The crypto industry has experienced tremendous growth and continues to expand, but an issue that remains unresolved for some is scalability and interoperability. The bridge to this point of friction is the Polkadot and Kusama projects and their parachain auctions. Both projects were conceived in 2016 to serve as a decentralized blockchain that could connect other blockchains and enable communication without permission.
While this is no small feat, doing so will revolutionize the way blockchains work with each other, provide scalability along with a growing user base, and remove the need for a centralized network. Accordingly, one of the most anticipated events of this year is the launch of the Kusama and Polkadot parachain auctions, which allow projects to connect using parachains.
Parachains are separate blockchains dedicated to a specific application, and the Polkadot and Kusama networks support the use of parachains. Currently, separate blockchains (such as BTC and ETH) can’t easily exchange data with each other without permission. Still, the launch of parachains is the first big step for Kusama and Polkadot to ensure seamless communication between the chains. Since June 15, 2021, dozens of crypto projects have sought to raise hundreds of millions of dollars through crowdfunding.
Crowdloan for a chance to win one of the parachain slots on the Kusama network. Karura raised 501,137 KSM via crowdlone, Moonriver raised 205,935 KSM, Shiden raised 138,457 KSM, Khala raised 132,280 KSM, and Bifrost raised 136,817 KSM ahead of the parachain auctions. The crowdsign campaign allows projects to use KSM or DOT to participate in a parachain slot auction. Anyone can participate in the crowdloan and support projects by linking their KSM or DOT to a specific campaign.
If successful, crowdfunding assets will be blocked for a while of the parachain’s active reservation of a parachain slot. Assets are returned to those who participated in a crowdloan once the parachain slot expires. If an auction is unsuccessful, assets are returned to the campaign participants at the end of the crowdloan.
To better understand how this multi-chain technology works, its value proposition, and why global market participants have their eyes set on the Polkadot and Kusama ecosystem, we’ll deconstruct the Polkadot project, its canary network Kusama, and the purpose of parachain auctions and what it means for the broader cryptoasset ecosystem.
By reading this report, you’ll understand the value of parachains, how and why they may change the future of the crypto industry, and why many believe both projects will serve as the “internet of blockchains.” Readers should feel equipped to confidently participate in parachain auctions and realize the power and potential of parachains.
Polkadot and Kusama
What is Polkadot?
Polkadot is a blockchain network that aims to provide a trustless environment in which specialized blockchains can communicate through the Polkadot Relay Chain, the main blockchain of the Polkadot system, which is responsible for overall network security, consensus, and cross-chain. The Polkadot network scales by processing transactions across multiple parallel blockchain segments known as parachains, in stark contrast to networks that suffer from scalability issues due to sequential transaction processing. Parachains are sovereign blockchains optimized for a specific functionality or use and can dictate their own governance structure.
Interesting blockchain projects can win a parachain slot by linking DOT tokens, which can be obtained through the crowd side if the project does not have enough DOT of its own. Those unable to secure a parachain slot can also turn to para-threads, which allow non-permanent blockchains to operate on a pay-as-you-go model (like data oracles). Projects using para-thread pay a DOT commission for each block produced. The main difference between para-threads and other parachains is that para-threads are used by multiple projects that take turns producing blocks as needed.
Like the Bitcoin Lightning network, which allows parallel processing, Polkadot provides scalability by processing transactions in parallel on each parachain, rather than all in sequential order. Each of these parachains is in the form of a blockchain and operates in parallel with all other segments and the Relay Chain. Parachains and the untrusted backhaul communicate with each other using a technology known as the Cross-Chain Messaging Protocol (XCMP), which we will discuss below.
Although parachains can connect to a Polkadot relay chain via a parachain slot, the available slots are limited. As the number of available slots on the Polkadot network increases, more blockchains may be deployed to interact with other blockchains. However, it is worth noting that each auction does not require a new project to be created, and projects can re-bid for the auction after their slot lease expires. Parachains and paraflows can also connect to external, economically separate networks via bridged parachains. Blockchain bridges come in various designs, from centralized to more decentralized ecosystems.
