Preparing for Your First Parachain Auction
Parachains — we believe this is the killer app of Polkadot.
In this article, we walk through why it’s a good idea, how you can become one, and go deep into how you can prepare to become a parachain. It may sound daunting, but every step of the way, we at LongHash are here to help!
Many great posts on parachains (links included) have explained the concept and technical details. Here, we focus on the strategy and steps required to really make it work.
Here’s a quick summary:
- A parachain is basically a “parallel blockchain” or your own blockchain, with security provided by Polkadot. Compared to dApps/ smart contracts, you get a lot more flexibility and security. It’s much cheaper too, compared to managing your own blockchain’s security.
- To become a parachain, you need to participate in a parachain auction to obtain “leases” in 6-month periods of up to 2 years. Naturally, the highest bidder wins. To win, you are going to need Polkadot’s DOT tokens — lots of them.
- To get the DOTs we need, we need to first prepare a good parachain strategy which includes your ecosystem strategy, governance, and fundraising strategy. Then, we need to let the world know and share your story, especially DOT holders/ investors. Finally, we need to actually raise the funds: before the auction, during the auction, or simply through governance mechanisms.
- LongHash can support you comprehensively along each step of your Initial Parachain Offering. As a Polkadot investor ourselves, we can leverage our assets, influence, and experience to make sure you are fully prepared to win your bid and operate a successful parachain.
Now let’s dive into it.
What is a parachain?
Parachains are a core proposition of the Polkadot network. Put simply parachains are self-sovereign native blockchains that rely on Polkadot’s relay chain for security and communication with other relay chains. Multiple resources explain this in depth.
A parachain is a native blockchain with:
- Customizable governance
- Customizable block production
- Customizable tokenomics
- Shared security from Polkadot relay chain
- Ability to exchange messages/ assets between parachains
- Typically built with Substrate
Why should you consider becoming a parachain?
Before we trigger another ICO rush where every other project bids for a parachain slot, let’s first examine why you would consider becoming one. Given the costs of preparing for a parachain, it must be justified with projected future volume and revenue. That being said, the benefits are much greater compared to smart contracts only:
- Flexibility to customize the blockchain to your needs, such as:
• Flexibility for on-chain governance, as opposed to typical default of centralized off-chain governance, or free-for-all decentralized governance.
• Room to innovate by involving stakeholders in more ways, not only with tokens, but also in consensus and governance.
• Freedom to specify technical details of the entire stack, e.g. sharding
- Upgradeability of protocol including smart contracts, governance, and consensus
- Interoperability between parachains to exchange assets and information
- Shared security provided by the Polkadot relay chain
- Cost savings for high volume/ value applications:
Preliminary modeling by the Web3 Foundation estimates the annual cost of securing major chains (e.g. Cosmos, Tezos and EOS) is in the tens of millions of USD per year, with Ethereum and Bitcoin in the billions, while the estimated opportunity cost to lease a parachain is $100–200k for 12 months.
- Read more on parachain slots
- Popular dApps on Ethereum with 30–200k monthly transactions like Chainlink, MakerDAO, and IDEX and spend $18–60k per month on gas, which would be free for parachains.
To use an analogy:
- A dApp as smart contracts is like a company in somebody’s country, you can have some processes and practices, but have to follow the laws of the country.
- A native blockchain (e.g. using Substrate only) is like your own country on an island, with the flexibility to write your own laws, but comes with responsibility of governing your population, including providing security.
- A parachain is like a state in the United States, where you still have the flexibility and control over your jurisdiction, while sharing security/ military, and being able to move and trade freely between states. Over time, each state/ parachain can specialize in different functions for efficient trading, forming a robust economy and ecosystem.
- Read more on the concepts of Polkadot/ parachains
But what about Parathreads? For those who are not/ do not expect to become a scalable use case, consider being a parathread instead, which is a “pay as you go” model by block.
What is the process for becoming a parachain?
So you have evaluated your project, and have come to realize that the best way to enable or jumpstart your growth is by becoming a parachain. Now actually, parachain slots are limited, and are distributed by candle auctions or governance. Here’s how it works:
It is estimated that 50–100 parachain slots will be up for bidding in the first auction. The full or maximum duration of a parachain slot is 2 years, broken into four “lease periods” of 6 months, bidders may bid for selected lease periods. Exact date for the first auction is still unknown, to be decided by governance.
