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How Polkadot Works
7 min read
Polkadot is a blockchain network. Launched in 2020 by Ethereum and Solidity co-founder Dr. Gavin Wood, its token, DOT, quickly became one of the largest cryptocurrencies by market capitalization.
As of November 4, 2022, DOT is the twelfth largest cryptocurrency with a market capitalization of $7.6 billion. At its peak in November 2021, DOT commanded a market cap of $53.21 billion.
This article explains what the network is, why it exists, and how it grew so quickly to its high valuation.
How Polkadot’s blockchain network works
Polkadot is more like Ethereum than Bitcoin – for starters, it comes with smart contracts, the technological prerequisite for decentralized applications.
Protocols on Polkadot include DeFi hub Acala, whose stablecoin let users send the US dollar across the Polkadot blockchain – that is, before the token lost parity with the dollar in August 2022.
Others include automated market makers, a kind of decentralized exchange, such as Polkaswap, as well as protocols native to other blockchains, such as SushiSwap.
Like Ethereum, Polkadot is a proof-of-stake network, meaning that it’s more environmentally friendly than the energy-intensive proof-of-work consensus mechanism that dominated earlier blockchains, like Bitcoin.
Proof-of-stake networks rely on groups of validators. They stake coins to verify transactions; the technology replaces proof-of-work networks, like Bitcoin, which mine coins with power-hungry machines.
Well, technically, DOT is called nominated proof-of-stake – a way of allowing DOT stakers to choose which nodes can take part in the validation of new blocks on the Polkadot blockchain.
A novel structural design
Polkadot’s main innovation is found in the structure of its network.
On Ethereum, the base layer of the Ethereum blockchain, known as Layer 1, confirms all transactions on the network. The benefit is that it makes Ethereum super secure.
Users can draw on a wide pool of validators to confirm their transactions. But the disadvantage is that every decentralized application must rely on the same set of miners.
Polkadot is very different. The network comprises lots of different blockchains – not just one, like Ethereum. (That said, Ethereum has started to mimic the structure of Polkadot’s multi-chain infrastructure, embracing side chains and rollups to speed up its ailing chain).
The first chain on Polkadot, launched in May 2020, is called the Relay Chain. This chain coordinates all the other chains on the Polkadot Network. That’s about all it does – you can’t run a smart contract on it, for instance.
The Relay Chain uses DOT to settle transactions, similar to ETH on Ethereum. Consequently, DOT launched after the validation of the first block of the Relay Chain – known as the genesis block.
The blockchains that the Relay Chain coordinates are known as Parachains. Launched in December 2021, they can run their own tokens. While coordinated by the Relay Chain, Parachains can run with their own validators.
That makes Parachains entirely independent from the rest of the network. So if one group of validators turns out to be fraudulent, the entire Polkdadot network is not ruined.
Polkadot’s claim is that this independence also makes Parachains far more versatile than smart contracts on Ethereum, as the network can be structured in different ways.
They rely on a modular framework called Substrate, developed by Polkadot development company Parity Technologies. Substrate’s modularity lets developers choose which parts of the blockchain they need, and avoid wasting resources and time on things they don’t need.
So long as the Parachain can communicate with the Relay Chain, it can do whatever it wants. That’s largely thanks to a piece of technology called “heterogenous sharding.”
Polkadot’s chains are all interoperable with each other – just like how decentralized finance protocols on Ethereum glue together.
Polkadot also manages to help public chains connect with private chains. That means that businesses can switch from privately-validated transactions to public ones with ease, making life easy for entrepreneurs.
The number of Parachain slots on the network is limited to 100, and it costs millions of dollars to rent one. However, no fear: these are shared by innumerable network participants.
The network operates a third part of the network called Parathread”, a kind of “pay-as-you-go” system that dramatically increases the number of potential applications that can run on the network.
These Parathreads pool their staking power to run the Parachain slots.
Then there’s Polkadot’s bridge, which allows all of these protocols to port assets on other blockchains, like Ethereum or Cosmos.