The role of a mapping node is to maintain a full node for its particular parachain and a full node for the relay chain and collect and store parachain transactions from users and create new parachain blocks, much like miners on the Proof-of-Working blockchain. Those who manage and keep track of the para-chains and para-threads are known as pickers. Typically, they match and execute transactions to create new block candidates, which are passed to the Relay Chain validators responsible for validating and proposing the block of the parachain.
Pickers don’t protect the network, as this is the role of a validator, and having too many pickers could theoretically slow down the network. Until the block candidates proposed by the picker have been validated, pickers cannot create new blocks in the parachain. As complete Relay Chain nodes, pickers also play a key role in Cross-Chain Messaging (XCMP). They know about other sorting mechanisms on different parachains and communicate by sending messages from one parachain to another. However, since XCMP is still in development at the time of writing, the Polkadot testnet has a temporary replacement known as Horizontal Relayrouted Message Passing (HRMP).
Although HRMP has the same interface and functionality as XCMP, it is more resource-intensive because it stores all messages in the relay chain. To send transmissions and messages between parachains and the relay chain, each message is first sent to the relay chain and then from the relay chain to the desired parachain. However, once XCMP is implemented, HRMP will be phased out to achieve greater network efficiency.
Since pickers support the Polkadot network, validators secure the network by securing the relay chain and hosting DOT tokens. In exchange for placing DOTs as collateral, validators can validate transactions that have been forwarded from collectors, create blocks in the relay chain, and engage in consensus with other validators on the network. In this way, validators earn DOT rewards for transaction fees and block rewards in exchange for their services. Validators that don’t adhere to the agreed network algorithm will have their staked tokens stripped out, which is the act of partially or completely removing their staged tokens.
However, good performance results in validators receiving block rewards and transaction fees in the form of the network’s own token. Validators are elected by the nominators who protect the relay chain by placing points and choosing reliable validators for an active validator established by linking their stake. In turn, the selected validators usually give a portion of the staking reward to the nominator. At this writing, Kraken users can earn up to 12% on their KSM and DOT by placing on-chain Kraken bets. Any full node or parachain picker can also act as a network catcher and report bad behavior to validators.
Like collectors, fishers keep complete para-chain assemblies. Acting as the system’s bounty hunters, they monitor pickup processes and send invalidation reports to detect any irregularities. This ensures that invalid state transitions are not included in the parachain blocks, and fishers will be rewarded with a large payout if they are proven right about the alleged misconduct. Still, their share will be reduced if they are found to be wrong.
What is Kusama?
Founded in 2019, Kusama is the wild cousin of the Polkadot chain with much the same codebase. Kusama was created to allow experimental development for those looking to use the Kusama network or prepare for future deployment on Polkadot. It is also called the Polkadot “canary net,” a term coined from the practice of using canaries in coal mining to alert miners when toxic gases reach dangerous levels.
Like these canaries, Kusama was conceived as a network that warns project developers about problems that may arise in the future when deployed in a real environment. The two networks are similar but independent of each other. However, both networks are pretty much the same structure, and Polkadot and Kusama will auction off parachain slots to choose which parachains will be added to the main network. Accordingly, various updates and features can be demonstrated and tested on Kusama before being implemented on Polkadot.
Similar to the Polkadot network, Kusama has Parachain slot auctions where parachains are added to the Kusama relay chain to become part of the Kusama network. Parachain auctions can include crowdsourcing, where projects link KSMs to secure a parachain slot. The Kusama Council and the Kusama Stakeholders (KSM) make the final decisions about what happens on the Kusama network, including the timing of the Parachain slot machine auctions. While the Kusama network was intended to be a testnet for Polkadot, it’s worth noting that it could be the home network for under-funded crypto projects that can’t compete for a parachain slot in the Polkadot ecosystem.
