Jack of all Trades, Master of Scaling — Polygon Fundamental Analysis.

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The Need for Speed

We don’t use a 50-car freight train to deliver a single lump of iron ore in economies of scale.

We don’t use a plane to deliver the volume of a cargo ship with containers filled to the brim. Even if an aircraft were big enough to house those goods, it would likely never get off the ground.

There is a reason why Osprey helicopters don’t deliver Uber Eats. The costs would be high. But when scaled down to drones, they could deliver your Uber Eats. There are instances where operators have flown their drones to retrieve food purchased. However, this is not legal in many jurisdictions due to concerns around safety and regulation. But it works. To be practical, they still require greater weight-bearing capacity, flight range, and speed to deliver a new refrigerator that you ordered online. It is still more suitable for a truck or van to deliver it to your home in this instance.

No one delivery method fits all products.

These considerations around logistics are certainly not limited to the physical movement of items. It is also worth considering when validating transactions on the blockchain.

A drone may be a quick and cheap delivery option, but there is no guarantee of the security of goods in mid-flight, nor does it have the range.

A plane has the range to move goods over a significant distance, but there is still limited capacity.

A freight ship has the storage capacity to move a massive amount of goods, but the trade-off is speed.

If delivery is given priority at an extra cost, we may use planes to receive it quicker instead of waiting for a freight ship to arrive on our shores.

Suppose you have kept up to date with our fundamental analyses. In that case, you’d be all too familiar with the blockchain trilemma that considers three critical features of a blockchain: decentralization, security, and scalability.

The new year always seems to bring renewed attention to layer-2 solutions.

Why?

Well, we saw that 2020 ended the same way as 2021 with a continuation of high fees to operate on Ethereum, yet 61% of TVL across all blockchains valued at around $150B still sits on Ethereum. The next closest ecosystem is Terra, which sits around $18B TVL.

However, in the space of one year, we have seen blockchain technology move ahead in leaps and bounds. Layer-1s like Solana had captured the attention of the masses with their industry-leading finality and low transaction costs. But we have also witnessed several outages on Solana caused by networks bugs and DDOS attacks on the network. Speed and costs are prioritized in exchange for security.

Some analysts say that crypto mass adoption has yet to take place with estimates between 200–300 million users with forecasts of around 1 billion users by 2026.

It is broadly accepted that scalable infrastructure must be available to the end-user for mass adoption to occur.

Given that some delivery methods may be more suitable to ensuring security whereas others prioritize speed, Polygon has recognized there is no ultimate solution for economies of scale and have pivoted their ambitions toward becoming “Ethereum’s Internet of Blockchains”. Their goal is to be the go-to hub for L2 deployment that offer a wide range of consensus mechanisms that cater to the needs of a given protocol.

Some transactions may require directly leveraging the security of Ethereum, which may compromise speed (a package may be delivered by truck because it is safer and more reliable than a drone). Other transactions may have larger payloads (weight and spatial dimensions of a package) that require the likes of IPFS to reduce the computational burden and subsequently reduce cost per transaction. Then you have transactions that may need to filter through multiple consensus layers to execute a smart contract (range or distance to deliver from the source to the destination).

As it stands, Polygon is the most popular, developed, and ambitious layer-2 (L2) project in the space. To cover every aspect of Polygon would require a book as there is a lot of information (several research reports are sourced in references if you wish to dive deeper).

For this fundamental analysis, we will give a very brief overview of the history of Polygon and functions, developer activity through Dapp deployment, concerns around centralization, tokenomics, and discuss what the future may hold for Polygon.

Polygon Key Summary — TLDR; takeaways

From Triangle to Square, Brief history of Polygon

Polygon, formerly known as Matic, released a test net in 2017 and deployed the mainnet on their Plasma Chain with limited functions later in the year. Polygon network was built by Polygon Technologies, a for-profit software company based in India. The roadmap and subsequent developments are implemented by the Matic Foundation (rebranded to Polygon Foundation). Polygon raised $5.5M from various token sales in 2019 and has since raised millions through big players and institutions.

After several editions of the CCI Newsletter, you have made several steps on the path to becoming more refined in your understanding of technical discussions. When not much differentiates a product on the surface, it is important to strive toward a level of knowledge that enables you to differentiate a product based on what it does and how it does it. Refer to our previous fundamental analysis on Metis layer-2 and prior discussions on Layer 1 blockchains like Solana, where we discuss the blockchain trilemma in varying depths.

