Polygon makes the case for scaling solutions after ETH 2.0

Transcript

Angie Lau: To layer-2 or not layer-2? That is the question. What is Polygon, how is it helping Ethereum and does it have what it takes to remain one of the world’s most popular networks?

Welcome to Word on the Block, the series that takes a deeper dive into blockchain and the emerging technologies that shape our world at the intersection of business, politics and economy. It’s what we cover right here on Forkast.News. I’m Forkast Editor-in-Chief Angie Lau.

Well, some in crypto will say Bitcoin is the most important innovation in modern history. On the other side of the coin, you can also hear the case of the original smart contract blockchain, Ethereum. Ethereum has brought decentralized finance, NFTs, metaverses and so many other imaginations into reality.

But not even the mighty Ethereum can build a whole world on its own. Good thing it has some friends.

Projects from all around the world are gathering to scale Ethereum. But as stated by Vitalik Buterin’s scalability trilemma, scaling must come at a sacrifice.

And today, we learn more about this world. We’re joined by the co-founder and COO of Ethereum scaling solution and aggregator Polygon, one of the fastest-growing layer-2 platforms to date, Sandeep Nailwal. 

Sandeep, welcome to the show.

Sandeep Nailwal: Thanks for having me here, Angie. We’re excited for this talk.

Lau: It is great to have you. Now, where are you talking to us from?

Nailwal: I’m currently in Dubai, UAE.

Lau: You guys came out of nowhere, really took the blockchain industry by storm and it really seemed like it was an overnight sensation. But I know that it took years of hard work. Tell us about those early days when you were building Polygon, a few hundred hackathons, probably a lot more nos than that. And how did it all happen?

Nailwal: Lionel Messi had said that it took me 10 years to become an overnight success. With Polygon also, it has been the same story. We have been around since the end of 2017, and we have been building heads down for quite some time.

Just take a step back. If you go back to 2017 and even now — only now the Ethereum ecosystem, the products have kind of started rolling out. But ’till 2018 also or even 2019, many of the projects in the blockchain space, which used to raise tens of millions of dollars in funding, they actually were more of research, white papers done by some sort of scientist and all that. Nobody really had a focus on delivering and building [what] really can be used. Like it was more of, oh yeah, we are building this consensus, that consensus. This will be better finality, better this, better that.

But then they were not focused on building a product [that] actually gets used. That has been our thesis. Our thesis did not start from that we want to build this kind of blockchain. Our thesis started from: “How can we build a blockchain for structure which can bring hundreds and hundreds of applications, even thousands of applications building on top of it and millions of users using it?”

That’s where our journey started. Even right from the start, the solution design or the product that we wanted to build was basically based on not only building this layer-2 for payments only — which everyone was doing at that point in time, and many had raised like tens of millions of dollars on white papers — but we were looking to build and deliver something which is actually useful for the developer. So we started building that. “Let’s not only do payments on layer-2, but build smart contracts on layer 2, because that’s actual scalability.” 

Again, taking a side step on that, why exactly smart contracts [are] on layer-2. If you see blockchains, Bitcoin is the first blockchain. But if you see from the angle of business logic, Bitcoin blockchain executes one business logic or maybe a couple or two or three more, but primarily the logic is currency. I pay you US$50. My balance equals to my balance minus 50 and your balance equals to your balance plus 50 — in a very rough sense. This is one kind of business logic. What Ethereum came and brought to this world is that: “How about I create a general business logic execution layer, which is decentralized, like Bitcoin, uncontrollable, whatever, they are not dictated by one single party?” And then you can do it. We all know that Ethereum is very decentralized, secure but has scalability issues.

So what Polygon started to do is that we wanted to provide this entire Ethereum development capability on this layer-2, basically. So that’s where we started. And we also were very much focused on building something that gets used and all that. There were a lot of nuances in between. Like it took us a lot of time. We were not from Silicon Valley. We did not have like fancy big [venture capitalists] supporting us.

That actually worked in our favor. Because the blockchains that are built by or supported by VCs, they actually go from top-down. They will talk to top projects, top applications and convince them to build on them. And then they will start from here. But we do not have that choice. We had to go from the very bottom layer of the developers, individual developers, developers who are working on hackathons, developers, which are two-people-deep teams, not only from the U.S., I mean all across the world, especially on the Southeast Asia side and all that, and help them to build, and we converted it into like some sort of opportunity in adversity As a saying goes, that we actually started working with these people, these people provided a lot of feedback, a lot of tooling-related comments, which we realized that, “developers need this, okay, let’s build this, let’s build this, let’s build this.” Slowly and steadily, after like one-and-a-half years of alpha mainnet and beta mainnet that we launched that mainnet. Even on mainnet, we did like three to six months of iterations of this tooling and all that.

And then, like a little bit of luck that by that time, Ethereum was seeing a second or third wave of these high gas prices. The first time it happened and then it dipped, people were like, “Okay, it was a one-time phenomenon.” But then it happened the  second time, the third time, and people realized something needs to be done. By that time, because of this bottom-up approach, we were fully production-ready. And if you ask me what is the reason for Polygon’s success, because we are production-ready. We are getting more and more production-ready for building applications today, all the major wallets in the industry are supporting Polygon. All the infrastructure providers, middleware providers are supporting Polygon. Exchanges have integrated into Polygon. Now, if you, as a developer, want to really build an application, Polygon is by far the obvious choice to build on.

