From Messari by Nicholas Garcia

Key Insights

Primer

Polkadot (DOT) is a distributed blockchain computing platform that acts as a base layer for other sovereign blockchains, called parachains, for validation and shared security. Polkadot was built using Substrate, a blockchain developmental framework. Furthermore, Polkadot’s base layer is known as the Relay Chain, which utilizes a Nominated Proof-of-Stake (NPoS) consensus mechanism, and its state machine is compiled to WebAssembly (Wasm).

Polkadot Relay Chain’s core function is to validate and provide security to its parachains. Parachains are added to the Relay Chain through Parachain Slot Auctions. Today, the auction process is a candle auction that lasts for one week in which potential parachains “bid” DOT tokens to secure a parachain slot. However, this model is being updated in 2024.

Lastly, parachains on Polkadot can communicate with one another through the Cross-Consensus Mechanism Format (XCM). The XCM is a messaging format that standardizes messages between Polkadot’s parachains, allowing for greater interoperability.

Website / X / Discord

Key Metrics

Financial Analysis

Market Capitalization

In Q4 2023, the total crypto market cap experienced a sharp increase, largely driven by anticipation surrounding spot BTC ETFs. DOT’s circulating market cap increased 111% QoQ to $8.38 billion, more than double the overall crypto market’s growth of 54%. This Q4 growth brought DOT’s YoY change to 94%. DOT’s market cap ranks in the top 15 among all crypto projects.

Revenue

Compared to typical gas-metering transaction fee models, Polkadot follows a weight-based fee model, where transaction fees are determined and charged prior to execution The fee calculation encompasses three components: a weight fee reflecting computational resources, a length fee based on transaction size, and an optional tip to incentivize block authors. These fees originate from various activities such as token transfers, staking, validator elections, governance voting, and parachain slot auctions. It's important to note that transaction fees do not apply to parachain transactions.

In Q4, Polkadot's revenue amounted to $2.8 million, marking a significant increase of 2,880% QoQ. This surge was primarily attributed to the substantial rise in extrinsics in late December, driven by the Polkadot Inscriptions. Even without considering the four-day spike from the Inscriptions, Polkadot's revenue would have seen a doubling from the previous quarter. Of note, Polkadot's revenue tends to be relatively lower compared to its competitors due to the network's structural design.

Supply

Polkadot’s native token DOT serves three primary purposes: governance, staking, and parachain bonding. As of the end of Q4, Polkadot had a staking rate of 52%. DOT has an inflationary monetary policy and no maximum supply. DOT’s monetary policy is determined by its compliance to an ideal staking rate, which accounts for the sufficient backing of DOT to prevent possible security compromises while keeping the native token liquid. If the staked amount falls below the ideal rate, staking rewards for nominators increase, encouraging more staking. Conversely, if the rate exceeds the ideal, staking rewards decrease.

Treasury

The Polkadot treasury is financed through block rewards, validator slashing, transaction fees, and staking inefficiencies. The treasury funds, held in a system account, are allocated for expenditures within a 24-day spend period, with any unspent funds subject to a 1% burn. Notably, all treasury expenditures are executed automatically on-chain, ensuring transparency and accountability.

In the fourth quarter, the Polkadot treasury supported various initiatives. The introduction of OpenGov on June 15 revamped treasury management and enabled concurrent proposals with distinct requirements. As of the quarter's end, the Polkadot treasury held approximately 44 million DOT ($367 million).

Network Analysis

Usage

The Polkadot Relay Chain has several primary functions, including securing and connecting the parachains. As such, its end users typically transact and use the network primarily through the parachains.

Today, the Relay Chain does support some end user functionality, including token transfers, staking, validator elections, governance voting, and parachain slot auction participation. However, with RFC-0032: Minimal Relay, it is proposed to migrate several subsystems into system parachains. By minimizing state transition logic on the Relay Chain by migrating it into system chains, the Polkadot Relay Chain can maximize its primary offering: secure blockspace.

Following the launch of OpenGov in June, the Polkadot Relay Chain experienced an increase in account activity. This surge was attributed to heightened governance activity, as the Relay Chain plays a crucial role in facilitating governance processes. In late October, the DOT locked from the first batch of parachain auctions from two years prior completed its final unlock. This led to the yearly high of active addresses on the Polkadot Relay Chain on October 24th as users claimed their locked DOT tokens.

Overall, during Q4, the Relay Chain averaged over 10,000 daily active addresses, marking a 90% increase QoQ. Excluding the activity on October 24th related to the DOT claim, active addresses averaged 9,000, a 70% rise QoQ.

