Polkadot, launched in 2020, is being called a third-generation blockchain technology that has the ability to build user-created, interconnected blockchains on top of it. It is adding functionality and more straightforward interoperability between blockchains that have not been seen before.
Polkadot uses a staking mechanism that has two network actors, validators, and nominators. This combination secures the Network in a consensus mechanism called Nominated Proof of Stake (NPoS), and they gain rewards for their roles.
Image courtesy of polkadot
Polkadot differs from other projects in that it facilitates efficient cross-chain communication allowing Substrate blockchains to scale independently on Polkadot while simultaneously taking advantage of its features. This attribute means that applications can run on their own blockchains (called parachains) but can also transfer different tokens between them, gaining from the security of a more extensive system (called the Relay Chain). We’ll explain the benefits of this later.
Substrate- an open-source framework to quickly build entire configurable blockchains.
The native DOT currency is used to stake the different parts of the Polkadot network. Stakers can participate in platform governance and be rewarded additional DOT from the block reward mechanism.
Polkadot has two major staking roles:
Validators – Validate Parachain block data and participate in the consensus mechanism. Validators must run a “validator node” and “bond” a dynamic amount of DOT, which is locked for 28 days to be selected as a validator and participate in staking. Validators can also vote on proposed network changes.
Nominators – Nominators are DOT holders that wish to stake but can/do not want to maintain a validator node. They secure the Relay Chain by nominating (up to 16) trustworthy validators, delegating their staked DOT tokens to the validators, and allocating the votes to those Validators. Their DOT is locked for the staking period but can be “unstaked” after a 24-hour waiting period.
Polkadots Major Components
Relay Chain The main Polkadot system component; provides consensus and interoperability between linked parachains. Built with Substrate, and all wallets and governance are within its framework.
Parachains- User-created blockchains built with Substrate connected to the Relay Chain via “Slots.” Parachains can be fully customized for nearly any use, have their own token for transaction fees or other activity on that Parachain, and feed into the Relay Chain so that their transactions can gain from the Relay Chain’s security.
Cross-Chain Message Passing (XCMP)-The Substrate-based communication framework that allows understanding of the logic of smart contract assets between different parachains, creating interoperability.
Collators- Maintainers of a full-node of a Parachain and the Relay Chain to facilitate transactions between different parachains. Parachains will incentivize them to provide service with their Parachain’s tokens or transaction fees; there are no set rules for an incentive scheme.
Bridges- Connect Blockchains like Bitcoin or Ethereum, which are not built using Substrate, to the Polkadot network. A Parachain can host these to tokenize the bridged chain, making it Substrate compatible on the Polkadot network for the use of others.
Image courtesy of Harbermier
With these four components, the Polkadot team believes that transactions can be kept secure and accurate, only having to use the computing resources required to run the main chain.
Users gain the added benefit of many customized parachains for different uses, which the Polkadot team believes will make transactions more private by not disclosing user data to the public chain. Parachains can be used individually or in conjunction to complete a transaction. Imagine someone selling stock to buy a house that the seller wishes to receive Ethereum as their form of payment, all instantly possible via Polkadot.
The Network’s development is influenced by three stakeholders:
Staking Rewards and Slashing
The Nominators and Validators make up a validator pool, and they are rewarded with newly created DOT with each block (a designed 10% first-year inflation). Rewards are distributed equally to active validators regardless of the bonded or staked amount. Validators have a “validator payment” parameter that splits their reward with their backing nominators. A validator payment of 20% gives 80% of the reward to the backers (Nominators), subdivided by backing proportion, and the validator keeps 20%. This system incentivizes nominators to stake Validators with lesser DOT behind them, because they will inevitably collect a larger share of the Validator reward. It also decreases the concentration of power of a single validator pool, with nominators earning more when they back equally trustworthy validators who have fewer nominators.
If a validator violates the rules of the protocol, they and their nominators will get “Slashed,” losing a percentage of the staked DOT. The security threat level determines the slash, which can range from 0.1% to 100%. Therefore, nominators should be careful in choosing which validators they will back.
The Network has a Treasury pool that collects transaction fees, slashing charges, and other fees. Proposals can be made for spending Treasury funds, requiring a 5% deposit (to prevent spamming), and if ultimately denied by the Council, the deposit is burned or kept in the Treasury.
Polkadot Network’s Uses
Polkadot will be competing head-to-head with Ethereum and shares many similarities to ETH 2.0, but some key advantages.
