A Case For The Dotsama Ecosystem Overtaking Bitcoin And Ethereum
Welcome to the Dotsama ecosystem, home to Polkadot ($DOT) and Kusama ($KSM), whose names refer to Japanese artist Yayoi Kusama, who uses a lot of polkadots. These two make up an ecosystem because they are built on almost entirely the same code, and will shortly become connected and interoperable. In this article I will mainly reference Polkadot, but all points apply to Kusama as well. Later on I will elaborate on the differences between the two.
Now, for the Dotsama ecosystem to flip Bitcoin and Ethereum, the combined market caps of Polkadot and Kusama need to rise above the market caps of Bitcoin and Ethereum. Market capitalization is calculated as token price x token supply, and can be used as a proxy for the value of an entire blockchain or token. So, for Dotsama to flip BTC and ETH, it must become more valuable.
Beyond the mystical powers of memes, Elon tweets, and Bogdanoff FUD, what determines the value of a coin?
It comes down to Functionality and Tokenomics.
Functionality
Even absolute shit coins have functionality by nature of operating on a blockchain. Every coin let’s you send and receive that coin, but that’s just the bare minimum. Bitcoin does this, as well as operating on Proof of Work, which provides some base value to the coin, by nature of the cost of energy expended on it.
Ethereum (currently the 2nd most valuable blockchain ecosystem) came along and created a whole new world of possibilities.
Smart Contracts
Smart contracts are essentially immutable computer programs that live on the blockchain. Once launched, the code cannot be altered. This is great for trustless systems but poses problems if the code is bad.
Smart contracts can be used for many things, from creating video games, to gambling, to DAOs (Decentralized Autonomous Organizations — decentralized businesses), to Decentralized Finance applications such as 0.exchange which let’s you swap tokens in a permissionless and trustless manner, and various yield farming opportunities, such as Bancor and Curve.
The functionality of smart contracts is huge.
Blockchain developers have begun to use the tools at their disposal to replace traditional banks. People are effectively running businesses on the blockchain, comprised of a decentralized and anonymous team. The largest DAO, MakerDAO, is currently in the process of developing a system to conduct real estate loans on the blockchain.
Unfortunately, there are problems.
Current smart contracts are built on the Solidity programming language, which is only used for writing smart contracts. Developers have to learn an entire new language to build on smart contract blockchains. The user base is small, and it is harder to squash those pesky bugs, which are a big deal since contracts cannot be updated after release.
Ethereum, by far the biggest blockchain with smart contract functionality, suffers from crippling transaction fees during periods of high network usage. The second biggest smart contract chain, Binance Coin, gets around this by becoming very centralized, which does not align with the decentralized future we all daydream about.
Developers in the Ethereum community are working on creating Layer 2 scaling solutions for Ethereum, but they do not entirely solve the problems. The Ethereum development team has plans to upgrade the network from Proof of Work to Proof of Stake, along with some other measures to lower transaction fees. Those changes have been a long time coming and still have no definite implementation date. Ethereum has no built in on-chain governance system, so the blockchain has to fork anytime an upgrade is implemented. This is suboptimal.
Enter Dotsama
Polkadot and Kusama were built by Gavin Wood and his team over the course of a few years, designed from the beginning to overcome all of Ethereum’s flaws (Gavin Wood built Ethereum in a week or so, quickly realized all the problems it would have, and set out to create a better system). Polkadot supports multiple programming languages, and is secured by Nominated Proof of Stake (this allows any user to get rewarded for helping to secure the network). NPoS helps keeps transaction costs low, which is good because Polkadot will experience a lot of traffic due to being a relay/layer 0 blockchain. Everything else will be built on top of it as Layer 1 blockchains, like Bitcoin or Ethereum.
