You are reading an excerpt from our free but shortened abridged report! While still packed with incredible research and data, for just $20/month you can upgrade to our FULL library of 50+ reports (including this one) and complete industry-leading analysis on the top crypto assets. 

Becoming a Premium member means enjoying all the perks of a Basic membership PLUS:

• Full-length CORE Reports: More technical, in-depth research, actionable insights, and potential market alpha for serious crypto users
• Early access to future CORE ratings: Being early is sometimes just as important as being right!
• Premium Member CORE+ Reports: Coverage on the top issues pertaining to crypto users like bridge security, layer two solutions, DeFi plays, and more
• CORE report Audio playback: Don’t want to read? No problem! Listen on the go.

Parachains

Parachains are Polkadot’s solution to scalability. They are called “parachains” because they are unique chains/ecosystems running parallel to the relay chain with their own governance and token but connecting back to the relay chain and sharing its security. Instead of being incentivized by DOTs, each parachain has its own economics and incentive structures.

Visual of the relay chain-parachain architecture. Source: TechBullion

Each Parachain built within Polkadot uses the Substrate modular framework that supports developers building applications within parachains to fit their specific needs. This means that individual parachains can be optimized for specific use cases like DeFi, gaming, NFTs, etc. Substrate enables greater flexibility and optimization for developers than what they would experience building on a general-purpose smart contract blockchain like the EVM. Potential customizations enabled by Substrate include choosing your own transaction fees (even zero), data storage, speed, composability, and pallets (blockchain building blocks on Substrate). Furthermore, Polkadot can upgrade without the requirement for a hard fork.

The Parachains connect to the overarching Relay chain that secures the network’s parachains and maintains Polkadots consensus, transaction finality, and voting logic. Parachains periodically submit proofs back to the Relay Chain, which maintains consensus across all parachains and keeps the entire DOT universe in sync.

A critical differentiator of Polkadot is the shared security model. Polkadot seeks to enable disparate parachains to interoperate in a trustless way via shared security, meaning they do not need to bootstrap their own validator set like in Cosmos or Avalanche subnets. This allows developers to launch chains and applications leveraging a shared security model without having to worry about attracting enough miners or validators to secure their own chains.

This design decision places a significant strain on the Relay Chain. If the Relay Chain were to fail, the entire DOT ecosystem could be jeopardized. This centralization is also reflected in Polkadot's market capitalization, which is significantly larger than Moonbeam, Polkadot's largest parachain.

Network access is also a significant distinction between the two ecosystems: parachains on Polkadot must pay a costly admission price through auctions. In order to obtain a 2-year parachain space. Cosmos, on the other hand, has no entrance hurdles and does not collect setup fees or rent for app-chain maintenance.  In Polkadot, however, the benefit is shared security. Parachains pay in advance for shared security as a service, which includes free execution and guaranteed bandwidth for the duration of the lease. 

Polkadot also has capabilities for bridges that allow parachains to connect and communicate with external networks like Ethereum and Bitcoin.

Polkadot uses optimized quadratic messaging between nodes and a limited number of participants. Polkadot has 297 active validators and 1000 on Kusama. You currently need 1.75 million DOT, or approximately $33 million to be an active validator on the Polkadot relay chain. You only need 120 DOT to be a nominator. The total value staked is approximately $12 billion.

Polkadot has hierarchical inherited security. The central relay chain is connected to the parachains. The relay chain has validators, the parachains have collator nodes that collect transactions and produce state transition proofs for the relay chain to validate. The Cross-Consensus Messaging format (XCM) format allows for interoperability between the parachains. The inherited security makes arbitrary data passing possible. 14 parachains are currently live. They have different specializations like DeFi, EVM smart contracts, social media, privacy, and games. In development are bridges to Ethereum, Bitcoin, and other projects. Unified finality is guaranteed by the inherited security model. Under this model, parachains can safely pass arbitrary data among each other. 