All of this structure makes Polkadot pretty fast. Splitting up the network into various parts prevents everything from going through the Relay Chain, so it doesn’t clog up quite as fast.
The Relay Chain can process over 1,000 transactions per second, compared to about 13 transactions per second on Ethereum.
That said, Ethereum plans to increase the speed of its mainnet over the following years, and it’s already possible to reach higher throughput speeds when using a rollup network, such as Arbitrum or Optimism. Who governs Polkadot?
The main developers of Polkadot are Dr. Gavin Wood, Robert Habermeier and Peter Czaban. The company runs under the Web3 Foundation, where Wood stands as President. (Wood is also credited with having invented the term “Web 3.0” in 2014).
Wood released his whitepaper for Polkadot in October 2016. Then Polkadot raised $144.3 million in an October 2017 initial coin offering (ICO). The token sale lasted under two weeks, selling off 50% of the initial supply of DOT.
In November 2017, someone froze 66% of the ETH that Polkadot had raised in its ICO. The founders used the remains of the proceeds to build out the network, and raised more money in a 2019 private token sale, the details of which remain undisclosed.
Polkadot itself is governed by token holders, who use staked DOT to alter the blockchain protocol itself. DOT holders can increase the power of their staked DOT by locking it up for longer periods of time. The longer the stake, the greater the power.
Anyone who locks up DOT in Polkadot’s governance protocol also receives more DOT as a reward, incentivizing holders to get involved in governance.
Remember that, since the platform runs on nominated proof-of-stake, whereby stakers vote on which validators they’d like to process blocks. Those who nominate validators are called nominators.
Among the validators are T-Systems, a subsidiary of Deutsche Telekom, the European telecommunications giant. Deutsche Telekom is also a major investor in DOT.
DOT holders also elect Polkadot’s council. The council members can also propose changes, and decide whether to implement proposals from other DOT holders.
That doesn’t mean that DOT holders don’t have a say – it just means that the council has more power; proposals from the council don’t need as many votes to go through as those made by regular holders of DOT.
The council is also responsible for voting in members of Polkadot’s technical committee – a working group made up of the teams that build Polkadot. The committee is able to propose updates to the network in times of crisis.
The first official community vote, which went into effect in August 2020, redenominated DOT by 100 times.
Similar to a stock split, the redenomination didn’t change the market capitalization of DOT, but simply increased the total supply of DOT from 10 million to 1 billion, and decreased the value of each individual DOT token by a factor of 100.
DOT’s supply is inflationary. That means that it increases over time – the rate is a 10% increase each year when 75% of circulating DOT tokens are staked. Crypto analytics site Messari predicts that its supply will surpass 2 billion DOT in September 2027, all things being equal.
The governance module can vote on how much DOT the treasury receives; the initial design sent 20% to validators and 80% to the treasury.
That covers token governance. But those that run the validators are responsible for ensuring that transactions flow through the blockchain in a decentralized fashion.
Blocks are produced through two consensus mechanisms. Blocks are created through an algorithm called BABE – that’s Blind Assignment for Blockchain Extension, then completed through GRANDPA: GHOST-based Recursive ANcestor Deriving Prefix Agreement.
The Relay Chain uses four roles to maintain the system. As well as validators and nominators, the network houses “collators” – nodes that store a complete history of each Parachain, and comb through the data of each to shape transactions into blocks ready to be processed by the Relay Chain.
Then there are “fishermen”. These operators keep watch over the Polkadot network, snitching on bad actors to validators. They don’t take part in the validation of transactions but receive a greater share of rewards than validators.
It’s difficult to work out whether Polkadot will make it in the long run. Its main rival, Ethereum, is also proof-of-stake, and has a ton more development activity. That’s why ETH’s market cap is about 25 times that of Polkadot.
DOT’s main rival was SOL, the native token of Solana – but that token crashed after its major investor, FTX, went bankrupt in November 2022 after misappropriating customer funds. During the crypto winter, investors might have to wait until the market sprouts again to see a surge of activity in the so-called “Ethereum Killers.”