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The ethos of blockchain has always been user-focused. Distributed ledger technology showcases the ability to move away from centralized third parties, giving the power back to the community. However, there is a delicate dance between bad actors who attempt to take advantage of this lack of an intermediary and legitimate projects that need a way to bootstrap. So how can an ecosystem prevent those with malicious intentions from scamming communities out of their hard-earned funds?

Parity, the team behind Polkadot and its ‘canary’ network Kusama, have seemingly architected a solution to prevent so-called rugpulls: a crowdloan. Crowdloans have some of the community-related benefits of IDOs and ICOs, but they differ in two critical ways: projects don’t have direct access to tokens, and token holders get their funds returned at the end.

Let’s examine this unique bootstrapping mechanism.

Polkadot’s “Blockchain of Blockchains” Approach

Polkadot has a fundamentally different approach to building blockchains: its sole purpose is to connect different specialized chains (called “parachains”) and secure them. It’s not a smart contract platform. Rather, it’s a scalable new way for developers to build new blockchains that natively work with other ones, but don’t need to rely on messy bridging solutions and the poor UX that come with them.

What’s interesting about these Polkadot parachains is that they are built on a shared framework, Substrate, and yet, are completely customizable. With parachains, each developer can run their own independent network supported by the security and power of the Polkadot Relay Chain.

Notably, the Polkadot ecosystem features another novelty: the Kusama “canarynet.” Unlike an incentivized testnet, Kusama tokens (KSM) have real-world value, allowing the network to serve as an experimentation platform with rapid iteration. At Kusama’s launch, the network utilized much of the same code as Polkadot. They both run parachains, and both incorporate a nominated proof of stake consensus method. That said, the networks are expected to grow and evolve over time as their communities become even more separate and distinct. However, they continue to contain many similarities and fundamental value offerings, such as the parachain slot auction mechanism.

Parachain slot auctions provide Polkadot and Kusama with more range than other related projects like Ethereum. For example, Ethereum suffers from high congestion fees, quite often due to big NFT project launches, sought-after DeFi applications, and similar issues. Since parachains are each their own chain, a parachain launch does not affect the rest of the network, meaning all projects can run as efficiently as possible.

Crowdloans Help New Projects Launch to Polkadot

Crowdloan functionality was designed to help new parachains fundraise to get a “slot” on the Polkadot and Kusama networks. These slots are competitive, which means many projects may need to lock a large amount of tokens to secure the slot lease when they’re auctioned off. Crowdloans help continually bring fresh projects into the ecosystem by letting the community “back” a project without directly giving them control of funds.

Put simply, a crowdloan is a way for holders of DOT or KSM tokens to temporarily lock their funds to back a specific project that wants to launch to Polkadot or Kusama. It’s important to note that crowdloans aren’t spending assets, like in an IDO or IEO; instead, the assets are “pledged” to the project but never in the control of their development team. Importantly, these tokens can only be used for their intended purpose: to pay for a slot on the network.

Essentially, the act of crowdloaning requires projects to acquire community support and prove their value over and over again. Once the parachain slot lease runs out, the project needs to renew the lease, either by securing funds from users again or through the project’s treasury, which would only have value if the parachain demonstrated the value of its to the community. Parachain slots are quite limited as well, forcing projects to perform to the best of their abilities to earn (and continue to earn) a place.

How Crowdloans Present a Safer Bootstrapping Option

As mentioned, crowdloans present a way for users to help projects launch without jeopardizing their assets, as they are only locked temporarily. Here are some of the ways that crowdloans present a better way to support a project.

Tokens Are Not Accessible by the Project

Development teams do not control the assets contributed to the crowdloan and have no access to tokens. Once contributed, they are locked on the Relay Chain (either Polkadot or Kusama depending on where the project is trying to launch).
While other fundraising methods require users to exchange their cryptocurrencies to receive native utility or governance tokens, crowdloans do not. If a project ends up being a moneygrab with no future development, backers and participants have no way to recover their allocated funds.