The domain-specific parachains functionality becomes available when they are connected and synchronized to the relay chain via their collector nodes. A criticism of this mechanism is that different chains may not need the same level of security. The survival of the ecosystem should not depend on any single chain. Polkadot currently supports the idea that parachains do not need validators. A developer can use Substrate to create custom blockchains and cultivate a validator community without depending on the centralized relay chain. The parachain can have its DOT funds unlocked at the end of the lease period, and use bridges when cross-chain communication is required. There could be multiple relay chains developed which would benefit the Polkadot ecosystem overall. The hierarchical topology will probably remain because inherited-security-enabled cross-chain communication is much more efficient than using bridges between parachains.

A parachain may want to grow their own validator community so they can become a relay chain and lease security to other chains. A nested security-sharing mechanism could get increasingly complex but all sub-parachains would share common finality guarantees, and the total number of state transitions per second would increase. This would expand the aggregate computational throughput for the entire Polkadot network.

To obtain a slot on the Polkadot chain, a project must win an auction by locking up more DOT than other bidding projects. If won, your slot is only leased, anywhere from 3 months to 2 years. There is a limited number of parachains available, with more to be released in the future. Currently, the Polkadot developers believe ~100 different parachains can be supported in the current status.

Parachain Auctions

Polkadot is an open-source “Layer 0” blockchain designed to enable separate, siloed blockchains to become an interconnected network of application-specific sub-chains called parachains. Each chain built within Polkadot uses Parity Technologies' Substrate modular framework, which allows developers to select specific components that suit their application-specific chain best. The native token (DOT) is used to incentivize and coordinate behavior across the different actors of its ecosystem that promotes the well-being and proliferation of the entire project. 

The Polkadot network is the entirety of all parachains that plug into a single base platform known as the Relay Chain. This Relay Chain doesn’t support application functionality or smart contracts but instead provides generalized security, consensus, and finality to the network's parachains. It also assists in the network’s ability to scale proportionately to user growth. This is achieved through improved transaction finality and the use of pooled security Nominated Proof-of-Stake (NPoS) consensus protocol. 

Following the successful implementation of parachains in Q4 2021, the Polkadot network reached core functionality a little over a year after the genesis block was officially launched in May of 2020. Parachains operate as their own independent blockchains, enabling transactions to occur off the Relay Chain and removing the problem of network congestion on the Polkadot mainnet. A Cross-chain Message passing (XCM) system lets parachains communicate and transfer assets between each other. While other smart contract platforms attempt to scale the activity on their mainnet to reduce congestion (like Ethereum), Polkadot simply needs to vet and introduce new parachain projects.

Currently, there are 100 parachain slots available on the Polkadot network. Parachains (mostly) become part of the Polkadot network through an auction. To participate in an auction, a project must receive sufficient support through a community fundraising effort called “crowdloans” or Parachain Loan Offerings (PLOs). Crowdloans allow a team looking to earn a parachain slot to crowdsource DOT in order to bootstrap its parachain auction. DOT tokens are committed to parachains for a fixed period of time. These willing DOT holders generally receive incentives in the form of the parachain’s native token. The process of parachain approval through DOT-backed crowdloans essentially gives control of Polkadot ecosystem development directly to DOT holders.

The first auctions for parachain slots on the Polkadot network took place in Q4 2021, attracting a high number of participants and resulting in a bonding of 133 million DOT. The requirements to win a slot have decreased, allowing more projects to self-fund their slot acquisitions. Parachain slot leases are 96 weeks long and the first round of leases is approaching the halfway point as of 2023. Seven new teams won parachain slots in Q4 2022, including Bitgreen (climate-positive blockchain), Crust Network (decentralized cloud storage), Ajuna Network (decentralized gaming ecosystem), Parathread 2092 (anonymous project), Frequency (enables Web3 social), OmniBTC (decentralized omnichain liquidity protocol), and Pendulum (fiat-optimized smart contract blockchain).

However, as of 2023, the amount of DOT auctioned off in parachains has declined immensely, from 35M+ to approaching zero. This is a clear sign of waning interest in the Polkadot ecosystem.