Polkadot: a guide for beginners. Part 1
At Validators, we are currently working on the preparations to become a validator in the Polkadot blockchain. In this post we summarise the information about this blockchain and staking opportunities that is available to date. The launch of mainnet is expected in Q3 2019 and we are looking forward to contributing to the ecosystem.
What is Polkadot?
On the Polkadot website, you will see the following phrase: “Polkadot empowers blockchain networks to work together under the protection of shared security”
So what does it actually mean? What makes Polkadot an attractive project and what problems does it solve?
One of the existing challenges for blockchain projects going really “big” is a lack of interoperability and scalability. Interoperability means that different blockchains can interact with each other and safely exchange data and ensuring consistent results to a user accessing one or another blockchain. Scalability is a big issue in blockchain which is well described by the Scalability Trilemma. Scalability is measured by the capability of the blockchain to process many transactions within an interval of time, i.e. allowing fast operations. Both properties are important for real-life applications: 1) scalability attract more users and can process more data while interoperability makes it possible for blockchains with different functionalities to exchange data and perform common operations (imagine, for instance, a case of insurance payments where interactions of different agents are required).
Polkadot claims to address the issues of scalability and interoperability by providing a basis for the “Internet of blockchains” — a platform for different blockchains to interact while secured by a common consensus algorithm.
In order to understand how these issues are addressed, we first need to look at the proposed structure of Polkadot. Here we have 3 major components: relay chain, parachains, and bridges.
Parachains are parallelised blockchains with different functionalities (for instance, different applications) which are interconnected within the Polkadot network and share the security and achieve consensus through a common greater network’s consensus mechanism.
Relay chain is a “mother of chains” which connects the parachains and help to exchange messages between them whether it is a transaction or any other type of data.
Bridges are specific type of parachains which connect Polkadot chains with the external chains with their own consensus mechanisms and history of transactions. Bridges “enable existing blockchains with their own state histories and methods of consensus to link with Polkadot without having to be a native parachain. For instance, bridges can connect Bitcoin or Ethereum to Polkadot relay chain”.
The relay chain provides interoperability as parachains can interact with its help. The bridges further enhance this feature as they ensure that the system can also talk to the external blockchains. The scalability is improved due to parallelisation of the processes on parachains: all “transactions are spread across multiple blockchains and security ensured by common set of validators”. This makes it possible to achieve higher number of transactions per second. Polkadot states that the parallel transactions allow to achieve 1000 tps (transactions per second).
Along with interoperability and scalability, Polkadot claims to ensure simplicity and fork avoidance. Simplicity means that the network will try to avoid unnecessary complications in structure and operations. This makes the network more accessible and fast.
Forks in blockchains is a widely discussed topic (you can read more here and here). The solution proposed by Polkadot is on-chain governance which can significantly reduce the probability of a hard fork. We will address the Polkadot governance in the next posts.
The global vision of Polkadot ecosystem in the future include the relay chain which is providing a base for the parachains which can run different applications (for instance, banking, insurance, health applications). The users can add to the ecosystem and build their own blockchains. This ecosystem of interconnected blockchains represents a new web — Web3.
Web3 is a project that crystalises the overarching idea of Polkadot — interconnected blockchains with different functionalities with open access and diverse participants, all on the base of Polkadot. The scale and ambition of the project makes it definitely worth to keep an eye on.
Web3 and Polkadot have an impressive team behind them. Founders are Dr.Gavin Wood, co-founder and CTO of Ethereum, as well as Peter Czaban and a Thiel Fellow Robert Habermeier. The research work is conducted together with Inria Paris and ETH Zurich. The tech part is done by the developers from Parity Technologies, with the support of the capital partners from crypto-funds such as Polychain Capital. Strong team and good connections in the crypto world is one of the attractive points of the projects.
The problem of interoperability of blockchains has been occupying the minds of blockchain enthusiasts for some time. As a result, several solutions have emerged. The one competing with Polkadot directly is Cosmos. Cosmos is also positioned as an “internet of blockchains” and claims to solve the same issues as Polkadot — interoperability and scalability. At the same time, two networks have several significant as well as more nuanced differences. There are many articles comparing the two (for instance, you can read more here and here). At the moment, Cosmos has an advantage of early start as it is operational already. The more comprehensive comparison will be possible when both networks are up and running. It is likely that the projects will evolve to cater different needs and different types of blockchain so that cannibalization can be avoided.
Nominated Proof-of-Stake
Polkadot is using a hybrid consensus — GRANDPA and BABE. We will not go into details on the actual consensus mechanism (if you are interested and ready to dig deeper have a look at the GRANDPA paper), but instead will focus on how and by whom this consensus is ensured. The blockchain participants to support consensus are chosen based on their stakes, so Polkadot is a Proof-of-Stake (PoS) blockchain. The particular Polkadot mechanism is referred to as Nominated Proof-of-Stake.
In general terms, consensus is ensured by the network stakeholders — holders of DOTs (Polkadot tokens) who decide to become a nominator or a validator. Any stakeholder has a choice to become a nominator or a validator. To become a nominator you just need to own some DOTs and a respective desire to nominate some validators. The number of nominators in the network is unlimited. The only task of a nominator is to nominate one or several validators.