Polkadot operates what are known as parachains. Parachains are essentially entire blockchains of their own that are built on top of Polkadot, and connected to it from the ground up. Due to this, all parachains are connected to each other by default, via XCMP (Cross-Chain Message Protocol). Currently, moving assets across chains requires a cross-chain bridge which can be expensive and clumsy, as well as confusing. The Relay Chain and parachains will eliminate the need for cross-chain bridges within the Dotsama ecosystem.
Polkadot will eventually have 100 parachains running simultaneously. The first Kusama parachain, Statemine, just launched as a common good chain. More on that in a minute.
How are the parachains determined? Through candle auctions. One parachain slot will be auctioned at a time, and developer teams from various projects will bid for that slot. At the end of the auction, the highest bid wins. However, since they are candle auctions, no one knows exactly when the auction will end. A time range will be given in which the auction will end, and it will end at a random time within that range. This is to prevent auction sniping. Projects will bid with DOT tokens for slots. They can either bid with their own DOT, or they can create a crowdloan.
Think of crowdloans like Kickstarter. People give the development team their DOT tokens to help secure a parachain slot for that project, and in exchange receive tokens on that parachain. For example, the project most likely to win the first Kusama parachain auction is Karura. The native token of Karura is KAR. For each KSM contributed to the Karura crowdloan, 12 KAR will be received as a reward for contributing.
Now here’s what’s cool. The parachains are only leased. However, unlike a traditional lease, the KSM lent for the lease is returned to the lender at the end of the lease period, which can last up to 48 weeks, in 6 weeks increments. For example, if you contribute 10 KSM to the Karura crowdloan, and Karura wins the auction, you will receiver 120 KAR, and at the end of the “lease” you will get your 10 KSM back (if Karura does not win the auction, you still get your 10 KSM back).
Statemine (the first Kusama parachain, and a “common good” chain), which brings support for stable coins, as well as NFTs and FTs, was launched last week, and the auctions for the other 99 Kusama parachain slots have just started to roll out (one per week for the next 5 weeks, then one every two weeks), with Polkadot parachain auctions kicking off after there are five live Kusama parachains. They should all have no problem getting filled as there are loads of amazing projects looking to get a slice of the parachain pie.
Karura was already mentioned, on Kusama, and it has a counterpart on Polkadot named Acala. Acala and Karura will function as a Decentralized Exchange, lending platform, and more. Moonbeam and Moonriver, on DOT and KSM respectively, aim to implement the Ethereum Virtual Machine into the Dotsama ecosystem, allowing Ethereum developers to essentially copy and paste their Solidity smart contracts into the Dotsama network. Check out more of the upcoming Dotsama ecosystem projects here (especially KILT).
What if all the parachains are full and a team has developed something for Polkadot? Do they just get the shaft? Not at all! In addition to parachains, Polkadot supports parathreads. With parachains, the project has paid for (via the lease) space in every block on the Polkadot blockchain. When all 100 parachain slots are full, each 6 second block on the Polkadot blockchain will include data from Polkadot itself as well as from all 100 parachains. Parathreads on the other hand are pay-as-you-go. Data from a parathread will only be included in a Polkadot block if that parathread is used during that block. Parathreads make sense for applications that are not used as much, for example, using an oracle to pull weather data once an hour. A frequently used application, like a Decentralized Exchange, would absolutely want to secure a parachain slot.
Polkadot also features built in on-chain governance which allows for upgrading the network without forking. Software developers can submit proposals for network upgrades, and anyone holding DOT tokens can vote on whether to implement that change. Both Polkadot and Kusama have on-chain treasuries with funds that can be used to pay developers, marketers, etc. for their work, and it just requires a vote from DOT or KSM holders.
Polkadot vs. Kusama
Now, about the differences between Polkadot and Kusama. Kusama was originally designed as a testnet for Polkadot, to try new things out and check for bugs before deploying to Polkadot. This is no longer the case. Both Kusama and Polkadot have their own true testnets. These days, Kusama is treated as a canary network to Polkadot. They are both built on mostly the same code, and will be connected and interoperable soon, but they will evolve separately.