Polkadot was built as a smart contract blockchain, and Substrate supports the Ethereum Virtual Machine (EVM), allowing developers to instantly migrate any Ethereum Dapps to Polkadot. It has also integrated both WebAssemply (Wsam) and Rust development languages to allow for easier smart contract development due to language familiarity, which Ethereum requires the use of its native Solidity, which many developers lack experience.
Interoperability between blockchains is a key function of Polkadot. Allowing applications to be built on Polkadot while also providing connections. Popular Ethereum blockchain Dapps are congesting the Ethereum Network, and the same apps on Polkadot would divide the stress among different interconnected parachains. Substrate-designed blockchains have been shown to reach 67 transactions per second (TPS) and Gavin Wood, a co-founder of both Polkadot and Ethereum, showed that specialized Parachains could reach 1000 TPS, and he predicted that the Polkadot network could even reach 1 million TPS.
Tether (USDT) has its own blockchain, and transactions between Tether users can be independent of other tokens. When a Tether user wants to trade on a separate blockchain, for example, Uniswap, they must go through a cross-chain contract and get a credit on Uniswap. Through Polkadot, the Uniswap blockchain could also be configured to handle USDT or other token transactions from different exchanges in a similar way. All through Polkadot.
Scaling (able to reach 1 million transactions per second)
Because of the Relay chain-Parachain structure, it is believed that when Parachains go live, combined with the use of Parathreads, Polkadot will have a throughput of 1 million transactions per second (TPS). There has only been one other blockchain project able to reach 1 million TPS in testing but not commercially viable yet. Polkadot is similar to an airline with hub and spokes. Polkadot is designed to use Parachains, and scale is a benefit of it. The larger the network, the more it can process in total. Most flights are working independently of the rest of the airline, but the hub is there to make sure people get to their final destination. The more flights and planes available, the more the system can transport. Currently, the Relay chain has no slots filled and is able to process 1,000 TPS on its own. With other Blockchains, scale has led to throughput problems and high fees(ETH 1.0 can only process about 13-30 TPS and Bitcoin of around five TPS). These blockchains are more like a train; there are just so many people you can load onto it before it has problems, and the ticket prices go up as more people are taking up seats.
Parachains can have their own consensus model to personalize their security and speed, scaling easily as an independent but interoperable chain. This attribute and throughput will be useful for Decentralized Exchanges (DEXs) and lending platforms that can operate independently without affecting the other Parachain’s transaction load.
To be attached to the Relay Chain, Parachains must put up DOT tokens to lease a “slot” which prevents ghost chains with no economic value from spamming the platform. Slots are auctioned in six-month blocks, and up to 24-month (four blocks) terms can be bid on in an auction. The bonded DOT is returned at the end of the lease and this DOT cannot be staked or used another way while bonded but still have governance rights.
Image courtesy of Crust Network
Relay Chain transactions produce fees in DOT. These are usually token transfers, staking action, setting of identities, and governance participation. The 20% of fees are given to producers and 80% to the Treasury. On the Parachains, there is no DOT fee requirement, and builders are free to set up their own economic model.
Polkadot Now and its Future
Polkadot is at a very important period; it is about to auction off its first Parachain slots. The first slot auction begins on November 11th, 2021. There have already been Parachain networks successfully running on the live Polkadot cousin “canary” network, called Kusama (used to determine if the parachain will work on polkadot), which has been running its Statemine since June 3rd and already had 11 Parachain auctions.
If the first Polkadot auction runs smoothly and the first parachains can run successfully on the Polkadot network, likely because of Kusuma testing, then all eyes will be on the new race between Polkadot and Ethereum for the smart contract leader. This race will also be blurred with the bridges built between Ethereum and Polkadot to make the two Blockchain systems interoperable.
It is an exciting time in the blockchain space, and it will certainly be for at least the next few years to come.
Disclaimer: The author of this text, Jean Chalopin, is a global business leader with a background encompassing banking, biotech, and entertainment. Mr. Chalopin is Chairman of Deltec International Group, www.deltecbank.com.
The co-author of this text, Robin Trehan, has a Bachelor’s degree in Economics, a Master’s in International Business and Finance, and an MBA in Electronic Business. Mr. Trehan is a Senior VP at Deltec International Group, www.deltecbank.com.
The views, thoughts, and opinions expressed in this text are solely the views of the authors, and do not necessarily reflect those of Deltec International Group, its subsidiaries, and/or its employees.
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