In Polkadot's blockchain framework, an extrinsic is a crucial element that facilitates state transitions within the Relay Chain. It acts as a generalized transaction, encapsulating external data that the network needs to validate and track. Commonly, extrinsics carry a signature and references to specific functions, enabling interactions such as token transfers between accounts. Through extrinsics, Polkadot efficiently handles external inputs, ensuring a seamless operation of its blockchain network.

From December 20th to 23rd, Polkadot extrinsics surged due to Polkadot Inscriptions. During this period, the Polkadot Relay Chain processed an average of 4.3 million daily extrinsics. The network successfully managed this influx without any performance decline. Excluding these dates, the average daily extrinsic count still showcased an increase of over 100% QoQ, with a new baseline of 17,000 extrinsics.

Development

Polkadot boasts one of the largest developer bases in the crypto industry. According to Electric Capital, in December 2023 Polkadot averaged nearly 2,100 total developers, of which 792 were classified as “full-time”, placing the ecosystem second behind Ethereum.

Polkadot provides comprehensive developer support through its open-source tech stack, encompassing various categories such as user interface, tools, APIs and languages, smart contracts, chains and pallets, network maintenance tools, consensus, networking, and more.

Fourth quarter highlights included:

Decentralization and Security

Polkadot employs a unique consensus mechanism called Nominated Proof-of-Stake (NPoS). Validators receive payments every 24 hours based on their completion of payable actions, known as era points. Every four hours, a subset of validators is randomly selected to validate all parachains with a multiplier applied to their era points. This combination of era points and random parachain validation creates a probabilistic guarantee that validators earn rewards that are nearly identical. Because validators earn near-equal rewards and distribute these rewards pro-rata to their nominators, nominators are incentivized to stake with lower-staked validators to earn higher rewards. The validator-nominator reward model is designed to decentralize Polkadot’s validator set.

The active validator set on Polkadot has been stable at 297 for years, with no immediate plans for changes. During Q4 2023, the validator reward model continued to demonstrate its effectiveness in promoting validator stake decentralization. Of the 297 validators, 296 fell between 2.13 million to 2.73 million DOT staked.

The even reward distribution of the validator model incentivizes node operators to operate multiple validators. This strategy has been adopted by multiple entities.

The Nakamoto Coefficient refers to the minimum number of entities required to control a significant portion of the network, often leading to consensus failures. For PoS blockchains, this threshold is tied to the control of over 33% of the total stake. The Polkadot validator model resulted in a high Nakamoto Coefficient of 93 at the end of 2023, higher than other leading networks.

Governance

OpenGov, the new governance model for Polkadot launched in Q2 2023, marking an important milestone after months of anticipation. Referendums in the OpenGov system undergo a structured life cycle for enactment, including the Lead-in Period for proposal submission, the Decision Period for voting and approval, and the Enactment Period for execution. Open Gov allows multiple referenda to run concurrently, allowing for the faster passage of motions. During the initial six months of OpenGov operating on Kusama, the number of proposals increased more than four-fold compared to the previous year.

In the OpenGov system, the Council and Technical Committee have been replaced by the Fellowship, which acts as a developer DAO and ensures decentralization through community voting and checks and balances. Additionally, the new model introduces flexibility for delegation, allowing users to delegate their voting power based on conviction and the number of tokens committed.

Following the launch, Parity Technologies shared details on its ongoing relationship with Polkadot and the evolution of its role within the network. Parity has stated that "go-to-market will be more effectively driven by the broader Polkadot community" and is therefore "sunsetting its go-to-market functions to make room for the emergence of new ecosystem leaders beyond Parity." According to the team, future initiatives will focus on "delivering Polkadot's next-gen technology, improving the developer experience, and fostering a strong developer community."

Ecosystem Analysis

XCM

The Cross-Consensus Message Format (XCM) is a standardized messaging format and language that enables seamless communication between parachains and other consensus-driven systems. XCM plays a crucial role in facilitating interoperability and complex cross-consensus interactions. It allows blockchains to exchange messages, perform operations, and transfer assets, among other use cases.

The launch of XCM V3 on June 15 generated significant excitement. This new iteration of the messaging format introduced advanced programmability, bridging capabilities with external networks, cross-chain locking, improved fee payment mechanisms, and support for non-fungible tokens (NFTs).

In Q4, Polkadot's XCM transfers increased by 150% QoQ, from 557 to 1,385 daily. Non-asset transfer use cases, categorized as 'XCM other', increased by 8.2% from 61 to 66 daily. The proportion of non-asset transfer use cases of total XCM messages decreased to 5%, down from 10% in the previous quarter. The total number of active XCM channels reached 203 by the end of the year, nearly tripling in 2023.