The winners will be determined by candle auction mechanism. In brief, in a candle auction, bidders can submit increasingly higher bids during the open phase; The close moment of the auction will be randomly generated and retroactively applied; The bidder with the highest amount at the closing wins. This mechanism prevents “sniping” whereby bidders only put in a winning bid slightly higher than the highest bid right before the closing moment.
- Read more on parachain auctions
How do you prepare for a parachain auction?
Working backwards from being able to bid in the parachain auction, we foresee 3 key steps everyone needs to take in order to win a parachain slot:
- The Basics: Formulate parachain strategy including value proposition and fundraising plans.
- The Method: Raise awareness of parachain value proposition, especially among DOT holders.
- The Goal: Fundraise an appropriate amount of capital for parachain auction.
The Basics: Formulating Your Parachain Strategy
Most of the value in technology companies are projected in the future, which is why the valuations are sky-high while cash flows are nowhere near traditional industries.
Accordingly, parachains, as part of this technology ecosystem, will likely start with a current problem or context to justify their existence, a promise of future value, and indications of success or clear plans to build confidence in that belief.
As a parachain, there needs to be additional considerations regarding governance, which will eventually solidify the community and direction of the parachain.
Lastly, there needs to be a clear details around the fundraising itself, which strives to be of fair value and risk/reward to all parties involved.
These components make up the Parachain Strategy:
- Ecosystem Strategy
First, explain the problem/ context to justify the need for the parachain. Then, craft your value proposition of how the parachain will address this problem.
Elaborate further on the business model and mechanism design for the players to act as intended.
Lay out a roadmap on the steps to realize that solution and scale up.
Keep in mind comparisons to existing solutions or substitutes (“how do people deal with this today?”)
And finally, introduce the team with relevant details to inspire confidence.
- Governance Strategy
Most importantly, investors will look for tokenomics describing the use case of the token, its economics (e.g. minting/ burning/ staking mechanisms) and its role in the mechanism design to incentivize intended behavior in the ecosystem.
A parachain also has the flexibility and therefore the responsibility to implement on-chain governance which includes the end-state of decentralization once the ecosystem is mature, and the mechanisms to implement and maintain that system.
Alternatively or in combination, there could be a plan for off-chain governance to provide transparency in how the parachain will be run before decentralized on-chain governance is fully implemented, or if no such plans exist (for example, a private enterprise parachain).
- Financial strategy
This part should cover the total valuation and its justification (note: if there is insufficient volume or revenue to justify the auction bid, it may not make sense to even obtain a parachain slot, see parathreads instead). There should also be financial projections for the ecosystem (taking into consideration assets or liabilities in fiat and other tokens). Of course, investors will be looking out for the rewards and incentives for investors (e.g. tokens, time lock, council seat). And finally, there needs to be clear steps for investors to participate in the fundraising process
- (optional) Technology architecture and details — For proprietary technology, a separate segment can describe the details for other stakeholders e.g. architecture, underlying mathematics, security audits, guiding other developers to use open-source components or build on the ecosystem
The Method: Telling Your Story
Of all the ways of fundraising, as long as external funding is required for your bid, it is important to engage DOT holders or new investors. Hence, publicity and marketing are a key component to a successful auction. There is a wealth of accessible online content for effective marketing, which we hope to summarize in a few points:
- Tell a compelling story
Foremost is the content, where the message should be simple, personal, and tailored to the target audience. In terms of structure, a compelling format is often a journey from context to complication and resolution. Finally, use a visual format whenever you can (e.g. pitch deck, tweets, short videos) to capture attention, and then build confidence with detail (e.g. whitepaper, articles, video explainers).
Read more on how to tell a great story: 1, 2
- Engage your target audience
Before engaging them, you must first know your target audience. For example:
• Individuals — From Polkadot’s ICO of 10M DOTs, it is estimated that ~60% or 1801 of 3050 are probably individuals who hold <100 DOTs. That corrborates with the ~1320 active accounts we see on Kusama.
