The Downside of Polkadot: 5 Challenges Facing the Blockchain

After achieving an all-time high of $55 in November 2021, the value of the DOT cryptocurrency has been on a steady downturn for two years. At the time of writing the article,DOT's value stands at $5.6, marking the lowest point in the past three years.

This trend is mirrored in the ecosystem of Polkadot projects as well. The Total Value Locked (TVL) in protocols such as Moonbeam, Acala, or Astar is dwindling, which in turn adversely impacts the value of these projects' native tokens.

In this article, we delve into the main reasons behind Polkadot's slow-paced development and the gradual erosion of its user base.

Polkadot was initially envisioned as a large-scale blockchain designed to build a vast cryptocurrency network where different blockchains could interact seamlessly. The sphere of cryptocurrency is indeed witnessing rapid advancements in cross-chain technologies. A rising number of protocols are being introduced, facilitating asset transfer across different networks. Cross-chain bridges are morphing into comprehensive DeFi protocols, offering more than just token exchanges - they now provide functions like lending, yield farming, and more.

Some projects, such as LayerZero, are crafting fully-optimized ecosystems enabling fund transfers between blockchains via a single application and transaction. This evolution is putting tremendous pressure on Polkadot, resulting in its liquidity being siphoned off to its competitors.

On a technical level, the Polkadot blockchain consists of three main components: the Relay Chain, Parachain, and Bridge Chain. A detailed overview of Polkadot's working algorithm and the project can be found in our dedicated article.

The Relay Chain forms the core of the multi-blockchain structure, interacting with other networks. It connects to the parachains, which in turn link with other blockchains such as Solana, Ethereum, or Bitcoin via a dedicated bridge (Bridge Chain).

Creating such an expansive cross-chain network necessitates significant investments of time and capital. However, many current projects like Multichain, Allbridge, or Orbiter have streamlined this process through the implementation of a single smart contract.

Every parachain that aims to launch its unique cryptocurrency network has to win a parachain auction. This process involves users locking their DOT for 2 years to receive a certain amount of new platform tokens.

However, due to a decline in the DOT rate and unprofitable investments, parachain auctions have lost their appeal, which significantly hampers the growth of the Polkadot ecosystem. For example, the first five parachains managed to accumulate 113 million DOT, equivalent to $4.5 billion during autumn of 2021. Now, projects struggle to collect even $1 million, which demotivates both developers and investors.

In the course of parachain auctions, DOT coins are not withdrawn from users but only locked for 2 years. After this leasing period, assets can be locked again to continue receiving tokens from the project.

However, due to these investments' unprofitability, most auction participants are likely not to continue, resulting in large volumes of DOT being sold. This phenomenon primarily occurred in the Kusama network, Polkadot's test blockchain, where KSM coins are locked for just a year. Consequently, the first parachains have already returned the leased coins, with 90% of funds not being relocked.

If parachain auctions' profitability continues to be low, the unlocked DOT could negatively influence the price. In fall 2023, users will get back 113 million DOT, which is currently valued at $600 million. And this only accounts for the first 5 parachains - there were 45 successful auctions in total.

The main Polkadot network was launched seven years ago, and to date, only about 50 parachains have been deployed on the blockchain. The total TVL of these does not exceed $150 million - a modest figure for a project with a capitalization of $6.6 billion and the ambition to create a sizeable multiblockchain.

Each parachain needs individual integration into the cryptocurrency network, developing a DeFi ecosystem, an NFT sector, and attracting developers and investors. However, due to the bear market and Polkadot's overall development dynamics, fewer people wish to engage with the network, thereby further decelerating its growth and belief in the project.