Polygon, in simple terms
Polygon is a Layer 2 solution that aims to create “Ethereum’s internet of blockchains”.
Its main focus is scaling the Ethereum network, mainly by improving:
- Transaction speeds
- Lowering fees
- Developer experience
We’ll discuss how it aims to solve these problems, but to understand how Polygon works, we need to understand the difference between layer 1 (L1) and layer 2 (L2) solutions.
L2 vs. L1 Solutions
Layer 1 can be thought of as the bedrock of crypto.
It refers to blockchains that are not dependent on any other blockchains to maintain their functionality.
They usually consist of a network of nodes, a validation system, and have the capability to execute smart contracts.
The largest L1s are Bitcoin, Ethereum and Solana.
Several of the layer 1 blockchains face challenges in terms of scalability and transaction speed. This is especially the case with Bitcoin and Ethereum.
It is possible to address these problems by updating the blockchains, Bitcoin cash (BCH) for instance, has updated its blocksize several times (from 1 to 8, to 32MB).
Still, this approach has limitations.
Layer 2 solutions on the other hand, are well equipped to solve scaling issues.
A Layer 2 blockchain is built on top of a layer 1.
They are usually built to solve one or several of the problems mentioned above.
Think of it like this:
A layer 1 solution like Bitcoin is a highway and every transaction equals a car.
As all roads, the highway has a maximum capacity.
Instead of improving the existing highway by for example building a new lane, one could build a new highway on top of the old.
This would be the layer 2 solution.
Now, this is a simplification and we will come to see why the comparison to a highway is not entirely correct.
Polygon and scalability
First, lets recap the aims of Polygon:
- Increase transaction speeds
- Lowering fees
- Improve developer experience
How is this done?
Polygon has several features that aim at solving these problems. Most importantly:
- Polygon PoS
- Polygon kzEVM
- Polygon 2.0.
Let’s take a look at each.
Polygon PoS
Polygon PoS (Proof-of-Stake) is a side chain running parallel to Ethereum.
This just means that, in addition to being a blockchain with its own consensus mechanism and validators, it is also connected to the Ethereum main chain.
There is an ongoing discussion about whether this chain is to be considered layer 1 or layer 2, but in this article we will just categorize it as a layer 2.
What’s important is that the Polygon PoS chain itself can handle a large volume of transactions.
In other words, you can build an app on Polygon and the transaction will be processed on the Polygon PoS and finalised on Ethereum.
Doesn’t this mean that all transactions have to be processed on Ethereum after all? How is this faster?
The Polygon chain processes the data and groups them into clusters of transactions.
It groups them together before sending them to Ethereum where they are finalised and stored.
As storing requires way less computing power than processing, Ethereum is able to handle the bundles coming from Polygon despite them carrying a lot more transactions than Ethereum can normally handle.
To summarise:
The Polygon PoS chain processes and bundles transactions before sending them to Ethereum for storage.
The capacity for transactions per second (TPS) becomes much larger because Polygon does all the processing and Ethereum only stores the information.
Polygon kzEVM
Polygon kzEVM is another important solution in the Polygon ecosystem.
The name kzEVM refers to two things:
EVM: The EVM (Ethereum Virtual Machine) is the software running on the Ethereum blockchain. Being built into Polygon, it allows developers to easily migrate apps running on Ethereum to Polygon.
Basically, EVM ensures compatibility with Ethereum-based applications.
ZK: It also uses zk-proofs (zero-knowledge proofs) which can prove that a transaction happened without showing the transaction data.
Zk-proofs allow for transactions to be processed off-chain where only a single proof is published on-chain.
This innovative technology makes the transactions use even less storage.
In short, Polygon kzEVM is used to lower gas fees, increase throughput, and ensure EVM compatibility.
Further, the technology of Polygon kzEVM makes the basis for what is the future of the Polygon Network: Polygon 2.0.
Polygon 2.0
The rollout of Polygon 2.0 started in 2023.
It involves several changes to the ecosystem, notably:
- An upgrade of Polygon PoS to Polygon kzEVM Validium
- The launch of the Chain Development Kit (CDK)
- The migration from MATIC to POL
The upgrade to kzEVM Validium makes the original chain faster and even more scalable.
The CDK is a huge step towards the polygon “endgame”.