Polkadot has placed a much greater emphasis on security. It’s more conservative. Parachain costs will be higher, and development will move slower, as it will take 28 days for governance proposals and changes to go into effect.
Kusama only needs 7 days for governance proposals to go into effect, and it will be cheaper (most likely — it depends on how fierce the auctions are) to deploy to parachains.
Polkadot will be used for things requiring more security, such as banking applications and financial activities, like transferring real estate ownership, while Kusama will be more innovative, fast, and furious, and see the birth of all sorts of new wonders.
There’s no telling what kinds of things will be built on Dotsama. Think of Ethereum in 2015. I doubt most people could have imagined NFTs or DeFi as we know them today.
In short, the Dotsama ecosystem provides far more functionality than any other blockchain currently in the space. It outclasses Ethereum in every way, and will even incorporate it via parachain projects running the EVM. The only solid point for Bitcoin, Proof of Work, can be brought into Dotsama as well.
Tokenomics
Here is where those in the know start fueling up their rockets, because once you get it, oh baby.
But before we get to the filet mignon, a quick overview of basic economics, and the tokenomics of the two main contenders, Bitcoin and Ethereum.
Supply and Demand
Here is a typical supply and demand graph.
Let’s start with the line labeled S. This is the line that graphs supply. If chocolate bars only sell for $.40, only 100 chocolate bars will get made. If they sell for $2, then 500 get made. If a product has higher profit margins, there will be more producers, and thus, more supply.
The two lines labeled D1 and D2 are demand lines, which show that the number of chocolate bars demanded increases as price decreases. If a chocolate bar costs $2, you might only want to buy one, but if it’s only $.40, you might buy 3. Line D2 represents a new level of demand, for example, a famous doctor said on national TV that chocolate bars are good for you. Suddenly, people want to buy more chocolate bars, and demand increases. People are now willing to pay more for the same amount of chocolate bars, so instead of only buying one chocolate bar for $2, you buy two.
The red dot where line S and line D1 (before the doctor’s announcement) meet is the equilibrium. Here, 300 chocolate bars get made and sold for $1.20 apiece. If the producers make 400 chocolate bars they will have 100 leftover, because there is only demand for 300 chocolate bars that cost $1.20. If they want to sell those remaining 100 bars, they will have to lower the price.
Once the doctor makes their announcement about chocolate bars being good for you, demand increases, which shifts the demand line from D1 to D2. Now there is a new equilibrium point, with 375 bars selling for $1.50 each. Previously the chocolate bar producers were only making $360 in revenue, but now they can make $562.5 in revenue, which is pretty powerful for a 25% increase in demand. Thanks, Doc.
Usually, in the real world, when demand increases, price and quantity of goods produced will increase. Demanders will pay more for the same product, and suppliers will receive more money. Which brings us to…
Bitcoin
There will only ever be 21,000,000 Bitcoin. The supply is fixed and cannot move. The demand curve is free to move any way it pleases, but the supply is fixed. Due to this, when demand increases, the price must increase. There is no limit to possible demand, therefore there is no limit to the possible price. Bitcoin is inherently deflationary — each Bitcoin should appreciate in value over time. Contrast that with any fiat currency, where the supply is unlimited and routinely increased, lowering its value.
So the tokenomics of Bitcoin are to hold long term, and your coins will increase in value as demand for them increases. Even if demand stays the same, their value should increase relative to fiat currencies that are being constantly devalued by their respective central banks, at a rate higher than any guaranteed rate you can earn by depositing in a bank.
Ethereum
Ethereum is currently inflationary. It runs of Proof of Work at the moment and mints new Ether tokens to pay the miners. Unlike Bitcoin, which has a fixed supply, and will stop creating new Bitcoin when 21M have been mined, Ethereum has no fixed supply cap. If nothing is done, it will inflate forever.
The Ethereum blockchain is planning to switch to Proof of Stake in the future. That will reduce the inflation rate, but will not eliminate it. That said, Ethereum’s inflation rate does get reduced every year, and will trend toward zero. This chart is from Ethereum’s whitepaper. The Y axis is theETH inflation rate and the X axis is months from network inception.
