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Polygon over the last day (29.05.2023)
Polygon is a blockchain platform providing scaling solutions for Ethereum with the aim of offering faster and cheaper transactions. The Polygon ecosystem utilises a native token called MATIC to pay for transaction fees and validation rewards.
Polygon is often described as a side-chain, but ‘Ethereum in the fast lane’ -- as it markets itself -- is a better analogy as you can think of Ethereum as a motorway which at busy times suffers from congestion which also pushes up toll fees.
To solve that traffic issue Polygon operates a road network running in parallel with Ethereum that can only be reached via purpose-built bridges. As users bridge or on-ramp from Ethereum they can benefit from different rules for processing transactions and setting fees which means less traffic and much cheaper tolls.
Given that Polygon’s main chain promises up to 65,000 transactions per second, with less than two seconds for block confirmation and fees of around $0.002, it has naturally become popular with protocols that have high transaction requirements and are time sensitive, such as DEFI and NFT.
Polygon was created by three Indian entrepreneurs in 2017 - Jayant Kanani, Sandeep Nailwal, and Anurag Arjun. It was originally designed as a single instance Ethereum scaling protocol called the Matic Network but rebranded to Polygon in February 2021 as it developed into a multi-chain ecosystem that supports custom Ethereum-compatible blockchains.
In 2021 Polygon announced a strategic goal to invest $1bn in Zero Knowledge solutions for scaling Ethereum. They are essentially banking on the success of Ethereum’s Merge (expected in 2022) and the growing demand for cheaper and more efficient ways to move Ethereum-based assets.
This multi-chain/multi-layer approach puts Polygon into a similar bracket as Cosmos, Avalanche and Polkadot, though those operate as direct rivals to Ethereum rather than scaling on top of it.
Polygon promotes the ease of spinning up side-chains that benefits from the security of Ethereum’s base layer but the speed and cheaper transactions of second layer consensus.
Polygon is like a swiss army for Ethereum scaling based on the Polygon SDK framework; you can choose the appropriate component depending on your need.
The Polygon Proof of Stake blockchain bridges to Ethereum using a technology called Plasma. Plasma acts like a sidechain with its own consensus method for producing blocks - Proof of Stake - but publishing the roots of these blocks with Ethereum, described as ‘check points’, as a way for users to have a verifiable claim on funds that are secured by Ethereum.
Anyone can use Polygon PoS chain by bridging funds from Ethereum to Polygon via a supported wallet like MetaMask, then using any of the applications built on Polygon, paying fees in MATIC.
Polygon isn’t just a single sidechain of Ethereum, it allows you to create your own EVM-compatible sidechain following your own consensus mechanism and with your own token, but benefiting from high transaction throughput (Tps). That function is called Polygon Edge.
As of April 2022, Polygon’s blog states that more than 20 web3.0 applications are using Edge’s modular ‘lego block’ approach to blockchain design, but this doesn’t come without challenges:
Polygon’s solution is introducing what they describe as Supernets, blockchains that are spawned from the Edge framework and offer as much or as little support from the main Proof of Stake chain as is required.
The Supernet approach will enable four broad categories of sidechain:
The main Polygon Chain uses a version of the Tendermint Proof of Stake consensus mechanism called Peppermint. As with Tendermint there is a limit on Validators which Polygon has currently set at 100.
Peppermint requires a network of Validator nodes to stake MATIC and run a specific piece of software to enable block creation and validation.
Polygon’s Consensus Mechanism works on three levels:
Given Polygon uses a modified version of Tendermint, the consensus method used by the Cosmos Network, Polygon chains can bridge to any of those chains through the IBC framework.
As mentioned in the introduction, in 2021 Polygon announced what they described as their strategic thesis, a commitment to invest heavily from their treasury in the development of scaling solutions for Ethereum based on rollup approaches.
Rollups describe a category of solutions built on top of Ethereum - aka layer 2 - that can compress, or rollup, transactions into batches which are then confirmed on-chain to achieve greater efficiency in terms of speed and cost..
There are two broad approaches to achieving that efficiency - Optimistic and Zero-Knowledge. Optimistic assumes all the transactions are valid but has a system for dispute resolution. Zero-Knowledge, uses a cryptographic solution for proving data is valid but without having to provide supporting evidence.
In practical terms Polygon’s rollup investment will go into:
The first significant investment in this strategic push was the acquisition of the Hermez Network - a Zero-Knowledge Rollup solution - for $250million in August 2021, which was then rebranded as Polygon Hermez.
Polygon promotes that Hermez can batch up to 2,000 transactions at a time with one proof which they claim reduces fees by 90% and increases throughput by x133.
The cost of Ethereum transactions on Hermez is just $0.25 at the time of writing though there are even cheaper L2 options. There is of course a catch with rollups as they are computationally heavy so the use case isn’t universal.
Polygon is actively developing other rollups solutions which are in various stages of development:
At the time of writing there are 13,000 MATIC holders delegating their tokens to Validators, with just around 2.5 billion in MATIC staked, worth just over $1 billion. In return, stakers are receiving just under 8% according to Staking Rewards.
Polygon supports 13.5 million addresses that have made 1.6 billion transactions.
Polygon ranks third by the number of DEFI protocols, according to DefiLama, supporting over 250 applications but is sixth in terms of TVL at $2 billion but declining heavily due to the ongoing market correction in mid-2022.
Polygon generates just under $30,000 a day in fees which when compared to close to $6 million a day generated by Ethereum really is chicken feed. This illustrates the tension between renting the security of Ethereum and creating its own revenue stream from fees that are so much cheaper.
MATIC is the token used by the Polygon system to pay for transaction fees, block rewards and facilitate the staking element of the Proof of Stake consensus mechanism.
