What is DOT, the native currency and protocol of Polkadot and what is its role in the Polkadot network and its economy? Let’s connect some dots here, shall we?
To understand the function and utility of the DOT token, we must first refresh our memory on the Polkadot network itself.
Polkadot is a platform for cross-chain interoperability. It introduces a new, level-zero Relay chain that allows to connect scattered and fragmented blockchains via one universal protocol. This is the layer where Polkadot’s consensus is being achieved and fulfilled, and the main medium, where the DOT token is being utilized.
The next level of Polkadot infrastructure is the Parachain level, a level for Polkadot-native application-specific blockchains and bridges to connect the Relay-chain to non-Polkadot-native blockchains, such as Ethereum, Bitcoin, Cordano etc.
Each parachain in Polkadot is an entire blockchain in and of itself, with its own logic and features. Parachains play a huge role in advancing the TPS (transactions-per-second) speed of the Polkadot network by processing their own transactions, parallel to one another (hence, the name). They produce their own blocks with transaction information, which are then sent down to the Relay-chain for validation and recording. And that’s when we get back to the level-zero, where our DOT token is performing its magic.
Now let’s take a closer look at the token itself.
What does DOT Token do?
Staking and Validation.
DOT is a fundamental, basic currency on the Polkadot Network, kind of like Ether on Ethereum. DOT too is an uncapped token, the footsoldier of the Polkadot’s economy, serving as a default unit of value and buttering up every transaction by carrying the smart-contract and also making it profitable for the Nodes. But it is also fundamentally different from Ether in a number of ways.
First of all, Polkadot uses a different Consensus mechanism. The Relay chain has Nominated Proof-of-Stake Consensus implemented in its design. That means that DOT has a central role in incentivization of the network.
Proof-of-Stake relies on people who hold tokens to act as validators (as opposed to relying on miners, who compete for fastest computation in Proof-of-Work Consensus). But the classic Proof-of-Stake may be inclined towards centralization, as the biggest hoarders of the staked tokens are slowly monopolizing the validation process. That is why developers of Polkadot chose to take a slightly different route and chose Nominated Proof-of-Stake Consensus.
Nominated Proof-of-Stake is designed to oppose this tendency towards centralization, as validators are nominated by other actors (Nominators) not only based on their stake, but on reputation and trustworthiness too.
In Polkadot, nodes must stake at least 10,000 DOT tokens. It is a major commitment, which incentivizes them to act fairly and transparently in the network. Those willing to make this commitment, can get the right to verify legitimate transactions, add new “blocks” of transactions to the relay chain, and potentially earn newly created DOT, a cut of transaction fees, and tips. Nodes, acting maliciously, on the other hand, are ousted from the network and have their staked tokens taken away. Or, as Uncle Ben says: With great power comes great responsibility.
Any DOT holder in the network can participate as a nominator and join a party responsible for choosing and supporting trusted nodes to act as validators. A nominator can publish a list of validator candidates and put down an amount of DOTs at stake to support them with. If some of these candidates are then elected as validators, the nominators get their share of the profit or the sanctions, on a per-staked-DOT basis.
This can suggest a continuous source of revenue for the nominator, as long as it chooses validator candidates with good security practices.
So, for a quick recap: DOT token is used in Consensus mechanism for:
- Staking by Nodes.
- Supporting Validators by Nominators
- Rewarding Validators (Nodes, chosen by Nominators) for their work
- Rewarding Nominators, who suggested trustworthy Nominators
Polkadot uses a pretty sophisticated governance mechanism, which is also currently undergoing some changes. Here’s the link to a much more detailed material on Polkadot official website.
But in essence, all DOT holders are given power to vote on decisions that govern the Polkadot Network, such as upgrades and network fees. After votes have been cast, the voices are then weighted using several metrics:
- the amount of tokens, held by voters, who cast their vote towards each decision. Hence, a lot of coins = a lot of votes.
- The lock time. Votes from actors with DOT tokens locked for longer duration of time are prioritized over votes from the non-locked or short-locked DOT token holders
Now, at last, we’re climbing up to Polkadot’s exterior – Parachains. But firstly, we need to figure out how the Parachains are connected to the network.
For a Parachain to be firmly tied and fixed to one of the corresponding slots on Polkadot’s Relay chain, a substantial amount of DOT has to be “bonded” to it.
Polkadot isn’t giving out spots for Parachains left and right. When a certain project comes to Polkadot and wants to become a Parachain, it has to prove its potential demand and benefit for the network by attracting investments from actors. For that, a certain amount of DOTs has to be “bonded” to it.
Bonding is essentially committing tokens to the network for a specific period of time. The standard bonding period for actors to support a certain candidate Parachain is roughly two years (96 weeks). This period consists of several contiguous 12-week periods. This means that investors (big and small) freeze their DOT tokens in crowd loan pools in support of a certain project for a period of two years to illustrate their commitment to the project and help it cross the threshold of bonded DOTs to get connected to the Relay Chain.
Supporters don’t “bond” their DOTs just for the sake of supporting the project. They usually get airdropped a corresponding amount of tokens and other goodies from developers of a supported project. The more a user contributes – the greater its reward is going to be.
The best aspect of “bonding” is that it is low-risk. If the supported project fails to gain enough investments and doesn’t take the Parachain slot, the “bonded” DOTs unfreeze and are again available for their holder.
Rather than to simply give a parachain slot out to a candidate with the fattest wallet, the Polkadot team came up with a parachain auction mechanism as a method to distribute the available slots in a more equitable manner.
Holders bond their DOT to support the project that they believe should receive a parachain slot. Then the system randomly selects a snapshot in the bidding time frame, calculates bids and determines the winner.
The first Parachain to win the slot in Polkadot was Acala, which raised a staggering 32,5 million DOT, bonded by supporters in its favor.
The most recent project to win a Parachain slot was Efinity, which gathered over 7.7 million DOT during the sixth parachain slot auction.
The real cost of leasing and maintaining a parachain for 96 weeks was estimated to be around $100-200K in the early stages of Polkadot and before the first auctions took place, but it has eventually proven to lean towards the higher end of this spectrum and beyond it.
Polkadot is all about playing it safe when it comes to realization of new features. This is why developers also launched a twin testnet of Polkadot, called Kusama – smaller in scope, but much more experimental “sandbox” network, where every new feature and technology is put to the test before being employed by Polkadot.
As Polkadot and Kusama are both standalone projects, they implement different native tokens. Kusama uses KSM tokens, which, due to the nature of the Kusama network, has a lot in common with DOT in terms of utility.
In its current state, both the Polkadot and Kusama Relay chains can support up to 100 parachains, a number that is flexible and subject to change by governance vote over time. But Kusama, for example, has a shorter parachain leasing period (48 weeks) and overall lower market capitalisation. Kusama can be an ambitious medium for business by itself, it also holds parachain auctions and hosts a number of successful projects. However it’s Polkadot that is considered the main flagship network and is seen as the future of blockchain relations.
These are the main roles of DOT in Polkadot’s network. A clear utility token, that helps this ambitious and grandiose system operate, remain decentralized, beneficial and fair. As for the DOT’s market price, at the end of the day it is still a volatile cryptocurrency. But it’s primarily designed for the purposes outlined above and not for speculative trading.