Plasma was the first implementation of Polygon’s design that involved rolling up transactions into a parent chain that can send fraud-proofs (an internal proof of consensus) to the Ethereum Chain. The general idea is that computations are performed on the Polygon network, and signatures are sent back to the Ethereum chain to record blocks. Polygon removes the computational burden from the Ethereum layer to increase throughput and reduce storage requirements.

After two years of building, Proof of stake consensus was integrated onto the Polygon network to increase scalability, Dapp functionality, and internal consensus to limit the involvement of the plasma chain. PoS chain operates as a “sidechain”, meaning it runs parallel with the Ethereum mainnet, enabling validators to checkpoint and validate transactions randomly. Polygon’s PoS sidechain also enables virtual machine capability within the EVM whereby DApps can be deployed and utilized on the network.

Smart contracts functionality on Matic (Polygon) Mainnet went live in June 2020. Though development is considered ongoing while the plasma and POS implementations are live, Polygon’s focus is now on integrating layer-2 solutions that are accessible to developers that wish to implement a unique consensus structure.

The Ethereum layer secures Polygon through smart contracts deployed on Ethereum that executes critical logic. Instead, the information you can’t leave out when the rolled-up transactions from Polygon get sent to Ethereum.

The security layer acts as a meta-blockchain running parallel to the Ethereum/Polygon smart contract layer. Deployments on this layer are abstract and operate on custom validation mechanisms to achieve consensus. These two layers are optional to developers seeking to deploy their blockchains, and the Polygon SDK has simplified this process immensely.

The Polygon Networks Layer and Execution layers are mandatory layers that require validating deployment and interaction with smart contracts.

Dapp deployment gone viral — Ecosystem growth

Polygon claims that over 3000 DApps have deployed on their mainnet, which surpasses Ethereum. That may be a confronting statement, but keep in mind not all DApps are developed on the Ethereum public chain. They often deploy on Binance Smart Chain or other blockchains that leverage the EVM to quickly migrate and deploy onto Polygon.

In the following infographics, you are bound to recognize a Dapp that you have used on another protocol. The interoperability narrative has fueled Multi-chain and cross-chain implementations. The consensus is that DApps, whether they are DeFi or NFT based, are NGMI (never gonna make it) if they operate in an isolated silo.

Polygon’s commitment to having DApps deploy on their network is evident by the $150M of $MATIC set aside for the ‘DeFi-for-all fund’, which also offers 2% of the total $MATIC supply as liquidity mining incentives for promising projects.

There is no shortage of activity that has taken place at Polygon. Notable developments are as follows:

• Polygon integrated with trustless cross-chain protocol REM, making it possible to wrap additional tokens on the network (Bitcoin, Doge and Luna).
• Polygon announced an integration with Google’s Big Query. Making it possible for developers to analyze data on the POS chain.
• Polygon announced The Sandbox would be migrating from Ethereum to Polygon.
• Mid-July, Coinbase wallet enabled compatibility with Polygon POS chain. This integration led to 120M unique addresses on Polygon Chain, a 1000x increase since March.
• Binance added support to the PoS chain, enabling direct withdrawals from Polygon.
• Polygon acquired Hermez, a layer-2 scaling solution for ETH that leverages Zero-knowledge (ZK) tech.
• Polygon Ecosystem DAO gives users a say in the direction of the protocol.
• Ernst & Young (EY) to deploy a privacy-focused scaling solution using ZK rollups. EY is one of the big four accounting firms (Sandeep Nailwall formerly worked for Deloitte; Polygon has direct relationships with two of the big four accounting firms).
• Polygon active user accounts have briefly surpassed Ethereum.
• Early October, NFT Marketplace Opensea announced and have since deployed on Polygon.
• Aave deployed on Polygon in April 2021, attributing to the 10x increase of active users on Polygon in the first half of the month.
• Bitwise launched a fund for institutional investors on Polygon.
• Google Cloud provides blockchain insights for Polygon Network.
• Polygon paid a $2M bounty on a caught and corrected bug.
• Polygon announces Miden, another ZK scaling solution. It uses a more elaborate ZK technology called ZK Starks, and Miden will have its own virtual machine compatible with the EVM.
• Facebook’s former ZK researchers developed Miden.
• NFL announced it would issue tickets on Polygon’s POS chain.
• Polygon announced an integration with Arweave that seeks to store data decentralized.
• Pending developments on the network: Avail Side Chain, Nightfall ZK Rollup, TBA Optimistic Rollup, Application-specific sidechains, and Enterprise Side Chains.
• Polygon announced allocating $1B of MATIC tokens to a ZK Strategic Fund.
• Polygon implemented EIP-1559, which emulates the burning mechanics implemented by Ethereum’s EIP-1559 known as the London Hard Fork. This upgrade involves Polygon switching from a first-price auction as the primary means to calculate transaction fees. Instead, Polygon will implement a base rate fee, and any increased costs caused by demand will be subject to burn.