MATIC has a fixed maximum supply of 10 billion tokens that were premined with the following initial distribution. IEO refers to an Initial Exchange Offering which was managed by Binance
The unlock period on the initial private distribution can have a significant impact on price as it can cause a significant volume of tokens to be dumped on the market in one go. According to Messari, 50% of all private sale tokens unlocked at the time of listing and the rest vested after six months.
There are 8 billion MATIC in circulation at the time of writing and a liquid supply of just over 9.1 billion. The nature of MATIC’s supply schedule and rewards structure means that it currently has an inflation rate of 5.6% but the maximum distribution is expected to be reached by the end of 2022. You can see the token supply schedule for Polygon over on Binance Research.
The impact of Ethereum’s EIP-1559 in August 2021 is creating deflationary pressure on supply. EIP-1559 includes a feature to burn a proportion of fees generated from Ethereum transactions.
Given that Polygon relies on Ethereum for security and decentralisation, periodically publishing block roots to Ethereum, MATIC will inherit the impact of the burn. This is estimated to result in an annualised reduction in the supply of MATIC of 0.27%.
Once MATIC’s treasury has distributed all tokens set aside for block rewards Validators will only receive fees. According to Messari this will happen in 2025.
According to DappRadar the most popular applications on the Polygon PoS chain are DEX applications, benefiting from the fast and cheap transactions. The Dyfn Network generates $20 million in volume from around 200 users.
QuickSwap has a lower volume at around $15 million, but over 13,000 users taking advantage of the ability to easily swap ERC-20 tokens.
Polygon also has active partnerships with some significant blockchain services that benefit from its speed and cost-effectiveness including Opensea -- the largest NFT marketplace -- and Decentraland, the leading decentralised Metaverse.
The steps for using Polygon will depend on which of the services you want to use.
If you want to use Polygon as a side-chain for faster/cheaper Ethereum transactions you can bridge via an Ethereum wallet, such as MetaMask. Users need to purchase MATIC from any of the popular centralised exchanges such as Coinbase, Binance or Kraken - in order to pay for transaction fees on Polygon - then connect to the relevant dApp.
You can earn rewards from staking MATIC either by directly running a Node or delegating your stake to a Node.
The technical hardware requirements and know-how for becoming a validator are complex though there is no explicit minimum token requirement for running a Polygon node. You theoretically need just one MATIC but given the way Nodes compete for the limited number of validating slots the average stake per validator is far greater than that minimum.
Rather than run a node you can delegate your stake. There is no minimum requirement though individual staking providers may set their own criteria. You’ll need a MATIC supporting wallet and to choose from a list of Validating nodes. Be aware there is a 21-day unlock period and a minimum withdrawal of two MATIC.
In order to use Hermez - the layer 2 rollup solution - you need need to register your Ethereum address with the Polygon Network (using a wallet like MetaMask) and get a Polygon Hermez Address. You can then deposit Ethereum-supported tokens, swap and move them, and then reverse the process to withdraw your funds back on chain.
On paper, Polygon sounds like a clever solution to Ethereum’s obvious scaling problem, but to be clever it has to be complex, and complexity generally leads to security vulnerabilities.
This was danger was highlighted in December 2021 when a white hat hacker exposed a Smart Contract vulnerability that put 9 billion MATIC, 90% of the entire supply, at risk.
Polygon quietly patched the vulnerability on December 5th and forced through a hard fork, paying the good Samaritan a $2.2 million bug bounty.
That wasn’t before approximately 800,000 MATIC was lost to malign hackers but Polygon really got off lightly losing the equivalent of $1.4million as opposed to $20.2bn, the value of the MATIC that was exposed.
Alongside the security risks that come with the complexity of Polygon’s scaling solution is the lack of decentralisation of the underlying Consensus Mechanism, Peppermint.
In common with Tendermint, on which it is based, Peppermint has a fixed limit of Validators, currently set at 100. This represents a significant compromise given the main premise of blockchains is to offer decentralisation. The problem is that raising the number of Validators increases fees which negates Polygon’s main USP.
The current bear market has seen decreased demand for Ethereum transactions, especially from minting NFTs, bringing down transaction fees and reducing Polygon’s comparative advantage. However, offering the lowest transaction fees brings its own set of problems as Polygon has attracted huge amounts of spam transactions.
As reported by Cointelegraph in October 2021 bots were exploiting Polygon’s low fees to balloon daily transactions to 8million (roughly eight times the throughput of Ethereum). Polygon responded by increasing the minimum transaction fee from 1 GWEI to 30.
There is also a question mark over how MATIC will generate value once block rewards are exhausted, expected in around 2025, and Validators are rewarded solely with fees.
Targeting Ethereum’s scaling solution has brought a lot of users over to Polygon but that use case will be challenged by the Merge, Ethereum’s move to Proof of Stake and the host of other Layer 2 scaling solutions like Metis or Loopring mean there is plenty of competition.
Anyone who bought into MATIC at launch will have enjoyed parabolic returns, and the deflationary pressure from EIP-1559 is good news for MATIC holders today but the economic model can really only generate value through scale.
$30k in daily fee revenue is simply microscopic so whether MATIC can deliver value to holders will rest on how much they grow their user base and whether their solutions can handle those potential users. History has shown that fees rise with transactions, putting them in a Catch-22 situation. Success may come down to the effectiveness of their development pipeline and how well Ethereum itself functions post-merge.
Polygon’s roadmap shows that they are trying to grow into a wider ecosystem through the introduction of Supernets - which has similarities to Avalanche’s Subnet approach - and the huge investment in rollups, but only time will tell how well this strategy plays out and what wider adoption looks like.
The entire network came dangerously close to being wiped away by a Smart Contract flaw, and that kind of risk will only increase with the added complexity of what Polygon is trying to achieve, but it has little choice but to innovate in order to survive.
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