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EP45 The Economics of Betting on NFT | Polygon (MATIC) NFT Infrastructure
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TLDR below. This is not financial advice.
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Up to now, when the bottlenecks of the Ethereum network have not been able to be fully resolved, Layer 2 solutions have stepped in, revealing their remarkable advantages.
Formerly Matic Network, Polygon has great ambitions to deploy all layer 2 solutions for themselves, to be an all-in-one solution platform for both users and developers.
What is Polygon? What is $MATIC?
The token is $MATIC and Polygon used to be MATIC about three years ago. There are three groups of developers who had this idea of creating layer 2 just for the Ethereum layer. They called it MATIC. They've been working for some time and today it is live! Now it has changed to Polygon.
Layer 1 is the base layer which is things like Bitcoin, Ethereum, Polkadot, etc. This is the core underlying fundamental layer that allows all these different transactions to work. All the transactions that are taking place go into this big database that is layer 1.
Layer 2 is the smaller database that exists on top of the layer 1 database for faster and cheaper transactions. As you know, the transactions on layer 1 are very expensive because it is more secure. So, if there is going to be a lot more art going around or a lot more NFTs being created, we do not want to be paying so much money all the time. This is where layer 2 comes in because we have faster and cheaper transactions in layer 2 which is the perfect use case for NFTs.
How does Polygon work?
Polygon works in four composable layers:
The Ethereum Layer
I call this the OG layer or the original layer. This is where the core basic or the fundamental architecture involving different transactions is recorded which is like a huge core database.
This is where finality, staking, disputes, messaging and all these different crypto-related verifications happen. This is very secure but because it's so secure you sometimes have to make a trade-off in terms of scalability.
The Security Layer
This layer exists above the Ethereum layer and runs parallel to it. It is like a synthetic world, or the Sims world. You exist in real life but in your Sims computer game you have this person that is living a similar life with you although in a different kind of house.
It's the same idea where you have all these transactions happening on the Ethereum layer and on the security layer they run parallel with each other. You can share the different kinds of validation in the Ethereum layer and the security layer.
The Polygon Network Layer
In the Polygon network layer we look at transaction collateral, consensus, ordering and data. This is basically where layer 2 exists and where you can have your own consensus in your various applications.
Let's say I'm going to create a $LISA token and a LISA network. Ethereum uses proof of work now and are in the process of changing to proof of stake. But I don't want to use any of that because in my LISA ecosystem I want to use delegated proof of stake which is a different consensus mechanism. I still like a lot of things that the Ethereum layer does, but that consensus mechanism is not related to what I want.
I can still tap into the layer because all this is based on the Eethereum layer, but I can create my own sub blockchain ecosystem using the Polygon network. Polygon allows me to create my own consensus and to create my own structuring of economics.
This Polygon network layer is where ZK roll-ups, optimistic roll-ups and all these different types of layer 2 scaling solutions can be added. Thus, the Polygon network layer allows you to create your own logic for your own blockchain and it's a lot faster and cheaper.
The Execution layer
The Polygon network layer is where I create my own logic and consensus. But the real value add is in the execution, because I can code a lot of different economic logics into smart contracts and then they can be executed. The Polygon network layer allows you to build an execution environment to execute your ideas so it is basically a smart contract application layer.
Polygon and NFT
Problem with NFT
There are two main problems that boil down to the same core problem of high transaction fees. You can look at transaction fees in two ways:
Minting: When you're minting you have to pay a lot in transaction fees as a minter. As an artist, creating your art and putting it on the market for sale is very expensive, because to create it you need to pay transaction fees.
Buying: When I want to buy from an artist I'm willing to pay the artist for sure but I'm also paying a lot in transaction fees to buy that art. One of the reasons why all these NFTs are so expensive is because the cost of minting is added into the cost of the NFT itself. This is not really fair because some NFTs are really beautiful and we want more people to have access to them. The basic idea of crypto and blockchain and DeFi or decentralizing is to make things accessible to people, but having this barrier to entry where it is so expensive to even get started with buying one small art piece is not exactly what the philosophy of bitcoin or blockchain or decentralized ecosystems is all about.
The core argument is that we want to make minting cheaper because minting is part of the cost price for the artist in creating these art pieces. If you reduce the minting cost or if you reduce the minting fees, then the cost price to create or produce these art pieces will be less. The art pieces will be slightly cheaper and therefore more accessible for people to buy.
The Ethereum layer and the security layer are kind of expensive and it takes time to validate. This process is expensive because it is all about security, finality and validation. Can we do something on top of this secure stuff but allow things to be a bit cheaper using Polygon?
The project started about three years ago and right now 70% of the tokens are in circulation and the inflation rate is about 14.2%. The full circulating supply will end in 2022 so a lot of these rewards will be given to the validators and stakers. What we have seen so far in a few of the other tokens is that they represent some form of structured products - you buy these tokens to get exposure to some underlying asset.
On the other hand, with NFTs, the tokens represent the asset itself and then you have these tokens in the infrastructure layer. The transactions are validated by miners in the polygon network — the Polygon Network Layer.
The inflation rate of 14.2% is actually quite high but at the same time there are so many different kinds of projects and protocols being built on the Polygon layer you will need more validators because there will be more transactions going on and so this high demand ties in very nicely with the inflation supply or inflation rate of 14.2%.
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Polygon demand is growing due to a shortage in Layer 1 infrastructure. The solutions offered by Polygon are perfectly suited to the current market needs.
In terms of design mechanism, Polygon focuses entirely on network activities. Voting incentives are undertaken by the core team. $MATIC holders have voted only for selecting Block Producers. In terms of token mechanism, $MATIC has major benefits from the point of view of transaction verification. Providing evidence of fraud is also rewarded.
In the future, Polygon will do well until Layer 1 has a better, cheaper way for users to improve performance. For example, when Ethereum's Sharding launches, that network will operate more efficiently and cheaply, so the demand from Polygon will decrease. However, Polygon is developing solutions that Layer 1s themselves take a lot of time to develop. This is the potential that Polygon will be able to achieve in the future.
Ps: Order the textbook "Economics and Math of Token Engineering and DeFi" today!