How do Polkadot and Kusama parachain auctions work?
Polkadot is an exciting project that’s solidly established itself as a top 10 cryptocurrency. Its sister chain, Kusama, is coming up quickly behind. Why have the DOT price and KSM price gone up so fast?
The Polkadot project is offering a unique solution to one of the most concerning problems in crypto right now. Ethereum is very popular but it can’t scale! A simple transaction can cost as much as $20 and more complex transactions can cost $100. Ethereum needs to scale but so far it hasn’t been able to.
Polkadot and Kusama solve the scaling problem with Parachains. A parachain is like a separate blockchain that runs parallel to the main chain (in the Polkadot network the main chain is referred to as the “relay chain”). By processing transactions on multiple parachains, Polkadot can clear significantly more transactions per second than the current version of Ethereum.
In this article we’ll look at how Parachain auctions work and how a cryptocurrency project can purchase its own Parachain.
Is Polkadot a Good Investment?
It’s impossible to say with 100% certainty that any cryptocurrency project is a good investment. Blockchain is still a relatively new technology and something can always go wrong. That being said, so far Polkadot has been a great investment.
Interoperability is the reason that Polkadot is going up so much. Although the Polkadot crypto project is in competition with other smart contract platforms, Polkadot is creating value for the entire cryptocurrency ecosystem from a macro perspective.
Blockchains are networks and the more connections that a network has, the more valuable it is. That’s true whether we’re talking about a cryptocurrency network or a social network. Ethereum and Bitcoin are both valuable, but they’re even more valuable when they can interact with each other.
The problem is that, with a few notable exceptions like WBTC on Ethereum, blockchains can’t interact with each other. At least not yet… By solving the interoperability problem Polkadot is creating massive value for the cryptocurrency ecosystem. By extension, we can expect that the Polkadot project is going to be very successful. As more people use Polkadot, and demand for Polkadot services go up, the DOT token price should also go up accordingly.
What is exciting about the Polkadot Altcoin (DOT)?
So far the Polkadot coin DOT is one of the best performing crypto assets of 2021, which is exciting for investors. There is a sizable and diverse community of DOT investors. Lots of retail investors hold DOT but the biggest holders are professional investors. Polkadot has received a significant amount of venture funding since its launch.
It’s not just the Polkadot blockchain that’s receiving funding either. VC funding is helping to grow the entire Polkadot ecosystem. VC investors are hoping to build out DeFi on Polkadot, similar to what already exists on Ethereum.
In terms of price appreciation, the best way to benefit from Polkadot’s continued growth is to buy the Polkadot coin, DOT. There are a couple of reasons why we would expect the DOT token to appreciate in value as network adoption increases.
- Transaction Fees - All transaction fees on the Polkadot network must be paid with DOT. This creates a steady demand for the token. The reason that transaction fees are important is that they prevent spammers from taking over the network. Recently the cryptocurrency Nano, which has zero transaction fees, has been having a problem with a spammer who is creating a lot of congestion on the network.
- Sending value - The DOT token is used to send value in the Polkadot network, just like BTC on Bitcoin.
- Buying a parachain - Anyone can buy a parachain on the Polkadot network. To pay for the parachain they have to use DOT. This is another source of demand for the token which can help to raise its price.
Now that we’ve gone over why Polkadot is an exciting project and what’s driving up the DOT token price, let’s look at how Parachain auctions work.
As of April 2021, Parachains are still in the testnet phase. The developers are working out all of the bugs before the eventual rollout of their scaling solution, but that is expected to be any time now!
The parachains are underging their final trials on the Kusama network. Kusama is a mix between a fully functioning blocking and a testnet. It’s a live blockchain but it’s designed to test new technologies in an environment where failure doesn’t lead to financial loss.
Anyone can build on top of Kusama and it’s a great place for new teams to try out their products before they launch them on the Polkadot mainnet. Once Parachains have been completely checked out on Kusama they will be released on the Polkadot relay chain. From there the parachains will be auctioned off.
How do parachain auctions work?
Parachain auctions are permissionless, which means that anyone can participate. The Polkadot team cannot block someone from purchasing a parachain.
Even when there are multiple chains for sale the auctions take place one at a time. When someone buys a parachain they can select how long they want to own it for. The maximum is two years, but a project can bid for a shorter interval like six months or one year. Although we talk about selling and buying parachains, a better description might be “leasing” a parachain.
We don’t know yet how many parachains will be for sale in the first auction, but it will probably be between 50 and 100. As the parachain leases begin to expire there will be new auctions to sell off the parachains.
The parachains will be sold off using a candle auction. A candle auction encourages everyone to submit their highest bid as soon as possible.
In a normal auction the participants may wait until the last moment to bid up the price. When someone submits a high bid at the last moment it’s known as sniping. This is only possible because all of the bidders know the exact moment that the auction will terminate.
In a candle auction the bidding period ends at an unknown time. In the old days the auction would end when the candle went out, hence the name. However, in an online auction the end period is determined by a random number generator.
This auction technique encourages everyone to get their bid in early which can ultimately lead to a higher selling price for a parachain. All parachain purchases must be made using the DOT token.
Since cryptocurrency projects buy (or lease) a parachain, they can customize it as they see fit. There are a couple of ways to customize a parchain.
A parachain owner can set the parameters for governance, how quickly blocks are produced, and the tokenomics for the chain. Each Polkadot crypto parachain can be customized to suit the needs of the owner.
How much does a parachain cost?
The price of a parachain is not determined beforehand. Whatever price the parachain sells for in the candle auction is the market rate for that parachain. A parachain could sell for $10,000 or $100,000, it’s difficult to say how much people are going to be willing to pay. Once the auctions start happening, we’ll have a better idea of the perceived value for a parachain.
To say that a parachain costs money is a little bit misleading though. When a project “buys” a parachain, they put up a bond for that amount. Say that the parachain sells for $100,000. The winner of the auction must lock up $100,000 worth of DOT for as long as they own the parachain. At the end of the parachain lease the $100,000 of DOT is returned. The dynamic is the same for parachain auctions on Kusama, except that the currency used is KSM, and the amount needed is expected to be less.
So the real cost is opportunity cost. Polkadot uses a proof of stake consensus mechanism but a crypto project can’t stake the Polkadot coins DOT or KSM they’re using for a parachain bond. Because their tokens are locked up as a bond, and not as a stake, the parachain owner is giving up a source of passive income. More information is available on Polkadot’s website.
This however can be good for retail traders, who will be able to lend their DOT or KSM tokens to projects that wish to buy a parachain. The projects will likely choose to compensate crowdloan participants with a steady stream of their native tokens, which could end up being really valuable.
Projects may also choose to reward crowdloan participants with stable coins, which could be useful for reward distribution during a bear market, or with DOT coins, which may be preferable for investors who wish to increase their DOT holdings and not miss out on staking rewards.
A full list of upcoming Parachain auctions can be found here.
Cross-chain swaps are a way to exchange assets between Polkadot and another cryptocurrency. For example, Polkadot is going to be connected to Ethereum in the future.
Once that happens, someone could swap their DOT tokens on Polkadot for ETH on Ethereum. A lot of different projects will be able to take advantage of this feature and Bancor is a great example of a project that’s taking advantage of cross-chain swaps on Polkadot.
Overall, 2021 looks like it will be an exciting year for the Polkadot ecosystem.
This content is for informational purposes only and is not investment advice. You should consult a qualified licensed advisor before engaging in any transaction.