Kusama vs. Polkadot
Kusama and Polkadot are nearly identical in their codebase, and while Kusama is best known as the Polkadot testnet, they remain independent and autonomous networks. Kusama and Polkadot were created with different intentions; the former focuses on daring experimentation and early deployment speed, while the latter prioritizes reliability and predictability. To better understand networks, we first look at the common features and differences between them.
As conceived from the outset, both networks serve different purposes. Polkadot and Kusama may be better suited for different projects.
Even though Kusama is associated with the testnet, it is likely to remain a highly sought-after network in which blockchain projects are deployed. Initially, Kusama provides an ideal pre-production environment where teams can test projects in real-world conditions with lower rates in the event of bugs or problems during the testing period. Polkadot is best suited for deploying applications that require the highest levels of security and stability, including higher transaction costs.
Once both networks are up and running, projects can choose to exist on both networks and similarly use Kusama as a test environment. Some teams may stay and exist only on Kusama, especially if they do not require the highest level of security or high bandwidth and want to take advantage of the lower connectivity requirements offered by the Kusama network.
Since most of the Polkadot updates will first be tested in Kusama, this could provide an opportunity for those using the Kusama network to be the first to experience the latest technology changes. Whichever ecosystem projects are chosen for use, both will coexist as close but distinct communities with their own set of governance rules and use cases. In the future, Kusama will also be able to connect to Polkadot for interconnection.
Parachains: Scalability and Interoperability
One of the value propositions of the Polkadot and Kusama networks is the concept of pooled or shared security. Blockchains can benefit from the overall security provided by Polkadot backhaul validators by renting a parachain slot. The number of parachain slots is limited, and they will be auctioned individually, so only one parachain auction can take place at any given time. But before we dive into how parachain slots are acquired through parachain auctions, we first look at how parachains work.
For both Kusama and Polkadot networks, parachains will most often be in the form of a blockchain, but they do not need to be developed strictly in a blockchain form. Parachain managers, known as pickers, should also not be tied to a ladder or own any DOT tokens unless the specific parachain they support provides such a requirement. Since the networks are liberal about how each parachain sets the rules for its respective network, the parachains are free to choose their economy and method of verifying transactions (i.e., through transaction fees). The transaction's validity is still checked at the relay chain level regardless of the form and method you choose.
The Polkadot network requires inter-network latency in the transmission of messages from one parachain to another. Ideally, the latency is about two blocks: one block is checked to send the message, and the other is checked to process and create a block in response to the message by the receive chain. There may be cases in an application where the latency exceeds two blocks, if messages end up being queued for processing, or if there are no nodes that run both parachain networks to transmit the message.
Because of this necessary delay in sending messages between parachains, some parachains are being developed to become parachains hubs for entire subsectors. For example, the Acala parachain project aims to become a hub for DeFi applications. The applications of parachains are endless, and now that we understand how parachains work, we’ll look at how a chain can protect a parachain slot from becoming part of the Kusama or Polkadot network.
Parachain auctions were supposed to be a fair distribution tool and give competing teams a chance to win a slot. Both Polkadot and Kusama currently have a limit of 100 parachain slots. For efficient distribution, the parachains will be split and allocated into three different categories of parachains: management-provided parachains, auction-provided parachains, and parachains. The first category, provided by control parachains, is also known as “common good” parachains and is distinguished by the Polkadot network control system. They are called “common good” chains because they will be chains that benefit the entire network, such as bridges connecting the Polkadot network to other networks or chains.
These system-level or utility chains usually do not have their own economic model and help remove transactions from the relay chain, allowing for more efficient processing of parachains. Another category is auction-provided parachains, which are auctioned off without permission, which means anyone can bid to participate in the ecosystem. Projects can place bets using their own DOT or KSM tokens or collect DOT or KSM from the community through a parachain crowdfunding or crowdfunding campaign. Finally, some paraflows are identical to parachains, except pay-as-you-go with an auction for each block. Para streams are more suitable for projects that do not require a permanent connection to the network.