It is an open-source blueprint that anyone can use to launch their own Layer 2 on Ethereum.
It is the basis for a network of layer 2 chains which can consist of, in theory, unlimited chains.
The network of chains will be interconnected via a cross-chain coordination protocol which makes it feel seamless for the users.
When fully launched, this network of L2s takes the team behind Polygon closer to the vision of creating “Ethereum’s internet of blockchains”.
Tokenomics
The native cryptocurrency token for Polygon is POL (until September 2024 it was MATIC).
POL has three functions:
- Pay fees on the Polygon network
- Governance
- Staking
Since the fees on Polygon are paid in POL, it means that the more people using the network, the more demand there will be for the token.
POL is a governance token. It means that holders get to vote on changes to the Polygon network.
This process ensures a democratic and decentralized management of the project.
POL is used to ensure the security of the network. Users can stake tokens, to ensure the security of the network.
Note that staking is not necessary for the kzEVM versions as the zero-knowledge proofs “does the job” of ensuring security.
The POL token has a maximum supply of 10 billion tokens.
With 9,9 billion in circulation, there is little room for inflation.
The adoption of Polygon
Many dapps have migrated from Ethereum to Polygon due to its high capacity.
Still, the competition in the layer 2 space is brutal and Polygon needs to constantly innovate to compete.
Let’s first take a step back and remind ourselves that Polygon is built on Ethereum.
Ethereum is just one of many L1s that compete for the dapp ecosystem.
But it is the largest by far:
In terms of TVL (Total Value Locked), Ethereum constitutes about 69% of the total market.
Currently, 69% of the market in terms of TVL is roughly $104 billion.
The TVL on Polygon is 1,1 billion, which equals 1% of the Ethereum ecosystem.
This is low compared to its glory days in June 2021 when it made up 14,5%.
Actually, at that time, it’s TVL made up 10% of the whole market across all chains.
Today that number is just 0,7%.
So the question is, is Polygon dead?
The answer is no, at least not yet.
First, if Polygon has a low TVL compared to other projects on Ethereum, how come it is still number 22 in terms of market cap?
That is, how can it be the 22nd largest project in the crypto space, even ranking above Aave, a Lending protocol with a TVL 19x higher than Polygon?
The reason why it seems like the project is doing bad, is that the leading sector of activity on the network has recently shifted away from DeFi.
In terms of TVL, which is one of the way to measure how defi apps are doing, Polygon is not doing well:
But in terms of activity on the Platform, the numbers have been pointing up.
At least until the current correction.
For example, the number of daily active addresses on Polygon PoS doubled from December 2023 to July 2024:
The increase is explained by the fact that gaming has become the largest sector by activity on Polygon.
Of the 600-800k daily active addresses, about 400k come from gaming.
95% if the 400k comes from MATR1X, a global web3 entertainment platform.
Lets use the pivot to gaming to make some predictions.
The Future of Polygon
Polygon has seen a turn from being one of the largest DeFi ecosystems to hosting a variety of applications, notably gaming platforms.
The upgrade to Polygon 2.0 and migration from MATIC to POL make it a promising project.
Lets speculate on the future of Polygon by making some assumptions about the future of the project.
To estimate how Polygon will do, we can use the relationship between active users and market cap.
This is market cap divided by the number of users for each quarter from 2022 to 2024:
The number decreases when the market cap decreases and the number of users increase.
In other words, in a bull market, when the market cap increases faster than the number of active users, the ratio will be higher.
For this reason, we assume that the ratio in the next bull market will be similar to the beginning of 2022 when Polygon was doing good in terms of market cap.
This leaves us with a ratio of 0.04.
Now, lets calculate the potential future market cap of Polygon, assuming that the launch of Polygon 2.0 succeed and they manage to double their user base in 2025.
In addition, we assume that the MC / Active Users ratio is 0.04.
This would give us a market cap of 96b.
As almost all POL tokens are distributed, there is no inflation. We can use the current number of tokens in circulation to calculate the potential future price.
A market cap of 96b would result in the following price: 96b / 10b POL = $9.6.
Conclusion:
If the ratio between market cap and active users increase to 0.04, and Polygon manage to double its number of users to 2,4M in the next bull run, we can see the price for the POL token increase to $9.6.