The 2017 crypto rally spawned thousands of projects. Many likened it to the dotcom bubble, where a speculative boom and bust led to hundreds of low quality projects folding, while a few companies emerged triumphant from the chaos. For many who were investing during the last cryptocurrency bubble, the question was “How do I pick the next Amazon, Google, or Facebook?”
Polkadot has some similarities to those internet giants. It was one of hundreds of projects that appeared during a surging market that subsequently crashed. It has now survived the bear market and rallied from relative obscurity to one of the top four cryptocurrencies in terms of market capitalization.
So does Polkadot have what it takes to be the next Facebook or Amazon? It’s too early to tell for sure, but its price explosion suggests that some are willing to bet on it. This article is intended to bring you up to speed on the ins and outs of Polkadot, and its long term prospects.
Background: The Origin of Polkadot
Polkadot was founded by Gavin Wood, one of the co-founders of Ethereum. He also helped write Solidity, a programming language which is currently the most widely used language for smart contracts, and served as Ethereum’s first CTO. Wood is also known as the lead developer behind Parity, a software which allows users to run the Ethereum network.
While Parity has generally run smoothly, it achieved a degree of infamy in 2017 when a hack resulted in more than $150 million worth of Ether being frozen. More than 3 years later, the funds have still not been recovered. Ethereum developers would probably respond by pointing out that there were lots of plane crashes during the early development of aviation.
The idea for Polkadot originally came to Wood while he was working on a proposal to make Ethereum more scalable called sharding. He felt that Ethereum was becoming too complex, and wanted to create as simple a protocol as possible.
Initially, Wood compared the development of the Ethereum ecosystem to the Linux operating system. At times, he has described Ethereum as a “world computer” in which Ethereum is the “kernel” or core of the operating system. He has compared his projects, like Parity or Polkadot, to software libraries or executables which form a bridge between an operating systems kernel and other programs or users.
The motivation for the project came partly from frustration about the slow pace of Ethereum’s development. Wood preferred to start with a “blank slate” and address some of the concerns that he saw as holding Ethereum back. These concerns mainly revolve around scalability, interoperability, and governance, and are reflected in Polkadot’s technical architecture.
Polkadot was conceived with a multi-chain architecture in mind. It consists of a main chain, called the “relay chain” and a number of side chains, called “parachains.” This “multi-chain” environment allows developers to calibrate individual chains to the technical specifications their applications need.
The network has successfully implemented sharding already, which is an integral part of Ethereum’s long delayed Ethereum 2.0 upgrade. While established networks like Bitcoin or Ethereum require all network participants to maintain a complete copy of the blockchain, sharding increases scalability by distributing computing and storage tasks between nodes.
One of the drawbacks of decentralized networks is the difficulty in achieving consensus. When a centralized network like Facebook, for example, wants to make changes, there is an executive who simply makes a decision and enforces it. By contrast, Bitcoin took years of heated debate to push through a major network upgrade. Likewise, disputed changes to the Ethereum network caused the network to split into Ethereum and Ethereum Classic.
Polkadot remedies this by assigning voting rights to Polkadot’s native currency, DOT. In this way, network upgrades and changes can be decided more smoothly. Polkadot also achieves a higher degree of scalability and speed by means of hybrid consensus, where elements of transactions are split into parts that require differing security guarantees.
None of these features are entirely unique to Polkadot, but on the whole the project is very well composed and effectively managed, so it’s understandable that Polkadot has emerged as a leader in the space.
Polkadot’s Sudden Rise
In late 2020 and early 2021, DOT’s price increased by over 300%, positioning DOT as the 4th largest cryptocurrency by volume. A number of factors contributed to this rise.
Polkadot’s network was under development for almost 3 years before the community of developers and investors moved to enable transfers of DOT tokens. This led to a major increase in trade volumes as exchanges were able to integrate support for DOT.
In August of 2020, shortly after transferability was enabled, the Polkadot community voted on 1:100 split, meaning Polkadot owners got 100 tokens for every token they owned. This also drove increased interest in investment in DOT.
A number of venture capital backed DeFi (Decentralized Finance) projects chose to use Polkadot during a surge of interest in DeFi generally. This seemed to signal some migration away from Ethereum, which has suffered multiple delays in rolling out the Ethereum 2.0 upgrade, by developers.
Since these delays were caused by problems which Polkadot was intended to fix, it led to speculation that Polkadot could be an “Ethereum killer.”
As is common with higher performance blockchains, Polkadot’s consensus model has been criticized for centralization, since there is a limit on the number of validators. Polkadot is also based on Proof-of-Stake, which also has plenty of detractors, most of whom cite concerns about centralization.
There is intense competition in the decentralized application platform space, and most of Polkadot’s features also exist in other similar projects, so it’s not entirely clear if Polkadot will have any definitive edge over its competitors.
In order for the network to thrive, it would need to attract many developers, and in this regard Ethereum still has an edge over Polkadot. There is a learning curve associated with moving to a new network, so it’s unclear if Polkadot’s advantages will be big enough to attract enough talent.
