“You’ve heard the phrase ‘the pen is mightier than the sword.’ Well, the keyboard is going to become even mightier than the pen pretty soon. The world, in some sense, belongs to coders.”—Dr. Gavin Wood
Polkadot is a nominated Proof-of-Stake (nPoS) blockchain that uses a technique known as sharding to increase parallel transaction throughput on app-specific shards called parachains. Parachains plug into the relay chain in order to derive shared security, yet retain their sovereignty of operation. Polkadot is the one of largest chains by market capitalization, enabling multi-chain connectivity and cross-chain interoperability.
In this article, we’re going to explore the following four Polkadot misconceptions:
- Polkadot is a Layer 1 and parachains are Layer 2 blockchains
- Polkadot’s inflation rate is too high
- Parachains pay rent to the Relay Chain
- Kusama is a test network for Polkadot
Misconception: Polkadot is a layer 1 and parachains are a layer 2
Reality: Polkadot is Layer 0 and Parachains are the layer 1 chains with own dApps and flourishing ecosystems
Much of the confusion for this misconception comes from terminology issues. For example, what’s the difference between layer 1 protocol and layer 0 protocol?
The difference is this: Layer 1s allow for dApps to be created on top of them. Layer 0s allow for entire blockchains to be created on top of them which serve as respective Layer 1 chains, entirely on their own. Polkadot also offers a developer SDK known as Substrate allowing anyone to create a blockchain, irrespective of whether it will be a Polkadot parachain or not. These blockchains can plug in modular features which gives developers the necessary customizability and flexibility for any project, as well as the ability to interface with the relay chain in order to inherit security. Layer 0s also often have cross-chain interoperability often enabled and facilitated by their SDK. In Polkadot’s case, this is the XCM (the cross-consensus messaging format).
Parachains stand for parallelized chain and it is Polkadot’s unique use of sharding which allows app-specific chains to run in parallel, increasing overall transactional throughput. Parachains are then L1 blockchains using Polkadot for security via a “shared security” model and are interoperable using the XCM as a communication format (only recently enabled on the chain!).
Misconception: Polkadot is pumping out inflationary rewards and its inflation is too high
Reality: Polkadot has good reasons to pump out inflationary rewards and inflation is not too high when you consider the dynamic allocation.
Polkadot has sophicated tokenomics which cannot easily be boiled down to oversimplifications regarding its inflation rate alone, as there are too many other factors at play. Before we dive into it, let us explore why DOT is inflationary.
Polkadot uses DOT as a native capital currency for the relay chain. DOT can be used for delegating to validators (like Figment) to secure the network, used in governance once bonded to the chain, and to participate in parachain slot actions and transaction fees. DOT has inflationary supply and this inflation allows DOT rewards to operate as economic incentive for validators and delegators to secure the chain. DOT also needs to be produced in order to accommodate new parachains, or in the expansion of the parachain set currently limited to 100. Parachains are required to lock up DOT in what is called a slot auction, meaning that this DOT is not on the market and cannot be staked, thereby effectively reducing the circulating supply of DOT by rendering the DOT illiquid.
DOT’s inflation is set at 10% but the allocation is dynamic and based on the overall amount staked. Polkadot tries to maintain an inflationary equilibrium in regards to its staking rate; anything above or below this amount is sent to Polkadot’s treasury and the percentage of inflation sent to stakers is therefore less.
This equilibrium is better known as the idealized stake rate and it is 50%. Having 50% of circulated DOT supply staked rewards validators and network participants, but doesn’t provide money to the Treasury and maintains the security guarantees of NPoS. Currently, Polkadot has a staking rate of 55%, leading to a 7.83% inflation rate which corresponds to a roughly 14.12% APR according to staking rewards.
As can be seen below, if DOT’s staking rate remains at the ideal 50%, then the inflation rate to stakers is 10% and then network participants receive a whopping 20% in rewards (this is without minusing the validator fees). Any time the staking rate is above or below the ideal stake rate, the inflation sent to stakers decreases but the remainder of the 10% is sent to the treasury. It should also be noted that sometimes the ideal staking rate will not be 50% as the overall percentage of DOT bonded to parachains influences available staking liquidity.
However, when a treasury spend period ends and there are still unspent funds, a burn on a percentage of the funds occurs. For example, the next treasury spend burn will remove 315.44K DOT from existence. Already a total of 4,754,410 DOT has been burnt, functionally decreasing DOT’s overall inflation and making it much lower than the 10% people claim.
