Parachain auctions are a totally new way to interact with blockchains.
In case you’re new to Polkadot, or in need of a quick refresher, this guide also includes a general overview of parachains, parathreads, and everything Polkadot.
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What Is Polkadot?
How Does Polkadot Work?
What Are Polkadot’s Parachains?
A parachain – a portmanteau of “parallelized chains” – is an independent blockchain that runs in parallel to Polkadot’s relay chain and maintains a constant connection to it.
Parachains are usually built to serve a specific purpose and developers can customize them as they please. Each parachain can have its own governance structure and, as such, each parachain is considered to be a sovereign network.
Each parachain slot is leased on a subscription basis. The length of the lease is agreed upon before its commencement, which allows projects to connect to the Polkadot relay chain for as long as they need, without necessarily remaining tied to it forever. If a project’s developers decide they no longer wish to maintain a connection to the Polkadot relay chain, they can simply decide not to renew their lease.
The official Polkadot guidance indicates that “Polkadot places no constraints over what parachains can do besides that they must be able to generate a proof that can be validated by the validators assigned to the parachain.”
Another way to look at parachains is to think of individual employees in a large business. Each employee spends most of their time working on tasks specific to their specialty or position, just as parachains do.
All these employees congregate periodically to catch up and discuss their progress on their respective projects and tasks, just as the parachains link to the relay chain at consistent intervals.
A Glimpse Into Kusama
Kusama functions as an advanced testnet for Polkadot. It’s essentially a pre-production sandbox which developers can use to test the early versions of projects they plan to launch on Polkadot.
Kusama is, by design, extremely similar to Polkadot, but offers a little more flexibility for developers through more liberal governance rules. All new updates to the Polkadot network are also tested on Kusama before they go live on Polkadot.
Like Polkadot, Kusama features two types of blockchain: one main relay chain and 100 parachains, the auctions for which went live in June this year. Kusama’s parachains have a lower barrier to entry for parachain deployment when compared to Polkadot.
Projects starting out on Kusama can benefit from building a community base within the wider Polkadot community, which could help their crowdloan efforts should they decide to partake in a parachain auction.
How Many Parachains Will Polkadot Support?
At present, Polkadot will allow up to 100 parachains to connect to the relay chain at any point in time. However, most of the time, there will typically be at least one or two parachains left unused due to the auction schedule.
Parathreads are shards of parachains, which run on a pay-as-you-go model. Instead of maintaining a constant connection to the relay chain, as parachains do, they only connect to the main chain on a block-by-block basis.
Lean startups will greatly benefit from parathreads. Those that lack the means to crowdloan enough money to win a full parachain lease auction will, thanks to parathreads, still be able to access the Polkadot relay chain as and when they need to.
Why Are Parachain Slot Auctions So Competitive?
Winning a parachain slot offers a wide array of benefits, especially to those projects that are just getting off the ground.
Teams who win the first parachain slots will likely benefit from a first mover advantage. Yet there are various other benefits to consider as well.
Their transactions are less likely to get stuck in a bottleneck, as they are not faced with the classic network constraint of having to process every transaction sequentially.
Those who want to lease a much-coveted Polkadot parachain slot need to take part in an unique kind of online auction, more about which follows in the next section.
How Do Polkadot’s Parachain Slots Auctions Work?
In keeping with the spirit of the idea behind the candle auction — and in a digital context thankfully less vulnerable to these early modern shenanigans — Polkadot’s auctions end at a random moment during a predetermined ending period. And, as with the candle auctions of Galileo’s time, whichever project has the highest bid when the (proverbial) flame flickers out is awarded the parachain slot.
Each auctioned parachain lease is made up to four slots. Each slot lasts for six months, which means that the maximum lease time for any one parachain slot is two years. There’s currently no requirement for teams to bid for the full two years, as the minimum is for just one slot, or six months.
The flexibility in the lease duration gives smaller projects a chance to bid for slots that the well-funded projects don’t need or want. This can even entail competing projects winning a single auction — on the condition that they are bidding for different slots in a single lease.
How Does the Bidding Work?
If the project wins the auction, all the committed DOT tokens are locked into the Polkadot main chain for the duration of the parachain lease. This ensures that each project has some skin in the game.
It also keeps an additional degree of separation between loaned funds and project developers; your DOT tokens aren’t given to the Polkadot team to be spent however they see fit. As mentioned above, all the DOT tokens remain locked on the main chain.
There are two ways to bid for a parachain slot: either as a direct bidder, or through a crowdloan. Private bidders simply place a bid directly, an option that will probably be used by those well-funded projects that can afford to bid for themselves.
The other option is crowdloans.
What Are Crowdloans?
Whereas crowdfunding in the traditional startup space offers similar rewards to crowdloans, the latter offers far more security for investors.
Taking part in a crowdloan requires you to bond your DOT tokens to a project that you believe would benefit the Polkadot ecosystem were it to be awarded a parachain slot.
Any project you support by contributing DOT tokens to its crowdloan can reward you in a variety of ways. Most projects will airdrop you a quantity of their native token proportional to the amount of DOT you contributed to their crowdloan effort.
If the project you bond your DOT to wins the parachain slot, you’ll receive your rewards straight away. Your DOT will be locked into the project until the end of the project’s parachain lease. For the longest leases, this means your DOT will be inaccessible for 96 weeks.
Keep in mind that you won’t be able to trade all of your rewards right away. Depending upon how the project splits its rewards, a certain percentage will be locked in your wallet and released over the duration of the parachain lease. If the project you’ve contributed to hasn’t fully launched yet, you’ll receive your tokens at launch.
As you can see, had you contributed to Acala’s crowdloan, for example, 20% of your reward tokens would have been available for trading immediately, and 80% would have been available linearly over a 96-week period.