The main role of the validators is to actually participate in the consensus mechanism by creating and validating blocks in the relay chain. The blockchain performance is more efficient when the validators are reliable and can quickly provide block confirmation when needed. Therefore, there are specific technical requirements to become a validator. Also, the number of validators is limited by the blockchain (expected to reach a thousand with the blockchain maturity).
Nominated Proof-of-Stake uses economic incentives to ensure that the validators are playing by the rules and are not trying to corrupt the system. In order to become a validator, a stakeholder is required to lock a particular sum of DOTs in the network — stake. This stake can come from the validator’s assets and the assets of the nominators who nominated this particular validator. In case of adverse behaviour the validator’s stake is slashed. Slashing also happens if a validator is reported offline above some limit.
Nominated proof-of-stake differs from delegated proof-of-stake (used, for instance, by Tezos) in that nominators are subject to loss of stake if they nominate a validator who is behaving “badly” or is offline often. The delegates, on the contrary, are not subject to loss of stake based on the behaviour of the validator. This adds an incentive for the nominators to monitor the performance of the validators and increases the importance of the reputation. At the same time, there is a risk that this rule will increase centralisation in the network: nominators will prefer to nominate big and established validators and will be more reluctant to nominate new ones. Moreover, as the chances of the validator to be elected to validate a block is higher the higher the stakes, the incentive to centralisation increases.
To counteract the incentive to centralisation, Polkadot is planning to pay higher rewards to the nominators who nominate several validators. Furthermore, the reward per DOT will be higher if one nominates a validator with a lower overall stake. How exactly all these incentives will play out when applied all together is difficult to predict. There is a risk that many nominators will not want to spend time to optimise their nominations and will simply nominate the biggest and most reputable validators.
For participating in the consensus, validators are paid a reward in the form of DOTs. Validators then share this reward with the nominators who have nominated them. Here one can see an attractive investment opportunity.
Staking on Polkadot
DOTs owners can participate in staking by being nominators or validators. Becoming a nominator is simple and does not require any investments except buying some DOTs. Then a stakeholder can nominate one or several validators and receive the reward if these validators are doing a good job. Bear in mind that the tokens are locked so cannot be used or sold while being staked and there is a risk of the stake slashing if the validator is behaving “badly”.
Becoming a validator requires more effort: first of all, a validator needs a secure and reliable server which should be running all the time. Note, that unlike in Tezos, validator is not required to stake own assets though it can help increase the overall stake and, correspondingly, the chances to be elected. Furthermore, validators needs to convince nominators that they would do a good job. As a number of validators is limited, some competition is also expected.
The validators for participation in consensus are elected several times a day, based on proportional justified representation principle. The rewards are paid every “epoch” which is equal to an hour.
The rewards are distributed among the validators pools which consist of a validator selected to support consensus and nominators who have nominated her. The reward distribution mechanism is designed to ensure economic incentives for decentralisation: the validators pools get the same reward for equal amount of work, and not proportional to the validator’s stake. This way, the nominators of a smaller validator will get a higher return on their DOTs. Inside the pool, some share of reward is paid to the validator as a commission and the rest is distributed among the nominators and the validator based of the share in stake.
The rewards are paid out of the blockchain inflation growth. For the first year, the inflation rate is expected to be set at 10% and each validator is expected to get around 1,000–2,000 DOTs per month to share with their nominators.
After the first year, the inflation rate will be dynamically changed depending on the staking participation to incentivise / disincentivise token holders to participate in staking. For instance, inflation would be 10% if there is 50% of DOTs being staked to the network. In these conditions, expected return staking is 20%.
Note that Polkadot is planning to keep around 20% of the DOTs unbonded to create liquidity in the market and ensure price formation (exact share will be defined every hour by reverse auction where validators submit desired stakes and minimum payout rent).
In the April blog post, Polkadot Network introduced Proof of Concept 4 with new features for its staking system. These features include enhanced validator key management, offline validator preferences and “off the table” rewards.
The first feature improves the security of the validators’ stakes and gives them an option to choose where to send and how to use the rewards. The introduced “session key” allows validators to separate online node from their funds.
“Off the table” reward is a fixed amount of DOTs that a validator decides to keep from each reward to maintain high quality of service. The amount of DOTs “off the table” affects how nominators who have nominated the validator are awarded. “Off the table” DOTs can be used by the validators to control their own gains as well as the gains of their nominators. By taking more DOTs “off the table”, nominators with high stake and a large number of nominators can drive some of them away and by this increase the rewards for the remaining nominators.
The Proof of Concept 5 is expected to introduce new changes and upgrades, like “the ability of parachains to send each other all types of messages”. We will keep you updated!
In the post we have summarised some of the basic concepts of Polkadot. If you are interested and want more details, here is a list of useful resources:
Website
FAQ
https://polkadot.network/faq.html
Polkadot Wiki
https://wiki.polkadot.network/en/latest/
Whitepaper
https://polkadot.network/PolkaDotPaper.pdf
Polkadot on Medium
https://medium.com/polkadot-network
Disclaimer
This content has been produced by Validators IVS for general information purposes only. While care has been taken in gathering the data and preparing the content, Validators IVS does not make any representations or warranties as to its accuracy or completeness and expressly excludes to the maximum extent permitted by law all those that might otherwise be implied. Validators IVS accepts no responsibility or liability for any loss or damage of any nature occasioned to any person as a result of acting or refraining from acting as a result of, or in reliance on, any statement, fact, figure or expression of opinion or belief contained in this content. This content does not constitute advice of any kind.