Ethereum’s price has steadily risen since inception, showing that demand has increased faster than supply. Ethereum’s tokenomics will become more like bitcoin the further in time we go.
However, this may all get changed with the inclusion of EIP-1559, an Ethereum network upgrade scheduled for July. Normally, any transaction on Ethereum costs a fee, referred to as gas. At the moment, the gas fee is sent to the miners as payment for processing the transaction. EIP-1559 will instead cause the gas fee to be burnt (think of lighting a dollar bill on fire). This will reduce the supply of ETH.
As time goes on and Ethereum’s inflation rate continues to decline, and transaction count increases, Ethereum will very likely end up as a deflationary asset where gas burning exceeds issuance of new ETH to the miners. Being deflationary gives Ethereum even better tokenomics than Bitcoin, in terms of fiat pricing.
However, deflation has a classic problem. If your Ethereum is guaranteed to be worth more in the future, why would you use it now?
Dotsama
At time of writing, Polkadot is currently at 8.88% inflation and Kusama currently at 7.48% inflation. This seems quite high until you realize you can earn over 10% by staking your tokens, as both blockchains run on Nominated Proof of Stake. In other words, you can increase your purchasing power by parking your money via staking, which helps to secure the network, or you will lose purchasing power if you do not. This functions as an incentive to increase network security while also minimizing the issue of inflation. Also worth noting is that the inflation rate can be changed through an on-chain governance voting process.
But that is not the important part of Dotsama’s tokenomics. Remember supply and demand, and how they affect price? The key with supply is that it is circulating supply that matters, not total supply. What if there are 100,000,000 pumpkins in the world, and you want to buy a pumpkin, but only one pumpkin is for sale? The price might be astronomical, as the circulating supply is 1, and the price will be entirely dictated by demand. The seller can charge whatever he wants for that pumpkin, as you have no other options.
So how does circulating supply factor into the equation? Remember those parachain leases from earlier? All the DOT or KSM used to secure parachain slots will be locked up for 6–48 weeks until the lease expires. And then that slot will be up for grabs again, and DOT/KSM tokens will be locked up again. No one knows for sure yet how many tokens will be locked up for the parachain leases, but it will be a sizeable number as the different projects vie for the highest bid.
You may think that the inflation will increase the circulating supply, which is correct. However, it will most definitely increase the amount of DOT or KSM that are put up for auctions as well, so the circulating supply to total supply ratio should stay fairly consistent.
Just a few parachain auctions might not cause much of a supply shock, but there are 100 parachain slots on both networks. It’s entirely possible that with all 200 parachain slots full, 50%+ of the DOT and KSM tokens in existence will be locked into those leases, massively shrinking the circulating supply. Couple that with massive demand due to the amazing utility that will be provided by the parachain projects, and what do you get?
The Takeaway
Legitimate value is created by functionality and preserved by tokenomics.
The functionality of the Dotsama ecosystem outclasses any other major contender. Multiple programming languages, interoperability, on-chain governance and treasury, ability to run the Ethereum Virtual Machine, parachains, and parathreads. And that’s not including all the functionality that will be added by the parachain/parathread projects.
Dotsama tokenomics are world-class. The inflation issue is rendered obsolete by staking and crowdloan rewards. You can passively increase your purchasing power and wealth by simply staking and hodling. The impending supply shock and demand spike when parachains launch will cause monumental effects on the fiat price of DOT and KSM, and their respective market caps. This will trigger news that will increase demand and likely further reduce supply due to increased involvement in parachain auctions.
Dotsama is inevitable.
Expect Chaos.
Polkadot: 14x6ah3J21QonWASv6QKwqd8SWrS7ddqmMzyRCmGQWMaPzae
Kusama: GXR6g86nbAG6cyNjAANhe9yjV92Dztt9F7Eea3sLDYYxbRq