Polygon ($MATIC) tokenomics

As of 23/01/22:

• Price: $1.55
• Circulating Supply: 6,872,890,164
• Maximum Supply: 10,000,000,000
• Market Cap: $10,623,324,355
• Polygon Network TVL: $9,908,846,512
• Market Cap to TVL ratio: 1.07

Mined $MATIC and all vested tokens will be released by 2025. Currently, validator/delegators receive around 12% APR for staking on a node. Once the max supply is in circulation, transaction fees will be the primary incentive to delegate or validate the network.

There are more than two sides to a Polygon

While it seems that Polygon is making strides toward becoming Ethereum’s “Internet of Blockchains”, there are still glaring centralization issues.

To Polygon’s credit, they have acknowledged the risks associated with centralization. To achieve the speed and efficiency of the Polygon network, they rely on 7–10 block producers active at any given time. It is unclear who owns them, likely Polygon Foundation. While it may sound like block production is in good hands, any destabilizing event within Polygon Foundation will likely impact the integrity and ongoing operation of these block producers. If these block producers fail, the entire network will come to a grinding halt, including the layers built on top of this consensus layer.

Further, the top 10 validators control 80% of staked supply on the validation level. To be considered a validator, you must rank in the top 100 from $MATIC staked, a significant limitation as the average investor can hardly afford to stake enough $MATIC to receive validator rewards.

Polygon network was hacked on Dec 4th for over 800k $MATIC tokens. The team paid $3.46M to the two White hats that discovered the bug, saving further millions of dollars from being exploited off the network.

An additional risk is that Polygon Foundation’s primary source of income is through the sale of the $MATIC token. They have a significant share of the total supply, the team and foundation have sold a lot of $MATIC to fund their developer activities. While it is entirely their prerogative, it is a deterrent to investing in Polygon. That said, you look at the likes of $XRP, and you can see there are those with the appetite to have founders regularly sell their tokens at the community’s expense.

In the case of Polygon, there is something to show for the team selling the token for funding the development of new use cases. For the likes of $XRP, there are far fewer tangible benefits to the founders selling on top of their holders.

Further, they have announced plans for a Polygon DAO but have given no information toward governance structure. This non-disclosure is symbolic of a regularly perceived lack of transparency from Polygon. Again, to Polygon’s defence, the founders spend a lot of time explaining their operations and the goals they are pursuing. However, investors require greater clarity on how they will reach their goals to negate the impression that they are “biting off more than they can chew”.

Much ado about $MATIC — Discussion

Many analytical considerations fade from relevance when a project has been around for a few years and continues to push ahead.

There is no absence of a product for users. The team has stuck around and continued to put the work into growing the network and its capabilities. TVL, as an indicator of network popularity, shows steady user adoption. Polygon has retained its standing in the top 30 cryptocurrencies by market cap over the last year. Further, there is no question around awareness based on their consistent presence as a highly ranked project by market cap. There are only varying degrees of knowledge around the technology that powers Polygon among investors.

One thing to rule out in the mind of a potential investor is that Polygon as a technology accessible to the masses will not be rugged by the team.

Although we can never dismiss the possibility in the future of an exploit occurring as we saw as recently as last month, we know the team will not exploit the protocol at the expense of their users.

Why?

Well, they have had countless opportunities to do so already.

We cannot exclude that an exploit targeting the network will not occur again. Still, we can quite reliably assume most ongoing exploits will be Dapp specific, which comes with the territory when using untested DeFi instruments.

However, what is relevant to consider is the degrees of centralization that persist throughout the network. It is reaching a point in Polygon’s life cycle that serious attempts must be made toward achieving decentralization.

Reducing centralization means reducing barriers to entry at the validation level and allowing more block producers to operate on the network outside of the Polygon Foundation.

Many criticisms laid at Polygon’s feet revolve around centralization, an openly admitted trade-off to enable greater TPS.

While we must always strive to ensure accountability of those responsible for rolling out a project that we are invested in, the Polygon team has not changed. There are no internal issues that have leaked to incite doubt around the team’s integrity.

Over the last year, it may be in the team’s interest to retain network control to integrate new technologies, specifically ZK Rollup technology. But once complete, It would be a concern if the network did not take further steps toward decentralization during this time.

The history of Polygon Foundation is mired only by the source of funding for developments on the network; the community. Major sell-offs appear highly correlated with the release of vested tokens, which is no surprise as some may be awaiting tokens that they acquired at less than $0.001 each. Owners of the vested tokens would understandably be itching to sell some of their $MATIC after a 2500x on price.