• Read more on Polkadot’s ICO DOT holders
• Venture Capital — From the Polkadot’s private sale of 500k DOTs and the ICO, more than 20 VCs participated in Polkadot’s ICO and subsequent private sale, distributed across Asia, America, and Europe.
• Council/ Committees — While the exact members and mechanism are currently unconfirmed, members on the governance council and committees may have the power to propose referenda, e.g. public good parachains
Once we have identified the target audience, use effective channels to reach each group:
• Physical — Meetups for large groups, 1–1 meetings for focused discussions with VCs, included on a tour to strategic locations
• Digital — Company website, social media/ messaging/ fora, and mailing lists for your general community
• Proxies — News and media, institutions (e.g. VCs, accelerators), word of mouth/ introductions, to keep building awareness and goodwill
After contact is made, be sure to continue engaging your audience with:
• Regular updates
• Answering questions and comments
• Expectations for future communications
- (Optional) Engineer virality
To get off a strong start, first build a strong initial support base by inspiring confidence through progress and familiarity (e.g., getting commitment from VCs). Then, drive engagement by creating content which tap into cultural cartography, e.g. “this is me”, inspire emotion, practical knowledge. To close the loop, reward positive outcomes. This can be financial rewards for top priorities e.g. commission/ placement fee for bringing in an investor. There can also be non-financial rewards for strategic priorities e.g. recognition or in-kind reciprocation for sharing your content
• Read more on virality in Buzzfeed’s formula
The Goal: Raising Capital
The main constraint is usually gathering capital for the parachain auction and operations/ development. To obtain sufficient external capital, there are 3 potential mechanisms:
- Direct Deposit is most similar to the public ICO model, where investors send their DOT to the funding address during the auction, and receive project tokens upon successful bidding. When the parachain lease ends, DOTs are returned to the investors. This mechanism may be preferable for open-source projects which receive widespread support among a community that prefers on-chain transparency.
- The Transfer mechanism is similar to a private token sale whereby investors may not get the token immediately, but may be rewarded with a preferential price or other rewards (e.g. governance roles). This mechanism may be preferable for projects that are more attractive to VCs because they are run efficiently like a private organization with clear business goals for future growth.
- The Gift mechanism makes use of Polkadot’s distinctive on-chain governance, which can pass referenda to provide parachain slots for free, or subsidize the bid by gifting DOTs. This mechanism is most applicable to “public good” infrastructure.
In the traditional ICO paradigm, investors can only be rewarded with tokens. In a parachain, the project team also has the option to reward investors with roles/ benefits in governance or block production too.
These fundraising methods can also be used in combination, e.g.
- A referendum for the Treasury to contribute a 1:1 match for external funding
- Like traditional ICOs, a round of private sale using the Transfer mechanism, and then a round of public sale using the Direct Deposit mechanism at higher valuation.
Read more on the parachain crowdfunding module
How does LongHash help in securing a parachain slot?
Here at LongHash, we are excited to support projects in all 3 steps required in securing parachain slots!
- The Basics: Formulate parachain strategy
LongHash: Consulting in ecosystem, governance, and financial strategy — which covers business strategy, tokenomics, and financial projections.
- The Method: Raise awareness of parachain value proposition
LongHash: Storylining; PR/ marketing leveraging network offices in China, Japan, and Southeast Asia; Introductions to major DOT holders across Asia.
- The Goal: Fundraise an appropriate amount of capital for parachain auction
LongHash: Deploy capital from staking pool for direct deposit; Treasury management before and after auction; Campaigning for governance voting.
Why work with LongHash?
LongHash is a global blockchain incubator, which invests and incubates projects to realize a Web3 blockchain-native economy. We also invested in Polkadot in the first private sale round. We run 12-week incubation programs supported by the Singapore government. Our expertise in Asia is strengthened by our network of offices across Shanghai, Singapore, Tokyo, Hong Kong, Berlin, and Zug. We are an official partner to support Polkadot ecosystem projects in incubation.
Let’s get in touch!
If you’re interested to work with us for your first parachain auction, please drop a mail to email@example.com.
We will be publishing more articles about parachain auctions in future, including details of our support, perspectives from investors, options to structure your parachain offering, and many more. Be sure to follow us on your favourite platform: Medium, Facebook, Twitter, Linkedin.