Thus, saying DOT has too high an inflation rate ignores how it is allocated, potential treasury burns and the high reward rate for validator incentives.
Misconception: Parachains are paying rent to the relay chain
Reality: Parachains lease security through a shared security model and derive many other advantages from the relay chain
Many people falsely believe that parachains are paying rent to the relay chain through slot auctions, or just paying rent to exist on Polkadot. The reality is quite different.
Parachains are instead locking up access to the security they derived from the relay chain, in addition to many other features. As we mentioned above, Polkadot’s parachains have a shared security model by design, thus ensuring that parachains are beneficiaries of the relay chain’s validator set. This allows a base level of economic security assumptions at the parachain’s genesis reducing the likelihood of whales exploiting a project. This also allows sovereign blockchains to be bootstrapped via a provably secure validator set, provided they raised the capital to secure a slot for access to this security. Without this, a fledgling protocol is vulnerable to attack. Polkadot also ensures there is no weakest link in security, since all parachains built with substrate can be secured by polkadot’s validator set by default.
Parachains also derive interoperability benefits from their Polkadot lease. Polkadot‘s relay chain chain has a specific form of message passing called XCM with multiple subsets such as XCMP (Cross-Consensus Message Passing) as noted above. This allows a level of base interoperability with Polkadot and any other parachain or parathreads connected to the relay chain (or Kusama, in some cases!)
All in all, parachains are paying for the time-tested security, stability, interoperability and to derive economic benefits for Polkadot. Parathreads also share many of these benefits and do not “pay rent” however, the cardinal difference is in Parathreads competing for block production resources and have been described as being pay as you go parachains. Additionally, and most importantly, all DOT tokens that are locked up for the slot auction are returned to those who contributed at the end of a leasing period.
Misconception: Kusama is a testnet for Polkadot
Reality: Kusama is an experimental canary network and not a testnet
Many people falsely think that Kusama is just a testnet for Polkadot, but if this were true, then why would Polkadot have its own testnet called Westend and its own testnet for parachains called Rococo? What would have been the point in having the Westend testnet or Rococo if Kusama is the testnet?
The main distinction to bear in mind is this: Kusama is often used for testing, but it is not a testnet. Testing is just one of the functions that can be undertaken on Kusama, as it provides a “test in production” environment for chains that often eventually end up on Polkadot.
So if Kusama is not a testnet, then what is Kusama? Kusama is an experimental canary network that has its own economy, token, governance, parachains and simulates real life conditions akin to Polkadot’s. Kusama uses Polkadot’s code base and is nearly identical in some aspects with one of the major differences being that Kusama was designed for speed.
Parachains on Kusama have real life impact and effects on the whole of the Kusama ecosystem, unlike a testnet in which test tokens have no actual value. Kusama provides fertile ground for experimentation and iteration before deployment on Polkadot and a common development pipeline is “Testnet -> Kusama -> Polkadot” according to Polkadot’s documentation. All projects on Kusama are real projects with their own future prospects. Moreover, some parachains also intend to stay on Kusama and may never migrate to Polkadot, since the risk profile of those who use Kusama may end up being drastically different to those who use Polkadot-connected chains.
Unlike testnets, Kusama also has its own formalized governance structure which allows KSM holders to decide the future of Kusama. KSM tokens also carry real world value and have real world utility, unlike testnet tokens. Kusama also has a much quicker governance process than Polkadot, with a 7 day voting window and 8 day implementation period, compared to Polkot’s which is a month (28 days) for both. This allows on-chain governance and referenda be trialed rapidly on Kusama before it is refined or implemented on Polkadot should both communities wish.
As more and more time passes, Kusama’s future may become sharply divergent from Polkadot’s as Kusama’s community may decide to take a different evolutionary path to Polkadot’s.
Like many other ecosystems in Web3, Polkadot has its fair share of common misconceptions and misunderstandings. Due to Polkadot’s unique series of features, tech stack and tokemonics and intelligent game theoretical design, misconceptions are bound to arise.
As Layer 0s like Polkadot garner more and more adoption, we at Figment will continue to help dispel myths and help Web3 participants to understand the technologies that the new decentralized web is built on, in addition to providing the necessary staking infrastructure to secure the Polkadot and Kusama base chains.