Parachains

During Q4, Polkadot conducted eight additional parachain auctions, bringing the total to 58. The auctions resulted in 671,000 DOT ($5.6 million) being bonded. Out of these eight auctions, six were renewals by Centrifuge, Clover, Parallel, HydraDX, Interlay, and Phala. The other two slots were awarded to new parachains: Polimec, which focuses on decentralized fundraising, and Logion, which introduces the Proof-of-Law concept for asset transformation.

As part of Polkadot 2.0, the parachain auctions and general model will be overhauled. It introduces a marketplace for allocating "core time" via NFTs, allowing more agile and on-demand access to resources. The new approach aims to address drawbacks and encourage seamless application deployment and collaboration across chains. The transition would shift from chain-centric to application-centric focus within the Polkadot ecosystem.

In Q4 2023, parachain active addresses saw a notable uptick, increasing 93%QoQ, from 104,000 to 200,000. This growth was observed across all leading parachains.

Moonbeam maintained its position as the top parachain with 103,000 monthly active addresses (+81% QoQ). For more detailed information on Moonbeam's Q4 performance, you can refer to the State of Moonbeam Q4 2023 report. Nodle and Astar secured the second and third spots with 27,000 (+75% QoQ) and 24,000 (+51% QoQ) monthly active addresses, respectively.

Bifrost Finance witnessed the most significant rise among the top parachains in Q4, with a 1,400% increase QoQ. This growth was primarily driven by a surge in user activity in November, as users looked to liquid stake their unlocked crowd loan DOT from the first slot auctions, increasing Bifrost's total liquid staked DOT past 3 million.

In the fourth quarter, parachain transactions reached a yearly high, averaging 12 million monthly transactions. Phala Network maintained its lead with 4.2 million monthly transactions (+15% QoQ), followed by OriginTrail with 3.5 million (+150% QoQ), Moonbeam with 1.6 million (+22% QoQ), and Astar with 1.3 million (-25% QoQ). Notably, Frequency experienced the most significant increase with a 1,050% rise QoQ, driven by its support for the MeWe migration in October.

Additional notable parachain announcements from the fourth quarter included:

Ecosystem data on chain level is sourced from Parity Data’s Dotlake platform. For more insights, visit Polkadot in Numbers annual 2023 report.

Roadmap

Polkadot has completed and shared the official release of Polkadot 1.0, marking the completion of the Polkadot whitepaper. Additionally, the network's codebase has been fully transitioned to a repository managed by the community through Polkadot OpenGov and the Technical Fellowship.

The next iteration of Polkadot, Polkadot 2.0 as deemed by the community, will be determined by community discussions and consensus. Polkadot founder Gavin Wood proposed ideas such as "additional, more flexible and capital-efficient mechanisms for allocating Polkadot's blockspace beyond the parachain model, and an idea for creating opt-in' treaty-like' agreements between multiple blockchains called “accords''.

Moreover, in his annual year end review, Gavin Wood listed Parity’s core technical priorities. These priorities included Agile Coretime, On-Demand Parachains, Ethereum Snowbridge, and the Kusama bridge. A fifth technology, Elastic Scaling, is also expected to be introduced in 2024. Furthermore, the expansion of DAO primitives, including new fellowships, multi-asset sub-treasuries, an expanded XCM, and the development of novel primitives, is in progress. Sassafras, a forkless block-production consensus algorithm, has been developed and will undergo testing in 2024. Parity Labs is actively working on various new technologies, including CoreJam, as they continue to shape the network's future.

Closing Summary

Polkadot closed out 2023 on a high note, achieving significant growth across key metrics. Monthly active addresses on parachains increased by 93% QoQ, reaching a total of 200,000. The top three parachains were Moonbeam, Nodle, and Astar. Additionally, there was a 150% increase in XCM transfers QoQ, setting a record high of 133,000. The total number of active XCM channels reached 203 by year-end, nearly tripling throughout 2023.

In terms of development, Polkadot continued to be one of the largest developer ecosystems. Notably, Cardano announced its plan to adopt Substrate, the Decentralized Futures Program declared a $20 million fund, and the Polkadot Blockchain Academy its reach in the Asia-Pacific region.

Looking forward to 2024, Polkadot 2.0 is set to be shaped by its community. Gavin Wood, Polkadot's founder, has introduced several forward-thinking proposals. These included Agile Coretime, On-Demand Parachains, Ethereum Snowbridge, and the Kusama bridge. A fifth technology, and Elastic Scaling. Expect to be another year of strong development for the Polkadot network.