When we look at the traditional economy and recall past experiences of global recessions, we encounter the concept of an entity being “too big to fail”, which is often in reference to banks and major institutions that are critical in maintaining domestic and global supply chains.

This mantra does indeed hold some weight when it comes to Polygon.

With over 3000 DApps deployed on their mainnet, short of a network-level exploit, it is safe to say that Polygon is not going anywhere. If we require an example of what it looks like when a network effect takes hold, look no further than Polygon.

Polygon fits hand in glove with the scalability narrative. In the minds of crypto enthusiasts, the adoption of blockchain technology and cryptocurrencies are only just getting started. As discussed throughout, we have seen the rise of L1 technologies that have succumbed to outages and required the team’s intervention. While centralized, many systems lack a degree of resilience or self-correcting capabilities. If something were to go wrong, adequate measures would be in place to ensure validator participants can restore the network. The ongoing rebalancing of these priorities suggests that the scalability narrative, a critical narrative of 2021, is even more pertinent today.

By striving toward becoming “Ethereum’s Internet of Blockchains,” they have taken a technology-agnostic approach. Rather than favour one type of L2 solution, Polygon seeks to be the hub where developers and users can customize and deploy an L2 solution that suits their consensus needs.

The focus of the scalability narrative appears skewed toward the deployment of Zero-Knowledge (ZK) Rollups. At the highest level, ZK Rollups aggregate transactions into batches where only the ZK fraud proofs get transmitted to L1 for validation. But what they lack are smart contract functionality, though advancements are ongoing toward building an EVM layer on top of ZK rollups.

Polygon qualifies for the interoperability narrative, currently operating as a PoS sidechain of Ethereum with EVM compatibility. They have made progress toward becoming a deployment hub for L2s of all varieties. These L2s are EVM compatible, or in some cases (should the likes of Metis’s Andromeda mainnet deploy), EVM equivalent. Within the EVM, the Polygon blockchain can go anywhere.

Bitcoin is worth its various deficiencies as we exchange electricity and speed for trustless, permissionless, censorship-resistance and decentralized stores of wealth. In this sense, the Bitcoin network is unstoppable, but it cannot execute smart contracts in a manner as frictionless as the Ethereum chain. The consensus mechanism needs to match the utility of a token.

So, what does the future hold for Polygon?

Pricewise, you may be feeling mighty bullish right now, but let’s think this through.

At a $16B market cap, you may look toward similar scalable solutions like Solana which reached a peak of $75B. If $MATIC were to get Solana’s all-time high market cap, that would be close to a 5x from here. This growth would be the most bullish scenario where $MATIC goes from $2.33 to $11.65. In addition, if the market cap doesn’t reach the heights of Solana, the EIP-1559 implementation of Polygon will likely have a latent positive impact on the price over time. It will take less liquidity to move the price as more $MATIC is burned out from circulation.

While this certainly is not an impossible price for $MATIC and could be viewed as somewhat inevitable in the long-term, it is unlikely in the short term. Polygon has been in a league of its own as an L2 technology. No other L2 has held a candle to the TVL and market cap for the native token (Arbitrium, Loopring, DYDX, Metis, Optimism, Immutable X, etc.). Although, when an existing DApp deploys on Polygon or any of the mentioned L2s, they often bring their own liquidity along with them. Similarly, developers who wish to utilize the Polygon SDK to deploy their own blockchain may leverage the consensus of either Ethereum or Polygon. Still, they often rely on their own native token to collateralize their ecosystem(s). Increased Dapp activity on Polygon does not always mean that the price of $MATIC will increase proportionally.

With the recent downturn in the market, $MATIC is sitting around $1.55. This is a blessing and increases the upside potential, given that the market cap is sitting around $10.6B, it is not outside the realm of possibility to see up to a 5x on price, assuming the market has not turned bearish in the long-term. We need to keep in mind that the Polygon Foundation and Team still have a lot of $MATIC in the coffers to offload until their allocations are exhausted, they are sparing no expense to fund developer incentives for their ecosystem, and there is no telling when their selling behaviours will cease to thwart upside.

That said, we should not underestimate the exponential nature of the network effect. With multiple L2 solutions increasingly becoming available for deployment, should these environments leverage Polygon consensus, there will be a lot of burning and fees paid to validate on the network. The low costs only become meaningful to validators when there is a large amount of activity.

As for the various L2 solutions that Polygon is exploring, Optimistic Rollups and ZK Rollups both have a role in scaling for the future.

Polygon brands itself as “The Internet of Ethereum”. Their goal is to essentially become a repository that taps into every L2 solution available.

