Imagine a future where there are over a thousand blockchains, each dedicated to a specific use case. For example, a blockchain optimized for decentralized finance, another for decentralized identity issuance and verification, another for decentralized data storage, another for decentralized cloud computing, and yet another for decentralized privacy-enablement.
Now imagine that all these blockchains are interoperable, meaning that they can talk to each other — send tokens, call functions, initiate smart contracts, etc. Such a setup would obliterate the need for powerful, centralized middlemen across various industries.
For blockchain technology to revolutionize the world in the same way Bitcoin and Ethereum have revolutionized finance and digital ownership, then an Internet of Blockchains is the necessary next step.
Thus far, the blockchain industry’s best solution to this problem has been via the use of bridges. Bridges are wonderful — they are networks/blockchains that help connect other blockchains. That said, because this connection isn’t native, composability is affected. Composability is the ability for protocols (blockchains or decentralized applications) to interact with one another in a permissionless way — meaning they are constantly talking to one another and leveraging each other’s code, and therefore each other’s utility.
The unstoppable force that is Defi was only able to grow into this behemoth thanks to seamless interoperability between the smart contracts on the Ethereum blockchain. Take the auto-investment product, Yearn for example. People put their money in Yearn to earn a yield. In the back-end, Yearn uses this portfolio and places them into other DeFi protocols (Sushiswap, Compound, etc.) to generate that yield.
So what if blockchains could talk to each other without any intermediary? Wouldn’t that explode the use cases for blockchain technology?
Thankfully, Polkadot and its Parachains are poised to lead us to this glorious multi-chain future of seamless interoperability. But for this to happen, parachain auctions must be held. But what are parachain auctions?
Well, to answer that, we need to start at the beginning — what is polkadot?
What is Polkadot?
In technical terms, Polkadot is a meta-protocol that connects layer-1 blockchains (and any network). For better visualization, imagine a circular pipe with a lot of holes for pipes to connect to.
Because it exists to connect many blockchains, Polkadot is afforded a few advantages over regular layer-1 blockchains. The first is scalability. If one chain can process x transactions per second, then by having many chains run as one, more computation power is made available to each blockchain, helping fight the scalability problem. Other advantages include:
- Shared security: by design, all layer-1 blockchains on polkadot are tapping into the same security infrastructure. Security here covers both economic and network security.
- Interoperability: a bit has been said about this already. Because all parachains on Polkadot are speaking the same language, they are seamlessly interoperable.
- Upgradability: thanks to its modular architecture and an on-chain governance mechanism (whereby governance decisions are made on the blockchain and subject to public scrutiny), updating the polkadot network (code) doesn’t require any forks. This is true for every blockchain building on Polkadot.
Thus, any blockchain that decides to build on Polkadot is instantly offered all these benefits without having to source it for themselves. This brings us to parachain slots.
What are Parachain slots?
Parachain slots are the holes on the circular pipe. Any layer-1 blockchain that’s able to connect to the pipe will be upgraded to a parachain. Now, being a parachain is a pretty big deal because, in addition to all the benefits offered by the relay chain, parachains have the following advantages.
- They do not pay any fees (gas or otherwise) to interact with the relay chain.
- Unfettered access to the relay chain, meaning they can write transactions at any time. This is markedly different from parathreads (which are basically pay-as-you-go parachains).
The way the system is set up, there are no parachains by default. Every project (layer-1 blockchain) that wishes to become a parachain must first win a parachain slot. This is because our circular pipe has a finite number of holes. Further, even if our pipe could take all the layer-1 blockchains, for maximum security, it would be unwise to connect them all at the same time. In fact, it’s most sensible to connect them one at a time. And finally, we arrive at the main point of this article.
What are Parachain auctions?
Parachain auctions are auctions that are held on the Polkadot relay chain to determine which blockchain will connect to the parachain slot. Teams bid using DOT or KSM (if on Kusama — Polkadot’s younger, wilder cousin). They are very similar to regular auctions in that there are many parties that want an item and they all bid to get it. Normally, the one with the highest bid wins the slot, but because we are dealing with blockchains, Polkadot’s auctions are slightly different. To learn how let’s consider the auction process in-depth.
Crowdloans
Before every parachain auction, there is a period dedicated to crowdloans, which I’ve already written a detailed article about here. The summary is that crowdloans enable smaller teams (or teams with a stronger focus on decentralization) to raise DOT or KSM for the parachain auctions from their community or interested ‘investors’. To incentivize more people to bid on their behalf, teams offer the native token of their blockchain in exchange. For example, Acala would offer you some ACA for loaning DOT to their auction funds.
Now, the truly special thing about this crowdloan process is that the users’ tokens are never in the possession of the teams who are being loaned to. Rather, the relay chain holds these tokens for the duration of the parachain lease, at the expiration of which it will return the tokens to the users. When the crowdloan period ends, then the parachain auctions begin.