Although the parachain auctions on the Polkadot network have not yet started, Kusama is now offering the parachain auctions via a modified candlestick auction format. Polkadot’s parachain auctions will start in late 2021 and follow the same format as Kusama through modified candlestick auctions. Candlestick auctions are like open auctions in which bidders submit bids, and the winner with the highest bidder at the close of the auction wins. Parachain slot auctions are a modified form of this auction, where the duration of the auction is determined retroactively, which means that bidders do not have a clear idea of when the auction will end.
This format was implemented to avoid being followed by an auction when the end of the auction is known, and bidders post lower bids initially than what they think is really worth in the hopes of a slow increase in bids and purchasing items for a more low price. In essence, it makes winning a bet a manifestation of time and luck rather than a proper allocation of value and property. With this revised candlestick auction format, the bidding state is visible, but the end of the auction remains hidden so bidders can place their true bids early.
The duration of the slots on the Polkadot parachain is limited to two years and divided into three-month periods, while the duration of the slots on the Kusama parachain is limited to one year and divided into six weeks. This means that the slots of the parachain can be rented for any combination of slot durations. Parachains can lease more than one slot, which would allow them to rent on Polkadot for a maximum of two years if they choose to lease an adjacent slot. The individual slots of the parachains are interchangeable, which allows the parachains to continue to exist if they so choose.
Parachain Slot Bidding
Projects or parachain teams can bid on auctions by specifying the time range of the slot they want to rent, what specific periods, and the number of tokens they are willing to bind. For example, in the case of Polkadot, the range of time intervals could be any of the periods since each period within the range represents 3 months.
As discussed earlier, the parachains will host various decentralized applications that can communicate with each other at the same time via the Relay Chain. In addition, each network currently supports a maximum of 100 parachains, and auctions are used to determine the majority of teams that will launch their projects on the parachain.
The first operational parachain was launched at Kusama on May 17, 2021, under the name Shell. Parachain was designed as a hollow vessel (hence the name “shell”) that could be customized and upgraded to something functional. One week after launch, the Shell parachain was upgraded to Statemine, the Kusama equivalent of Polkadot’s Statemine parachain. As we discussed above, parachains for the common good are system-level chains or utility networks. According to Gavin Wood, founder of the Kusama and Polkadot networks, Statemine supports the following core features:
- inexpensive space to store and transfer KSM: minimum balance
and the transaction fees are significantly lower than those of the relay chain;
- transfers of permitted fungible assets such as non-algorithmic stablecoins; and
- illegal creation, issue, and transfer of both fungible and non-fungible assets (NFT).
Using the Cross-Chain Messaging Protocol (XCMP), Kusama’s own KSM token can move freely between Kusama and Statemine, as well as other parachains with Statemine. In this way, Statemine acts as a reserve that safely stores KSM and other assets in sovereign accounts.
Parachain Auction Winners
At the time of writing, with a lot of anticipation from the crypto community, the parachain auctions on Kusama have been launched and completed. The following teams obtained a place on the Kusama network through parachain slot auctions.
Each of the five winning teams raised a significant KSM ahead of the auctions to protect the parachain. The DeFi Karura protocol raised 501137KSM (approximately $91 million) through crowding, the Moonriver network raised 205,935KSM (approximately $37 million), the Shiden network raised 138,457KSM (approximately $25 million), the Khala network raised 132,280KSM (approximately $24 million), and Bifrost raised 142,431KSM (approximately $25 million) ahead of the parachain auctions.
As mentioned earlier, the crowdsign campaign allows projects to raise capital to participate in the parachain slot auction. Anyone can participate and support projects by investing in their KSM or DOT. At the end of the parachain lease, tokens are returned to those who participated in the crowdloan. If the campaign is successful and the parachain is active, the collected tokens are blocked in the parachain account for the entire period of its activity. If the project fails to win the auction, the assets are returned to the participants at the end of the crowding campaign.
