🔎 A Deep Dive Into Polkadot’s Parachain Auctions and Crowdloans

Last week, we traced the evolution of token distribution models from bitcoin mining and ICOs, to IEOs, launch auctions, and DeFi token issuance.

We pointed out that token distribution models in 2021 will start to blend key elements from traditional token sales (engaging the crowd) and DeFi token issuance (empowering users to provide value to the project). This week, we’re taking a deep dive into one of the hottest new models in protocol launch and token issuance that strives to accomplish just that: Parachain Auctions and Crowdloans.

The following questions and answers represent some of the most common questions we have seen and heard about Polkadot and it’s upcoming parachain auction system. The answers to these questions are derived from our conversations with the Polkadot team and community members, the Polkadot Wiki, and the Web3 Foundation.

Let’s dive in:

1. In order to understand parachain auctions and how they improve on earlier models, we must first comprehend the universe in which they live: Polkadot. Can you explain what Polkadot is and what makes it unique from other blockchains?

Polkadot is a protocol of protocols, but before diving into what that means, it’s helpful to look at the design motivation.

Polkadot was designed to provide the benefits of sharing a common environment in which applications can interact trustlessly, but without the burden of each building a chain from scratch, nor the limitations of sharing execution space. Teams building parachains have low level control over their blockchain and can design them to specialize in a specific task, but don’t need to develop the primitives like peer-to-peer networking, consensus, databases, etc. To accomplish this, Polkadot defines a “metaprotocol” as a protocol that describes a format for layer 1 blockchains. Any layer 1 blockchain that is expressed in this metaprotocol can connect to Polkadot as a parachain. As such, one can consider Polkadot a “Layer 0” blockchain.

Because the parachains are all blockchains, they can have their own communities and ecosystems as well. For example, there are several chains that will have smart contract platforms (in many flavors, from EVM to Wasm to TEE-based private contracts), and these chains will have their own ecosystems of contract developers. So from a technical “protocol of protocols” standpoint, Polkadot creates a “community of communities”, each sovereign but connected through a shared context that allows them to interact trustlessly. It is like the EU: a network of nation states that are economically sovereign, but linked through common agreements that allow them to trade.

2. There are three main parts to the Polkadot network — the main relay chain (Polkadot blockchain), parachains, and bridges. Can you explain each of these and how they relate to one another?

It’s easiest to start with parachains. Parachains are simply understood as layer 1 blockchains, like Bitcoin or Ethereum. They have their own state transition function, e.g. one can be a smart contract chain and another can be an identity chain. They are defined by their own governance and economics, so they can have their own designs in those regards.

The Relay Chain exists primarily to serve the member parachains. It acts as the consensus layer and validates the state transitions of the parachains, securing each one in its own blockchain. The Relay Chain is similar to a light client to all the parachains, keeping track of their headers.

Compared to hub-and-bridge models, the parachains do not need to trust the validator set of the other parachains that they interact with because the Relay Chain validates all of them. This takes a huge burden off of teams when it comes to developing a validator community. But at a higher level, it makes security collaborative, not competitive.

Bridges are just a special type of parachain. Actually, from the Relay Chain’s perspective, they are just other parachains. They have logic for interpreting the state and finality of other blockchains that are not parachains - like Bitcoin, Ethereum, Zcash, etc. - and relaying that information into Polkadot so that parachains can interact with those chains. Bridges take many forms related to how they actually interpret the finality of other chains and how they interact with them. There may actually be a whole ecosystem of bridges depending on the use case of bridge consumers, rather than just a single bridge.

3. Why should a project consider becoming a parachain?

Projects may consider becoming a parachain for technical, political, and economic reasons. On the technical side, developing a parachain gives granular control over the design of your blockchain. This access lets teams design and implement specific functionality right into the blockchain’s API. Rather than users interacting with contracts, which interact with the EVM, users can interact directly with your chain’s logic. Removing this layer removes inefficient gas metering, which allows for faster and more cost efficient execution.

Having a parachain also means dedicated platform design and governance. When applications share a smart contract chain, they are all beholden to that chain’s hard forks and logic changes. The Relay Chain validators don’t actually control a parachain’s state, they only validate their state transitions. It’s up to the parachain to encode in their state transition logic about how upgrades and changes to their parachain take place.

Finally, parachains can freely design their economic system. There is no need for their users to hold DOT tokens to pay fees with or otherwise use the parachain. And because the Relay Chain validators execute all the parachains in parallel, they do not compete over resources the way that contracts on Ethereum do. Parachain economies are self-contained, and high traffic on another parachain won’t have any impact on the fee market or throughput of your own parachain.

4. How do parachain offerings improve on previous forms of token distribution like token sales, launch auctions, stakedrops, and DeFi airdrops?

Parachain crowdloans have the potential to, in many ways, be a fairer, safer token distribution model when compared to past token distribution models. In the past, users might have sent their tokens to a developer team, hoping to receive a token of value in return. Auctions improved on this model by letting all the participants agree on a fair swap rate given the risk, but still use the same model of sending one token in hope of another. These were often done without a working product or proven team.

Stakedrops and DeFi airdrops come in many forms, so any comparison will be off point in some way. But broadly speaking, they reward participants in the network with some tokens of a new project. This model improves on direct swaps in that they put the onus on the project team to deliver something without exposing the user to too much risk. And although they may achieve a fairer token distribution, it’s difficult to measure the success of these mechanisms. Would the network have been able to launch without them, or did they primarily serve to allocate tokens?

Crowdloans are different. Like stakedrops, users do not permanently give up their DOT in a transaction, but rather allow their DOT to be held in a reserve and returned later. They remove the risk of having a team fail on delivery of the product that was promised and leaving participants with only a new worthless asset.

