What is Polkadot and how does it work? Everything you need to know

Polkadot functions as a blockchain tailored to accommodate other blockchain networks. Picture it as a network composed of various blockchain systems. If each blockchain represents a distinct dot, Polkadot forms a cohesive pattern with these dots. Delve deeper to understand its operational dynamics.

What is Polkadot?

Polkadot emerges as an evolved iteration of Ethereum, originating from the visionary Gavin Wood, co-founder of Ethereum, and launched in May 2020. Governed by the Web3 Foundation (W3F) and developed by Parity Technologies, also co-founded by Wood, Polkadot operates at a foundational level, facilitating the construction of other crypto projects. Unlike Ethereum, Solana, and Cardano, which are classified as Layer 1 blockchains, Polkadot positions itself as a Layer 0 blockchain. Wood's initial whitepaper highlighted the necessity for a system enabling interaction among diverse blockchain networks, addressing scalability concerns inherent in Ethereum's architecture. In response, Polkadot introduced a proof-of-stake validation mechanism, diverging from the traditional proof-of-work model employed by Bitcoin and Litecoin. This shift aimed to mitigate Ethereum's intensive computational demands, thereby enhancing scalability.

How does Polkadot work?

David Lawant, Bitwise Asset Management's research director, describes Polkadot as a "heterogeneous multichain system," which essentially means that various blockchains operate within the Polkadot ecosystem. Unlike traditional Layer 1 blockchains like Ethereum, which require building from scratch, Polkadot serves as a foundational layer (Layer 0) offering inherent infrastructure for developers to construct their blockchains with interoperability across chains. While Layer 1 blockchains enable the creation of decentralized applications (DApps), smart contracts, and non-fungible tokens (NFTs), the complexity of building them is significant, involving the establishment of the base layer and incentivizing nodes to run the network.

Polkadot streamlines this process by providing the foundational layer, allowing Layer 1 developers to focus on optimizing their projects. In contrast to siloed Layer 1 systems, Polkadot facilitates interaction among public and private blockchains, aspiring to become the "internet of blockchains," as emphasized by Thibault Perréard, head of finance at Bifrost, a cross-chain staking hub.

Polkadot's inherent cryptocurrency: DOT

The linchpin uniting proof-of-stake validation, cross-chain connectivity, and foundational programming within Polkadot is its native token, DOT. Validators stake or collateralize DOT to authenticate subsequent blocks on the Polkadot blockchain, serving as its proof-of-stake mechanism. Each distinct blockchain established on Polkadot, termed a parallel chain or parachain, operates within the ecosystem. To ensure data security across these parachains, Polkadot relies on a singular foundational chain known as the relay chain, which distinguishes it from competitors like Cosmos (ATOM), as highlighted by Lawant.

Perréard underscores the relay chain's role in ensuring security, enabling parachains to leverage Polkadot's architecture and infrastructure without bearing security concerns. Besides block validation, DOT serves additional functions within the Polkadot network, including governance and bonding. DOT holders possess voting rights on network governance matters such as upgrades and network fees.

DOT as Collateral

Another aspect that Polkadot's administrators must contemplate is the selection of projects granted a parachain within the Polkadot ecosystem. These parachains are acquired through competitive bidding by individual projects, utilizing DOT as collateral. According to Birmingham, projects can acquire DOT to offer as collateral for participation in the parachain auction. Successful bidders secure a parachain slot if they possess a sufficient amount of DOT. Upon approval for a parachain, the DOT utilized in the auction remains locked up for a duration of two years, with users receiving lock-up rewards in exchange for their support of the projects. Polkadot's inaugural parachain auction concluded in December 2021.

Polkadot vs. Ethereum

Ethereum, the second-largest blockchain globally, shares some similarities with Polkadot, but their differences outweigh their commonalities. Below are a couple of points highlighting both the similarities and distinctions between Polkadot and Ethereum:

Investing in Polkadot

Polkadot presents a readily accessible cryptocurrency asset. Whether developers are vying for a Polkadot parachain or investors seek tokens for investment purposes, DOT can be purchased on numerous major crypto exchanges worldwide. Additionally, investors can gain exposure to Polkadot through the publicly traded Osprey Polkadot Trust (ODOT) on the OTCQX over-the-counter market. Upon acquiring DOT tokens, investors can store them in a crypto wallet, available in online (hot wallet) or offline (cold wallet) forms. However, it's crucial to note that online wallets pose higher security risks, and it's imperative to verify wallet compatibility with Polkadot tokens. As with all cryptocurrencies, investing in Polkadot entails significant speculation and risk. Prior to acquiring DOT tokens, consulting a financial advisor is advisable, ensuring investments align with risk tolerance levels, given the volatile nature of cryptocurrencies.