Auction 1 winner: Karura
The first winner was Acala’s Karura (KAR) network, which provided the first-ever parachain slot on Kusama. The Acala Foundation founded Karura as a scalable network optimized for DeFi (decentralized finance). It aims to provide several different DeFi features on its platform, including a cryptocurrency-backed stablecoin, an automated market maker (AMM) decentralized exchange, access to liquid betting, and a blockchain compatible with Ethereum code.
It’s a versatile DeFi platform that lets you trade, borrow, lend, earn, and more; transactions will be made using micro gas fees that can be paid for with virtually any token, with the cost being only a fraction of what other networks require. The project aims to provide financial products and stablecoins for the entire Kusama network ecosystem.
Karura raised funds through a crowdloan, and in exchange for support, members received their own Karura token KAR. For each blocked 1KSM, participants were promised a minimum income of 12KAR, and the exact cost depends on the total amount collected and associated tokens. Currently, the estimated reward is 22KAR per 1KSM contributed, with 30% of rewards available for use in the KAR Decentralized Finance (DeFi) app.
The remaining 70% will be transferred and released gradually over a 48-week rental period. The parachain for KAR will be leased from June 22, 2021, to May 13, 2022. Karura’s own token, KAR, has a fixed supply of KAR 100 million, with the entire volume minted in the genesis block at launch. This results in 0% inflation, with a fixed and deflationary supply schedule.
Auction 2 winner: Moonriver
The second winner was the Moonbeam Moonriver (MOVR) partner network. It is a smart contract platform that supports Ethereum decentralized applications, providing full EVM implementation, a Web3 compatible API, and bridges that connect Moonriver to existing Ethereum networks. This is a canary network about the Moonbeam sister network, which means that anything deployed on Moonriver will later be implemented on the Moonbeam network on Polkadot.
Moonriver also plans to implement native integration for all Kusama and ERC-20 tokens and bridges to other assets such as Bitcoin. Ultimately, Moonbeam will become a smart contract platform that will allow developers to create applications compatible with the existing Ethereum toolchain and developer network.
Since Moonriver also crowded in, the network allocates roughly 14MOVR per 1KSM to members who have linked their KSM to support the project. 30% of the rewards are paid immediately after the launch of the parachain, and the remaining 70% are distributed linearly over 48 weeks or the parachain lease term. The lease term for the Moonriver parachain is from June 29, 2021, to May 13, 2022.
Auction 3 winner: Shiden
The third winner was Shiden (SDN), a smart contract platform for decentralized applications on the Kusama network. Shiden is built to support “Layer 2” solutions, which are secondary structures built on top of existing blockchains that improve network scalability and transaction speed. Shiden is also the Canary Network for the Plasm Network (PLM), later rolled out to Polkadot.
Shiden will act as the Plasm R&D chain, and PLM token holders can claim 1SDN token for owned 1PLM token. Shiden has rented the parachain from July 6, 2021, to May 13, 2022, and rewards crowdloan members with approximately 20SDN per 1KSM linked 31. Note that 20SDN stands for unprocessed crowdloan rewards and does not include early join rewards and promotional fees.
Auction 4 winner: Khala
The fourth winner is Khala (K-PHA), a canary network for the Phala Network (PHA), which appears on Polkadot. The network is a trustless computing platform built to enable cloud computing without compromising data privacy and providing scalable computing power by decoupling consensus from the computation. As a member of the parachain ecosystem, Khala (and later Phala) will provide computing power to other blockchain applications while protecting the data layer.
This opens up the possibility of privacy-protected DeFi trading positions and transaction history, co-computing sensitive DID data, developing light node interchain bridges, and more. The Khala network is currently developing online services such as bulk data analytics to provide a viable alternative to services such as Google Analytics without compromising personal privacy.
Like the previous winners, the Khala network participated in the auctions through the crowdloan and provided the parachain for 48 weeks, from July 13, 2021, to May 13, 2022. For crowdloan members, Khala awards approximately 150PHA for each 1KM glued. While 34% of the rewards are paid immediately, the remaining 66% will be paid on a linear basis over the entire lease term of the parachain.