Why Doesn’t Polkadot Use ICOs?
Auctions provide investors with a level of security and return guarantees that initial coin offerings (ICOs) have never been able to.
If you’re unfamiliar with the term, an ICO is the crypto equivalent of an initial public offering (IPO), through which a company sells shares of its business to the public.
During an ICO, a development team will try to attract funding by releasing a whitepaper, giving presentations and hosting Q&As, and so on. Many will also release a minimum viable product. The team will typically reward early investors with the project’s native tokens before they tokens are made available publicly.
There are a number of well-known and widely documented problems associated with using ICOs for funding purposes.
First, it’s terribly easy for a marketing team to grossly exaggerate their project’s prospects to lure those investors who lack a thorough understanding of crypto. Oftentimes, all they have is theory and speculation – alongside a hefty marketing budget. It’s difficult (if not impossible) for a startup to rebuild its reputation after being labelled a scam or a memecoin.
Second, investors can sell all of their early-bird tokens the moment the project launches, which immediately crashes the price and seriously harms the project’s long-term prospect of success.
Third, the project’s developers can use its investors’ money however they see fit. There’s no accountability to the investors, nor to anyone really.
Fourth, ICOs have been known to defraud invesors — a lot, especially in 2017. At this point in time, due to regulations and customer protection, it’s often difficult to host or participate in an ICO in a legally compliant way.
How Are Auctions Any Better?
Auctions don’t suffer from the same problems as ICOs and usually offer investors considerably more protection against scams and expertly marketed nothing-coins.
This higher level of investor protection, in Polkadot’s case, comes from your invested DOT tokens being locked into the Polkadot relay chain. They are not given to the development team at any stage.
Even if a bad actor had managed to somehow fool the entire Polkadot network, they still wouldn’t be able to make off with any DOT tokens. In this scenario — that of a full-blown scam — your losses would be limited to what you could have earned from staking your DOT tokens rather than committing them to a crowdloan.
Moreover, preventing investors from selling their airdropped tokens the moment they land makes avoiding a disastrous rug pull scenario much easier for new projects.
Projects competing for a parachain slot also need a stronger proof-of-concept than they would for raising funds by other means, like through an ICO, for instance.
In a parachain auction, each project is competing for a single, winner-takes-all prize. Accordingly, investors are incentivised to compare projects against one another directly, even when the services they provide are distinct.
Overall, crowdloans claim to offer a safer way to invest in early-stage projects overall.
Why Should You Take Part in Crowdloans Instead of Staking Your DOT?
This is a classic risk versus reward question, and the answer ultimately comes down to the risk tolerance of the individual. Doing your own research here is a must.
The main drawback to committing your DOT through crowdloans is that you can’t earn any staking rewards. Instead, you’ll acquire airdropped tokens from the project you’re supporting, which may or may not be worth more in the future.
Estimating how much you could earn from staking DOT for a year or two is straightforward.
Will Every Polkadot Parachain Be Assigned Through an Auction?
The free rider problem states that competing parties – in this case, projects competing for a parachain slot – are unlikely to invest time and money building something that will benefit their competition.
For example, a bridge from Polkadot to another network would benefit the entire Polkadot network enormously. However, any team building it would be using limited resources that they could, arguably, invest in attempting to win a parachain slot instead – to their own advantage.
In other words, why would a given startup commit their resources to building a bridge and thereby risk missing out on a parachain slot?
The free rider problem also hints at the fact that those teams that do not contribute toward building the bridge nonetheless will benefit from using the resulting bridge — without having contributed to it.
The first common good parachain was awards on Dec. 18 to Statemint.
How Can You Get Involved in a Polkadot Parachain Crowdloan?
There are three ways to take part in a Polkadot crowdloan.
1. Use Polkadot.JS
While this Polkadot app isn’t difficult to use per se, it is comparatively complicated for novice crypto users to navigate.
Moreover, Polkadot.JS requires you to commit a minimum of 5 DOT tokens to a given crowdloan. By contrast, the minimum commitment is 0.1 DOT on most crypto exchanges.
2. Use a Crypto Exchange
A number of crypto exchanges allow you to invest in projects competing for Polkadot parachain slots, including Huobi, Kraken, KuCoin, OKEx and Binance.
There are several benefits to using an exchange. First and foremost is easier navigation, especially for inexperienced crypto users.
As mentioned above, exchanges don’t require you to commit 5 DOT to partake in a crowdloan. Some only require as little as 0.1 DOT.
To take part in a crowdloan using Binance, open Binance in a web browser, log in, click on “Finance,” and then click on “Binance Earn.”
Navigate down to “DOT Slot Auction.” Find the project you want to invest in, then click the “Vote” button, which is on the right-hand side.
You’ll then need to input the amount of DOT you want to commit.
Some exchanges, including Binance, will give you the option of receiving tokens in exchange for the DOT you commit, allowing you to maintain your liquidity.
On Binance, if a project you’ve committed DOT to wins a parachain auction, you’ll be able to use the “Convert to BDOT” feature within 45 days. This feature converts your bonded DOT tokens into BDOT, a tokenized asset with a value pegged to the value of DOT. You can sell, stake or keep these BDOT to exchange for your original DOT tokens once the parachain lease period expires.
One downside to using an exchange to support a crowdloan effort is that your DOT tokens are locked with a third party for two years.
3. Use the Official Project Page
Find a project you want to support in the list, then click on the project’s name on the left-hand side. You’ll be redirected to a description page, which has a link to the official project page, as well as the auction details.
Official project pages usually have rewards calculators. These are useful when weighing up which project to support. Projects should also offer details as to how crowdloan investors will be rewarded, as pictured below.
Do be aware, some project pages aren’t user friendly at all. It’s highly project-dependent.
When Are Polkadot’s Parachain Auctions Happening?