The auctions
The auction process itself is pretty straightforward. The way it’s structured is that the start and end times will be known by everyone. Once it begins, then everyone on the network is free to submit their bid to the relay chain. Only one parachain slot can be auctioned at a time, and each auction process lasts for 7 days on Kusama and 2 weeks on Polkadot. Once the auctions are concluded, determining a winner is where things get interesting.
Choosing a winner
If everyone knows the end time of an auction, then there’s a potential for some people to game the system via auction snipping. This happens when a bidder had plans to bid 100,000DOT for a slot but decides to start his bidding at 50,000DOT and up it by 5,000 every time his offer is topped. Unfortunately for him, despite his higher funds, he loses out at the dine minute when another user with a faster connection (or the validator finalizing the block) bids 70,000DOT. In this scenario, the Polkadot network has suffered a serious loss of 30,000DOT and this is bad for all DOT holders. Ideally, the higher the amount of DOT bonded for a parachain lease, the more secure the network because fewer tokens will be available for speculative trading.
Thus, how do we guarantee that the network always has the maximum amount of DOT available from the most committed teams (teams who are willing to bond more DOT)? Polkadot uses a special edition of the candle auction whereby we know the start and end times but we don’t know the retroactive end time — a time before the end time when the auction actually ended
Basically, we know the end time, but then this isn’t the real end time because the relay chain already ended the auction in the past, we just didn’t know when. It’s only after the end time has elapsed that we find out the retroactive end time. The highest bid before this retroactive end time will win.
To make it clearer, let’s consider a just-concluded auction where the two highest bids are 100,000DOT from Project X and 80,000DOT from Project G. Naturally, Project X should win. But if Project X’s bid came in after the retroactive end time, then Project G will win.
Once a winner is determined, then the team that won the slot will be able to upgrade their blockchain to a parachain. But this may not always be the case.
Parachain slots in the secondary market
The way the auction process is designed, anyone is free to bid for a parachain auction, and because of this, it is highly possible that a regular account could win a parachain slot auction. If this happens, then the lease can be sold to a team in the secondary market. This is possible because parachain leases won from auctions are tradable, meaning one account can send it to another account. It’s interesting to see how much of this will happen in the future.
How long are parachain leases?
Parachain leases range from 6 weeks to 48 weeks on Kusama, and 3 months to 2 years on Polkadot. You can only bid for 6-week trenches, such that a project could win a parachain slot for 6 weeks or 12 weeks, but never 7 weeks or 13 weeks. The same goes for polkadot — only 3-month trenches are available.
One consequence of this is that project A could bid 40,000KSM for a parachain lease of 18 weeks while project B bids 60,000KSM for a lease of 48 weeks. Considering that both registered their bids before the retroactive end time, it makes sense to expect that project A will win because they are offering more DOT for a shorter time. But no, Polkadot isn’t only about the maximum amount of tokens offered.
Depending on the duration of other parachain leases, the relay chain can find it more beneficial to network security to lock 60,000KSM for 48 weeks, as opposed to 40,000KSM. Thus, it’s not only about the value of the bid, but also the time requested. Usually, the relay chain is designed to maximize network security. To fully understand this, I recommend reading this section of the wiki.
What happens to the tokens used in the auctions?
If the team loses, then the tokens can be used again for another auction. If not, then they are refunded to all those who partook in the crowdloan (assuming the team used the crowdloan module to raise tokens).
If the team wins the auction, then all tokens will be locked by the relay chain for the duration of the parachain lease. At the end of the lease, the tokens are returned to the original owners.
Important to note: Any DOT used to acquire a parachain lease (whether via crowdloan or otherwise) is excluded from earning staking rewards. This is why you have to unstake your tokens before participating in the parachain auctions.
The parachain games — to infinity and beyond
Things are bound to get very interesting during these auctions and that’s why I’ve termed them the parachain games.
For example, if there are 3 DeFi-optimized layer-1 blockchains waiting to connect to the polkadot relay chain, then the competition is as much about who gets it first as it is about who has better tech. The first to connect will have access to users (liquidity providers, traders, etc.) before the other two. Of course, a few weeks difference shouldn’t matter too much, but you never know with these things. Also, as already outlined above, asides from the blockchain teams vying for a parachain slot, the general polkadot community is also part of this game.
Consider a possible scenario where a whale (regular user with a lot of tokens) bids for and wins a parachain lease for 40,000DOT and then turns around and sells it to a blockchain team for 5,000DOT. Thus, he still has his 40,000DOT waiting to be refunded at the end of the lease and now has an extra 5,000DOT. In this way, he would have traded earning staking rewards on his original 40,000DOT.
Another aspect of the games I expect to be big is speculation on who will win a parachain slot. As the first parachain auctions on Kusama approaches, users have been voting for the blockchain projects they think are most likely to get win parachain slots in Zeitgeist’s #KusamaDerby. According to the first few rounds held last week, Karura would be first.
My overwhelming belief is that this is just the beginning. The parachain games are here to stay and they will only get wilder. Will you participate or watch?
Gilbert Bassey is a writer who firmly believes in the goal of decentralization. Join him on Twitter to have interesting conversations about polkadot and web3.
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