Auction 5 winner: Bifrost
The fifth winner was Bifrost Finance (BNC), a network that provides users access to DeFi applications, allowing token holders to place bets on any cryptocurrency on the Bifrost platform. In exchange for staking, users will receive a vToken of equal value — for example, 1ETH instead of 1vETH. This token will allow access to decentralized applications while providing staking rewards. Ultimately, once launched on Polkadot, Bifrost users will be able to trade assets over bridge parachains, convert their tokens to vTokens, and receive liquidity rewards in Proof-of-Stake (PoS) systems.
The advantages of vTokens are that users can avoid the risk of blocking their assets while receiving double the reward when placing an asset. For example, if a user connects their existing Bifrost-backed tokens, say 10TRON, they will receive 10 vTRON in return. This vTRON can be traded over bridged parachains, and users will also be rewarded for connecting their 10TRON.
For members of the Bifrost crowdsign, Bifrost rewards approximately CAD 22 billion for 1KSM. While 50% of the rewards are paid immediately, the remaining 50% will be paid on a linear basis over the entire lease term of the parachain. Bifrost leases the parachain from July 20, 2021, to May 13, 2022.
One of the possible consequences of parachain auctions is the supply of your own token (DOT, KSM). For a team to secure a parachain slot on the Kusama or Polkadot network, they must bind their own KSM token or DOT token as part of the parachain slot auction. After the slot is won, these tokens are locked in a smart contract that connects the project’s parachain to the Relay Chain. As long as the parachain slots are running, a significant amount of KSM or DOT will be locked and blocked. The total KSM raised for the first five projects to win the parachain is approximately 12% of the KSM circulating supply.
After the lease expires, tokens are returned to the project team and/or those who helped fund the project through the crowdloan. This binding of tokens to a project or network affects the availability of tokens in the market for alternative use since the supply will decrease with constant or increasing demand. Essentially, this is an opportunity cost that can affect the value of tokens if more tokens are locked and there is a tangible decrease in the number of tokens in circulation.
Likewise, a surge in demand for parachain slots could lead to positive feedback. For example, higher demand for parachain slots will lead to more demand for KSM or DOT tokens, leading to higher spot prices. As the value of tokens rises, market participants may be forced to buy more tokens, which heightens teams’ concerns about providing a parachain slot. This, in turn, could cause even more demand for KSM or DOT, which will lead to an even greater increase in token prices. Under a hypothetical scenario, when both networks go live and demand increases, we can see a potentially significant supply shock.
Alternatively, there are potential opportunity costs associated with bidding or pegging in parachain auctions. Those who participate in parachain auctions by linking their tokens to a specific project waive the staking reward if they choose to stake their tokens instead. The funds are also locked, which means users cannot access their linked KSM or DOT until the project lease expires.
While those who link their tokens to project auctions usually receive an incentive in the form of their own token, owning their own tokens would mean that the lender assumes the systematic risks associated with the KSM and DOT networks the additional risk associated with the project itself. It is worth noting that lending or placing bonds in parachain auctions involves both risks and benefits that should be weighed carefully.
Both Kusama and Polkadot are early in their journey to become ecosystems supporting many interconnected subsectors and projects. As a canary network, Kusama is paving the way for the most competitive projects in the crypto industry to evolve and improve and learn to interact with other projects in the ecosystem. Given the nature of parachain auctions, allowing community support and token support to be part of the winning bidding process, we believe there will be an opportunity for projects to evolve with the community through trial and error as the sectors of the crypto industry become more interoperable.
Kusama discovered an ecosystem in which interoperability comes with greater scalability. Parachains will continue to be leased out on a peer-to-peer auction, in which competing teams have a good chance of getting a slot. As with cryptocurrency, we hope that the Kusama and Polkadot parachains will create a more inclusive industry that gradually expands and replaces the existing inefficient and centralized systems in the modern world. While we are not yet sure if these two networks will become independently thriving ecosystems that serve the needs of various projects, or if one of them will remain a “wild” or coarser starting point for the other, we believe that both will lead to colossal growth in the industry.