Before we dive into Parachain Auctions and Crowdloans, let’s quickly run through the main components of the Polkadot network. Alternatively, you could read the articles covering the Polkadot ecosystem at length (Polkadot & Kusama).
Relay Chain, parachains, parathreads, and bridges are the four main components of the Polkadot network. For the purpose of this article, we shall focus solely on the Relay Chain and parachains.
Polkadot is a heterogeneous multi-chain framework that connects application-specific Layer-1 blockchains (parachains) into one unified network via the Relay Chain. The framework allows for blockchain interoperability and pooled security of parachains.
The Relay Chain forms the basis or the foundational layer of the network. It is a Layer 0 blockchain that enables other Layer 1 blockchains to connect to it. The relay chain utilizes a nominated proof-of-stake (NPoS) consensus and is responsible for securing, governing, connecting, and ensuring the seamless functioning of parachains. The Relay Chain is intentionally designed with minimal functionality and does not support smart contracts by itself.
Parachains (short for parallelized chains) refer to the custom-built Layer 1 blockchains that connect to the Relay Chain. Parachains are sovereign blockchains offering specific use cases and featuring their own tokens and governance mechanism. They’re secured by Polkadot’s relay chain (pooled security) and cannot choose their own consensus mechanism. Polkadot gets its smart contract functionalities from parachains.
Kusama and Polkadot share the same codebase implying vast similarities in the underlying structure (relay chain and parachains). Kusama is an early and unaudited version of Polkadot.
At present, the Polkadot and Kusama network can support 100 parachains. Connection to Polkadot/Kusama requires leasing an open slot on the Relay Chain via slot auction. This auction entails locking up a bond of DOT/KSM for the entire lease duration (96 weeks/48 weeks).
Parachain Slot Auctions and Crowdloans
At this point, it is imperative to reiterate the parachain model enables Polkadot to scale at Layer 1. To further increase scalability, parachains can incorporate Layer 2 solutions. Polkadot’s heterogenous sharding allows for parallel processing of transactions from unique and specialized Layer 1 blockchains, improving the throughput and scalability of the network.
Parachain auctions enable equitable distribution of available slots on Polkadot and Kusama. A safe approach (compared to ICOs) to bootstrap teams and support new startups in the Polkadot ecosystem, the auction is designed to create healthy competition between projects vying for a slot. The winner of the slot bonds DOT/KSM for the entire duration of the lease and benefits from various offerings such as plug-and-play security, interoperability, governance, forkless upgrades, and scalability during this time. Moreover, the hard limit on the parachains prioritizes high-quality projects and incentivizes the teams to demonstrate their offering and garner community support.
There are two ways parachain teams can bid in the auctions. The first one is to bid with team funds from a single account. However, this approach makes sense for established projects with sufficient funding or whale support. But Polkadot wanted to create a way for new projects to compete in the auctions, so it introduced crowdloans. Crowdloans enable projects to participate in the auction by enlisting the help of their communities and demonstrating demand for their idea. Essentially, a crowdloan allows the team to accept community contributions (DOT/KSM). The DOT/KSM locked is returned to the contributors at the end of the lease, and most teams tend to reward contributors with native project tokens.
Comparing Parachain Auctions to ICOs
In the case of Parachain auctions, the bonded tokens are stored in a separate crowdloan module on the relay chain. The project team has no control over the tokens, which are sent back to the contributors at the end of the lease.
An ethical and secure alternative to ICOs, crowdloans prevent rug pulls as teams cannot use the tokens at their discretion. In addition, the permissionless nature of protocols enables projects to secure a slot on the secondary market from anyone who won the auction.
The ICO model is riddled with scams and misinformation. In contrast, Polkadot’s crowdloans not only offer a new way for garnering support but ensure the contributed tokens are utilized for the good to provide teams with access to scarce network slots and parachain token launches. Moreover, unlike ICOs, where investors often lose money in hopes of high returns, the tokens are returned to the contributors in case the team fails at the auction.
The parachain auctions follow a permissionless candle auction format. Candle auctions date back to the 16th century and were used to conduct the sale of ships. Under this format, a candle was lit, and when it extinguished, the highest bid at that point won.
In the case of parachain auctions, adding an element of randomness encourages a fair and open bidding process to prevent auction sniping. So how does one know the auction has ended? Well, there will be a known open and close time. Once the auction opens, project teams can bid with a single account or use their crowdloan contribution. Post the pre-defined close time, the candle auction module generates a random end time (a random snapshot of the block at which the highest bidder wins) to determine the auction winner.
As stated, the DOT/KSM contributed shall remain locked in the relay chain for the entire duration of the parachain slot. The winning team shall not have access to these tokens.
At the end of the lease, funds are returned to contributors. Therefore, it is important to note that the main trade-off when choosing to participate in auctions is sacrificing the staking returns over that period.
Once the lease expires (96 weeks on Polkadot/48 weeks on Kusama), each project requires new funds for the lease renewal. The options available include-
- The project team hosts another crowdloan/self-fund
- The project team may opt for a parathread (pay-as-you-go model) instead of a parachain
Cost of running a parachain
Parachains leasing a slot have access to as much computing as they require without additional fees of any kind. However, they must bear the cost of running collator nodes on the individual parachain.
Other than that, the costs are negligible since the bonded tokens are returned at the end of the lease period, so the cost of running a parachain is the opportunity cost from not having access to the locked DOT/KSM for the entire duration of the lease.
However, projects that acquire slots through crowdloans may reward contributors and thus incur additional costs.
Parachain auctions ensure the fair and equitable distribution of parachain slots. The two main ways to compete in the auctions include crowdsourcing DOT/KSM or placing a private bid.
The parachain auction and crowdloan model is an accurate representation of the innovations and capabilities blockchain technology offers. Moreover, it has played a significant role in successfully expanding the DotSama ecosystem.
I hope this article helped you understand Parachain Auctions.
This is part of a series covering the Polkadot ecosystem.
The series consists of the articles outlined below.
Part III — Parachain Slot Auctions and Crowdfunding
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