ZK Rollups are all the rage at the minute — but their unique selling proposition resides around security and consensus efficiency.

But beyond that, they lack composability within a virtual machine (execution layer) that say Optimistic Rollups have. Something like this, built on top of a ZK Snarks consensus model, would create the ultimate L2 product that maximizes security and speed through ZK consensus and functionality through OR L2s, like Metis.

There is still tremendous upside to Polygon by bringing on these technologies, but that doesn’t necessarily mean Polygon will capture all of this upside. The products they integrate will likely capture their liquidity share based on a project’s merits.

For this reason, It is hazardous to subscribe to the idea that it’s going to be “one ring to rule them all”. While ZK rollups are primed for a big year on the back of a lot of pent up hype, It does not seem that ZK rollups will kill Optimistic Rollups or existing L2 solutions available on Polygon (POS Chain).

It is a long way off before ZK rollups can be EVM equivalent, utilize multiple sequencers, implement Decentralized Autonomous Companies (DACs) — all of which Metis (an Optimistic Rollup) aims to do.

While this response sounds like a Metis shill, the point is that for Polygon to succeed at being the “Ethereum’s Internet of Blockchains”, these products need to develop in isolation, and the Polygon team can cherrypick the strengths of each to offer an all-encompassing solution. Polygon will only be as strong as the technology they integrate. Further, that doesn’t necessarily mean you must have the $MATIC token to utilize these products. Each of these (apart from Arbitrium) has its native token required to use its functions.

For this reason, the idea of one product (Polygon) dominating all else is short-sighted. Though that said, Polygon will likely maintain market dominance. As alluded to, they’re becoming a go-to source of L2 solutions that will have tremendous utility based on the DApp that adopts the technology and their intended use cases. But regardless, Polygon still relies heavily on development across all other L2s, and their overall offerings will only be as good as what these alternative L2 solutions can bring to the table.

Once a network effect takes hold of a particular network, they become “too-big-to-fail” out of necessity. Polygon has set itself up as a critical piece of infrastructure to facilitate future adoption and scale towards greater efficiencies.

References

Binance Research Report, ‘Matic Network (MATIC) Scalable, Instant, And Secured Transactions for Blockchains’, https://research.binance.com/en/projects/matic-network

Coincu, ‘The internet and cryptocurrency adoption rate will reach 1 billion users by 2027’, https://news.coincu.com/47147-cryptocurrency-will-1-billion-users-by-2027/

Coindesk, ‘Google Cloud Now Provides Blockchain Insights for Polygon Network’, https://www.coindesk.com/tech/2021/05/28/google-cloud-now-provides-blockchain-insights-for-polygon-network/

Coinspeaker, ‘What Is Polygon (MATIC)?’, https://www.coinspeaker.com/guides/what-is-polygon-matic/

Crypto Wikipedia, ‘What is Polygon (MATIC)’, https://crypto-wikipedia.com/what-is-polygon-matic/

Messari, https://messari.io/asset/polygon/profile/supply-schedule

Polygon Insights ‘Year in Review’, https://polygonanalytics.substack.com/p/polygon-insights-2-year-in-review

Polygon Lightpaper https://polygon.technology/lightpaper-polygon.pdf

Polygon, ‘Polygon Is Bringing EIP-1559 Upgrades to Its Network With a Testnet Release’, https://blog.polygon.technology/polygon-is-bringing-eip-1559-upgrades-to-its-network-with-a-testnet-release/

Inside Bitcoins, Polygon SDK Launch: Developers Can Now Build Ethereum-Compatible Blockchains, https://insidebitcoins.com/news/polygon-sdk-launch-developers-can-now-build-ethereum-compatible-blockchains

The Crypto Basic, ‘Polygon Admits The Network Was Hacked, Hacker Swiped 801,601 MATIC Tokens’, https://thecryptobasic.com/2021/12/30/polygon-admits-the-network-was-hacked-hacker-swiped-801601-matic-tokens/

Youtube, ‘Polygon: When Will Matic Explode?’, https://www.youtube.com/watch?v=OECcDsmmhRg

Youtube, ‘POLYGON (MATIC) — Ethereum’s Internet Of Blockchains Explained — Layer 2’, https://www.youtube.com/watch?v=IijtdpAtOt0

Youtube, ‘What is Polygon? MATIC Explained with Animations’, https://www.youtube.com/watch?v=GWUwFDFOipo&t=1s

Youtube, ‘Polygon $MATIC Exit Strategy: ZK Rollups Update & Should I Sell and if so How?’, https://www.youtube.com/watch?v=nP2IKI8KmGE