Polkadot: Crypto Volatility Will Be the Ultimate Challenge

When assessing the view from above, Polkadot (CCC:DOT-USD) seemingly commanded the credibility needed to pull off the nickname many proponents afforded it: “Ethereum (CCC:ETH-USD) killer.” Leveraging advanced scale and efficiencies that the incumbent backbone of blockchain applications could only dream about, Polkadot appeared on the verge of sparking a paradigm shift.

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Now, it’s fighting for survival.

Obviously, with the widespread impact of the cryptocurrency fallout, it’s not the only one. And while Polkadot is unlikely to be completely wiped out, investors need to hope that DOT can maintain some semblance of positive trading. Otherwise, the circumstances could turn exceptionally ugly for the once-promising digital asset.

Swinging With a Credible Narrative

To appreciate the otherwise dramatically positive journey of Polkadot, one should view the blockchain phenomenon as an evolution. Initially, Bitcoin (CCC:BTC-USD) proved the viability of a decentralized digital payment network undergirded by a virtual currency. Prior efforts to create digital coins and tokens suffered from the double-spending dilemma. Nothing prevented a currency creator from copying and pasting coins, thus opening the door for infinite inflation.

The beauty of Bitcoin was its underlying decentralized protocol. Public actors actively engaging the network controlled the supply mechanism. And, in theory, the distributed nature of this network prevented any one entity from dictating terms. Thus, people across borders can send payments to each other under a trustless mechanism. Rather than a centralized authority, the community — governed by consensus — oversaw the work of the machinery.

Later, Ethereum entered the arena, evolving the blockchain’s potential from exclusively peer-to-peer transactions to facilitating decentralization in other transactional relationships. Called “smart contracts,” Ethereum laid the groundwork for potentially eliminating middlemen entities in all binding agreements. Thus, the only exchange that occurs is between the direct actors of economic value. Other actors that merely serve an overseeing purpose — the bankers, brokers, attorneys, accountants — could be axed. Again, in theory, decentralized protocols could eliminate valuation vampires.

But as Ethereum became more popular, the transactional fees collected within the ETH network (called gas) jumped exponentially. Becoming bulkier and more expensive, many developers sought superior alternatives. One of the most popular is Polkadot.

Now, I can start boring you with magic blockchain words (as I’ve done in the past and may do again in the future) such as “open-source sharded multichain protocol” and parachains. For the purpose of this article, Polkadot is a faster and cheaper Ethereum.

So, why is it struggling?

Polkadot Still Has an Economic Incentive Problem

In prior discussions about so-called Ethereum killers, I used real estate valuations as an analogy. I will continue using this analogy because it’s one of the most intuitive.

If you live in an expensive metropolis such as Los Angeles or New York City, you may bemoan that with the sale of your one-bedroom condo, you could spend your days like an aristocrat in Kentucky. Or you could buy the state of West Virginia. I’m kidding, but you get the point. Depending on your location, average real estate prices can vary dramatically.

On the same token, I would suggest that the blockchain is no different. Why do people continue to engage the Ethereum network when Polkadot is clearly superior? DOT may be more efficient, scalable and secure than ETH. However, it’s like asking why a mansion in North Carolina with acres of land is the price of a modest home in Burbank, Calif.

In Burbank, you’re surrounded by the movers and shakers of society. The place is abuzz with activities and access. I’m not suggesting North Carolina doesn’t have its charms. You can hike the trails of the Great Smoky Mountains and stand on the ground where the Wright Brothers launched the first aircraft. But let’s not kid ourselves. When it comes to economic prowess, California is the undisputed winner.

Therefore, the volatility in the crypto market is a true litmus test for Polkadot. While people may enjoy bolstering its network, they need an economic incentive to continue doing so. With the underlying DOT coin being more volatile than other virtual currencies, system users may not appreciate such financial pain, irrespective of Polkadot’s many technological advantages.

The Bottom Line on Polkadot

Although I’m a big proponent of cryptos, I’m also a realist. Indeed, I like to consider myself a realist before attaching any other label. Unfortunately, what I see is excessive speculation in 2021 that’s correcting itself in the new year.

That doesn’t mean all cryptos are going to zero (though some clearly are). Further, Polkadot has its place in the broader blockchain discussion. But that’s not going to exempt it from red ink in the near term. After all, Polkadot’s negative trading has demonstrated that economic principles trump parachains and sharding.

On the date of publication, Josh Enomoto held long positions in ETH and BTC. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare.