Crowdloan

November 21, 2023 - Around 2 mins mins to read

Understanding Crowdloans in the Crypto World

In the realm of cryptocurrency, numerous projects rely on Initial Coin Offering (ICO) as their main funding method in the early stages. However, ICOs do not guarantee success, as investors make decisions based on factors like the team’s credibility, whitepaper, and community support. To address this concern, Polkadot has introduced a solution called crowdloans.

Crowdloans play a crucial role in Polkadot’s substrate framework and facilitate the development of parachains. These parachains generate $DOT and compete in parachain auctions to secure a spot. Before the auction, there is a specific timeline dedicated to the crowdloan phase. During this phase, teams can borrow $DOT from community members to participate in the auction. Instead of directly giving their $DOT to the team, users contribute them to the relay chain for the project.

Once the funds are gathered, the project submits a bid using the $DOT received from the crowdloan. If the project wins the parachain slot, the investors’ $DOT are locked for the duration of the parachain lease, typically ranging from six months to two years. At the end of the lease, the $DOTs are returned to the investors. It’s important to note that the team never gains possession of the investors’ $DOTs or $KSMs throughout this process.

Crowdloans have revolutionized the concept of ICOs by introducing a reward system for investors who bond tokens on behalf of the teams. The most common reward is the project’s native coin. For instance, investors can lock their $DOT in a 2-year parachain lease on behalf of Acala and earn $ACA tokens.

Projects have a strong incentive to seek crowdloans only if they can generate an economic return, as the tokens used for crowdloaning parachain auctions are never in their possession. This ensures that investors’ funds are protected while providing them with an opportunity to earn additional tokens from potential projects.

Investors can always recover their $DOTs after the parachain lease expires, regardless of the project’s outcome. This gives investors confidence to participate in any crowdloan, knowing that their primary tokens are safe and not dependent on the project’s success.

Crowdloans are an exciting addition to the blockchain sector, as they help teams secure parachain spaces while safeguarding investors’ tokens. This measure also serves as a quality screening process for teams seeking crowdloans.