Tokens Are Returned Once the Lease is Over

Both Polkadot and Kusama have ‘slots’ for projects to participate in a crowdloan. Each of these slots on the network has an expiration date. Once the slot lease is over, users who participated receive back their initially locked assets; this is on top of the rewards they received in the form of native tokens for partaking in the crowdloan, bringing value directly to allocation providers.

Parachains Must Prove Their Value Again and Again

When the lease expires, projects must find a way to renew their lease. For projects with immediate success, they can often do this using funds from their treasury. For others, they may need to hold another crowdloan or find another way to raise the funds they need to secure the slot again. This dynamic creates a situation where projects must constantly prove their value in order to retain their spot on the network.

To earn a slot, projects compete in what’s called a parachain slot auction. Participants with the most staked funds from the community end up earning the available slot.

In the case of Kusuma, the first batch of slot auctions were held this past summer, with each auction lasting a week or so. From there, auction winners earn a parachain slot for a predetermined amount of time (up to 48 weeks or so on Kusama and up to 96 weeks or so on Polkadot.) This means projects have to put great effort into showcasing their value to users, otherwise, they’ll be out of luck and may have to search for another fundraising method.

Candle Auctions Reduce Sniping

While times can vary, winners earn that slot for up to two years, reserving a spot on the network. Slots are won through what’s known as a candle auction, meaning that the auction can end at any time (when the figurative “wick” goes out). This means that parachains are incentivized to make sure their crowdloan has as many bids as possible once the auction opens, so their best bid is reflected at all times. Once earned, a project can harness the additional processing time and security of, say, the Polkadot mainchain. This allows the team to focus more on developing and expanding their project instead of spending time worrying about security and other similar issues.

Combined with the Substrate framework, crowdloans provide developers with an extremely approachable way to build and fund new blockchain networks. The Polkadot approach removes a lot of the more difficult, tedious parts of building a network, while also securing the funds of network backers along the way.

Downsides to Crowdloans

They’re New and Complex

Unfortunately for users, crowdloans don’t eliminate all the associated risks paired with funding a project. For one, they can be quite confusing and often require a lot of research for those who want to participate. It can be easy to misunderstand many of these intertwining concepts, which can be tedious for newcomers to the ecosystem.

Tokens Are Locked for Long Lease Periods

Additionally, once your assets are locked (for up to two years on Polkadot or close to one year on Kusama), there’s no way to pull them out if you want to do something else with them. They’re locked. Therefore, it’s important to consider your options carefully before choosing a crowdloan to back, as there is an opportunity cost to not controlling your loaned assets.

Technology Support is Still Catching Up

In order to participate in a crowdloan, you will need to have your DOTs in a compatible wallet or exchange. This can be a bit daunting if you are unfamiliar with Polkadot.js (the official Polkadot wallet extension) or the other wallets that plan to support the crowdloan.

It’s also worth noting that you can’t always participate in most crowdloans with DOT/KSM stored in a hardware wallet, like a Ledger or Trezor. This is because Ledger does not yet support crowdloan transactions, and those that do support it will likely need you to use a proxy account which is quite advanced for most users.

Each Crowdloan is Different and Unique

Each crowdloan on both Kusama and Polkadot has its own unique terms and conditions. There are also many other variables to consider:

  • Lease period: how long your tokens are locked
  • Rewards pool: how many network tokens are being given to participants
  • Total genesis supply: what % of the network the rewards pool represents
  • Demand: how many people are expected to participate, since rewards pools are distributed based on share of the total contribution
  • Network value: how important the network will be to Polkadot, Kusama, or the blockchain industry as a whole
  • Hard cap: crowdloans are required to create a ceiling for the contributions they accept, which is often symbolic and intentionally high but sometimes represents a true maximum

Conclusion

While all forms of crowdfunding are technically legitimate in the world of crypto, it’s vital that communities continue to innovate in the ways projects gather and utilize funds allocated by end users. Polkadot and Kusama are doing just that with their crowdloan feature, providing backers with ways to participate and fund new projects without putting their initial funds at risk. Crowdloans present a novel method of raising funds that add a degree of separation from projects, a first for an industry that has almost grown used to rugpulls and other schemes and scams.

 

If you would like to learn more about Moonbeam and even develop and deploy a Web3 application, please visit the docs site and the Moonbeam Discord.

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