to freely transact on the network, and because of this exchanges have started to list the DOT token in their order books.
Now that the network’s Relay Chain is fully live, token holders can interact with it via Polkadot JS.
Token holders can stake their holdings to secure the network, which over 50% of the token holders have already chosen to do.
DOT token holders can also participate in the governance proposals through the same interface, currently, there is a referendum to vote on the maximum number of validators that should remain active on the network.
With the Polkadot Relay Chain fully live the next step is for a governance referendum to enable parachains.
Parachains will bring Polkadot's main functionality on-line that will allow projects to launch their blockchains on the Polkadot system and add the additional functionality to the DOT token of being bonded to parachain slots.
This next phase in Polkadot’s development is the most anticipated from the overall crypto community because there are already dozens of projects that are expected to launch as soon as the parachain slots become available.
There is no set date for when the next parachains slots become available.
In the next Polkadot article, we will explore the most popular Polkadot projects waiting to launch.