But unlike stakedrops, crowdloans could grant the projects behind them special privileges: namely one of a limited number of parachain slots (if their bid is selected at the auction) and the access to the security and interoperability of the Polkadot network that it provides. Participants express their long-term conviction that the parachain they are backing will be a long-term value add to Polkadot by locking their DOT for a long period of time and foregoing other opportunities like staking.

In the case where teams need or want to crowdsource DOT, all the participants are guaranteed to get the DOT that they loan back. This model holds teams accountable to deliver on their parachain.

This process can all be done autonomously and trustlessly on-chain, or managed by a trusted custodian like Coinlist. In on-chain campaigns, a team can configure a campaign with a cap and the details about the bid they will make (i.e. how long they want to be a parachain, and therefore how long the DOT will be locked if they win) and the duration of the campaign. A campaign can span several auctions, giving the team additional chances to win without restarting their campaigns if they don’t win the first one. Anyone can participate in these campaigns using the on-chain crowdloan logic.

Some teams will choose to manage their campaigns through a custodian like CoinList. In these cases, users will use their CoinList account to participate, and CoinList will aggregate all the contributions and work with the parachain team to manage their bidding. In instances where parachain teams choose the crowdfund module, CoinList can still act as an aggregator of DOTs for the auction.

5. How does a project become a parachain? What are the token distribution and auction mechanics?

Polkadot uses a candle auction, where the end is retroactively determined by a random function. The auctions are expected to last about two weeks each. The random end time compels teams to make their fair value bid early and not try to snipe the auction for a lower amount at the end. Like with a burning candle, you can guess - but not know - the precise time the candle will go out, signaling the end of the auction.

Step one to becoming a parachain is to build one. For that, Parity Technologies provides the Substrate development framework. Substrate is not the only means to becoming a parachain. As long as your state transition function exposes the API that the validators need, it can also be a parachain.

After that, the parachain community will just need to decide its strategy. There are two ways to participate: either use a single account to bid in the auction, or use the on-chain crowdloan logic. The crowdloan logic allows teams to crowdsource DOT from users and will automatically handle reserving the DOT if they win and returning it to users at the end of the parachain’s slot lease. There are many ways that parachain teams can create incentives for DOT holders to participate, from their own native token to special access rights and utility on the parachain.

6. What kind of projects are best suited for a parachain slot? Can you give any examples of current projects vying for a slot?

Any project that provides a service or application that’s in high demand might be well suited to a parachain slot. The parachain runtime allows an abstract state transition function, so almost anything can technically become a parachain. There are even some projects who have implemented the Ethereum state transition function in Substrate and will seek parachain slots, so teams can deploy Solidity contracts right on those parachains.

As far as known teams deploying parachains, there are several sources. PolkaProject is a community run website that lists teams building in the Polkadot ecosystem. For teams that appear close to launch-ready, there is the list of teams deploying on the parachain testnet Rococo, listed on the Polkadot Wiki:

● Plasm
● Acala
● KILT
● Interlay
● Darwinia
● Phala
● Crust
● HydraDX
● Bifrost
● Starks Network
● Clover
● Zenlink
● ChainX
● Robonomics
● Patract Hub

7. How much does it cost to become a parachain?

Tokens that are reserved behind a parachain slot cannot be transferred or used for staking. However, they are returned in full at the end of the lease. As such, the cost at this point is really the opportunity cost of not having access to your DOT for the duration of the lease.

8. What happens if a project does not win a parachain slot auction?

Projects that don’t win a parachain slot auction have many additional options in the Polkadot ecosystem. For one, any DOT used in the auction is returned to users at the end of the auction if the bid is not successful. Two, auctions occur on a rolling basis (more on that in the next question), so they can always try again several times. Three, Polkadot has a set of parachain slots set aside as a “parathread pool”. Parathreads are like parachains, but on a pay-as-you-go basis. Rather than reserving DOT for a slot lease, they share execution slots with other parathreads and use DOT to secure validators for a single block at a time, when needed. Parathreads will have a slower block time than parachains, but are a great low-barrier way to enter the Polkadot network and gain some adoption before transitioning to a full fledged parachain. Parathreads still enjoy the exact same security guarantees and cross-chain message passing features as parachains.

9. When is the first auction and how many slots will be available?

Based on our research, the first parachain auction is expected to take place first on Kusama — Polkadot's network for experimental and early stage deployments — in February or March, followed by Polkadot about a month later. This is just a rough timeline and depends on further issues with parachain code and the final audits and testing - we’re keeping a close eye on progress on GitHub.

All auctions are for only one slot at a time. However, about 40-50 slots should be available for auctioned parachains (the remainder being for the parathread pool and public-good parachains, granted via governance). With auctions lasting about two weeks each and determining the slot occupants for the next two years, you can do the math: there will almost always be an ongoing auction.

10. How can a project prepare for a parachain auction? What sort of marketing and strategic planning is required?

When a project enters a parachain auction, they should be almost production ready to deploy their parachain. The marketing efforts will depend on the project and their community. For example, some parachains will host applications, and their audience could be users, while others will host development platforms, and their audience will be application developers. Another factor that may influence marketing strategy is whether the project team plans on running a token sale in addition to the crowdloan event.

Before the auction, teams may want to gauge sentiment regarding the length of their lease; do participants want to vie for a full two-year lease, or only go for a one-year and then have to renew early?

Teams should be prepared to communicate what value they bring to Polkadot, their project roadmap and vision, and why DOT holders should participate. Their roadmap should also include how they plan to secure their lease in the future, for example, will they do another crowdloan event, or raise DOT in some other way?

Learn more about building on Polkadot: https://wiki.polkadot.network/docs/en/build-build-with-polkadot

Learn more about Polkadot Crowdloans: https://wiki.polkadot.network/en/

Stay tuned for more on this topic coming soon!

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