The democratic decision making model may help to avoid prolonged disputes about design choices, but on the other hand there are some concerns that DOT holders could make decisions that privilege short term gains over the long term viability of the project. For example, they may choose to further dilute the supply, which could eventually affect the market price of DOT.
Most of the risk factors associated with investing in DOT are not specific to Polkadot, but are general to the market for decentralized application platforms.
The Future of Decentralized Application Platforms
The future of Polkadot depends on what the future of decentralized application platforms looks like. The entire field of smart contracts, decentralized finance (DeFi), decentralized applications (dapps), and its associated infrastructure remains highly speculative. The vision of decentralized legal and financial infrastructure is very enticing, but this vision is in no way guaranteed. Polkadot is competing for market share in a very competitive space whose future is very much uncertain.
The questions revolve around several issues.
Ethereum has a number of active dapps, but the total user numbers for these dapps are still relatively small. These applications have been plagued by complaints of poor user experience and high cost of operation. The hope is that Polkadot, being designed from the ground up with scaling in mind, may be able to remedy some of these growing pains. A number of applications are under development on the Polkadot network, but so far none of them are operational.
Even fast and user friendly dapps are still likely to be slower and more expensive than apps hosted on centralized databases. Many supporters of the tech wave away these concerns by arguing that future technological improvements will enable a more seamless experience. Moore’s law, which predicts the rate of hardware improvement in computing, is often invoked to argue for a future where technology exists that allows blockchains to compete with the user experience of centralized databases.
Some argue, however, that Moore’s law will eventually bump up against the laws of physics. Others point out that while memory and processor power are increasing rapidly, throughput and network latency are not growing as quickly, which may also be an impediment to the growth of these networks.
Is Decentralization Necessary?
A blockchain was necessary for Bitcoin because multiple previous attempts to create a currency were shut down. This problem became more clear when centralized Bitcoin competitor Ripple was sued by the US Securities and Exchange Commission in December of 2020 for issuing an unlicensed security.
Ripple is much faster and cheaper to use than Bitcoin, but is still valued less than Bitcoin because it does not have the same security from corporate or government interference. So there is a clear advantage for currencies to be protected from manipulation.
This does not necessarily apply to all applications. If an application does not absolutely need to be decentralized, there is no reason to use a blockchain for it. Many legal services require some kind of government guarantee and need to be regulated anyway. This raises questions about how big the market for decentralized legal and financial services can grow.
The Multi-Chain Vision
One of Polkadot’s main goals is to increase the interoperability of different blockchains. This approach is based on a vision where different blockchains specialize to fill different technical needs in the future, and there is a need for them to communicate with each other.
This vision of the future is also speculative. All cryptographic tokens, whether a store of value network like Bitcoin, or a token which grants access to decentralized computing services like Ether, are strongly subject to the network effect, also known as Metcalfe’s law. This law states that the value of a communication network is proportional to the number of its users. For example, the more people own telephones, the more useful telephones become.
This is why many communication networks become monopolistic— Facebook dominates the social network space because of this tendency for value to concentrate in one network. Some argue that users will gravitate to Bitcoin due to its proven track record and robust security guarantees, and become the preferred store of value worldwide.
If value does concentrate in one currency network, it’s possible that smart contracts and applications that must be decentralized will be built on a second layer, rather than the protocol level. This was the case with the early development of the internet, where TCP/IP beat out all other protocols for the transfer of information. Some believe that one protocol will eventually beat out all others for the transfer of value.
If one network of value transfer does end up dominating, products like Polkadot could be very valuable in their own right, but would no longer need their own currency. Such a development would render the investment into interoperability unnecessary.
Some cryptocurrency idealists (especially younger ones) have dreamy-eyed visions of a world where decentralized networks eliminate government corruption. Many commentators have indeed noticed that these networks will take over some of the political functions that currently belong to governments, but you can expect that entrenched elites aren’t going to give up power without a fight.
This is one of the main reasons there is so much obsessing about decentralization. Even if a network is decentralized, however, more complex networks like Ethereum and Polkadot are more dependent on a large scale effort by developers, so many view them as more fragile than a clunky but robust and reliable network like Bitcoin.
Is Polkadot’s Valuation Justified?
To know if Polkadot is undervalued or overvalued, we have to ask two questions:
- How big is the future for decentralized applications?
- If this future exists, how big of a stake will Polkadot have in it?
This means many question marks surround Polkadot. Will there really be a multi-network world, where different networks co-exist like countries do today? Or will a few giants gobble up the whole market, as was the case with the first wave of the internet revolution?
Polkadot stands out among its competitors as a high quality project. There is a fair chance it could capture more of Ethereum’s market share as time goes on, especially if the Ethereum 2.0 upgrade sees more delays. In the long term, however, the market fit for Polkadot (and Ethereum) is still very much unproven when it comes to generating real productivity gains. Given the lack of functional products on Polkadot relative to Ethereum and its shorter track record, however, it seems that Polkadot being in the top 5 cryptocurrencies may be fuelled by quite a bit of hot air.
However, if platforms like Polkadot really begin to add value to the economy, the potential will be huge. If that does happen (and how big of an “if” depends on who you ask), Polkadot looks like it may have a credible chance of becoming a Google or Facebook of the web 3.0.
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