Lau: You were production-ready, and it perfectly coincided with the issues that Ethereum was facing in DeFi, and all of these dApps coming and trying to build in DeFi. And what ended up happening was, as you noted and as we’ve been noting here at Forkast, that gas fees were just getting to astronomical levels. It just became so enormously expensive and there were lags in the system.

So for developers, this was a problem. For dApps, this was a problem. Because you were able to have production ready. You already had projects working with Polygon that was production-ready. And all of a sudden you’re in this beautiful eye of the storm and you had the right answers.

When did you start realizing that, “Wow, we’re really onto something here and it’s coming and this is real, this is really happening. I’m going to pinch myself. Is this really happening? It’s really happening.” At what moment did you realize that?

Nailwal: I would not say that that happened in that sense, because even when we had not exploded, we still had 100-plus applications. We had a hunch. We, in fact, had this reverse feeling: “Why is this not happening to us? This should happen. This should happen three months back. Why is this not happening?” It’s like exactly what you said: “Pinch me. Is it not happening? Why?” And we realized that the reason is because we are not from Silicon Valley and then the Western audience did not take us that seriously also, to be honest. 

For a long time, like six months or so, it was a big meme on crypto Twitter that people are just sleeping on Polygon. Like every other day, some big application is launching Polygon, and people were dead silent. Nobody talking about it, no media talks about Polygon, whatever.

It’s not like it happened automatically. We then took a big shot. We did all of the things that we could have done, but it was not working. Then we were already talking to many applications when we said that we have to go all-in now. And we went to AAVE, we put a big stake on the table. We said: “Okay, if you guys build here, we will provide liquidity mining incentives to your users and whatnot, and let’s see how it goes.” And then AAVE agreed: “Okay. If you are bringing this much skin in the game on the table as a community, we are happy to explore.”

And the moment they came, that was kind of the basic money legos seeing their success. There was already some level of community on Polygon. Our community was already pretty big. They were just waiting for something like this. Then, people really started experiencing it — really took off to the next level. So I would say that it happened in the reverse, actually. We were just crying, “Why is it not happening?”

Lau: You are pinching yourself, like, “What’s going on?” But it’s here, it’s happened and MATIC is the token that is internally driving your ecosystem. Why is that integral? Now you have MATIC and now you have that on top of ETH. How is that part of the strategy?

Nailwal: So basically MATIC is a proof-of-stake token. We are a transaction-based platform. Ethereum is more of a settlement layer where ETH itself has a monetary value, whereas Polygon token is more of a transaction, proof-of-stake token, which is expected to grow in value when more and more transactions are out there.

That’s why we want to build the execution layer where this business logic executes. It settles. The final settlements can happen on Ethereum, but the smaller level transactions, think of it like you swiping your card in a mall and all that, then the mall’s internal system is consolidating all the kinds of internal transactions and then settling it on the larger banking network.

So our thesis is that Ethereum is going to remain because the kind of network effects that the team has is just too big and Ethereum is going to be that settlement layer. And then, solutions like Polygon are going to be those kinds of constellations — or you can call them as subnets — where these executions will take place and only when they need to come out to the mainstream global internet, which would be Ethereum in this case. Those transactions will come and settle into Ethereum with some proof that something like this already happened. So that is the long-term thesis. 

MATIC token is basically the proof-of-stake token, which means that people stake that token to become validators on these networks. Validators means miners on this network. So you stake tokens and you become a miner.

And if this solution on which you are mining, if the revenue on that chain goes bigger and bigger, you get to make more and more money on the money stake. And then as the transaction revenue on that chain grows bigger and bigger, more people want to join this network and stake that network and mine that network. So it automatically keeps growing the value of the whole keeps happening to MATIC.

Why that token is important is to provide that network security. All these proof-of-stake systems basically are very simple. There’s only one concept, that you have to put something at stake and then you can do some work. If you do some wrong work, your stake can be fortified or slashed. That’s the simple concept of proof-of-stake. In proof-of-work what happens is that when you do some work, if you do wrong work, your block production is simply discarded and you lose out on the electricity that you spend to mine the block. In proof-of-stake, you don’t spend anything. Too much computation — that’s the second stage of this. That’s why you say that proof-of-stake is [more] environment-friendly and all that, that it consumes less energy. You put the stake, the computation is not that costly. You just compute. And if you compute wrongly, then you are slashed. So MATIC token is for that only. Basically, all of these constellations, like Polygon is a multichain network, all of these multiple chains which will be connecting back to Ethereum will be run using proof-of-stake token, which is MATIC token. 

MATIC token is basically, as I was saying, a proof-of-stake token, which you as a validator would want to stake in the network and then derive your transaction fees with that. And that’s the use of any proof-of-stake token and MATIC network is like that. The good thing about MATIC token is that since it’s a multi-chain ecosystem, in no other proof-of-stake system, as a validator, you get a chance to be validating and earning transaction fees from multiple networks. 

Here, that’s why we feel that eventually the validator ecosystem will be very big for this network. Because, you, being a staker, are able to run various different kinds of networks and be able to participate in earning transaction fees on various different kinds of networks. And this is also a good exercise for people who understand how the valuations of the networks are derived. I can give a very simple business model. Think of it like how much transaction fees a particular token or the transaction is or the network is generating. And generally, let’s say a particular network is generating US$100 million in transaction fees. And let’s assume that 5% is an acceptable market return in the condition. So to earn US$100 million of fees, you would basically be ready to stake somewhere around US$2 billion for it to be 5% of your return on the capital. So US$2 billion will be staked in the network. And then generally a proof-of-stake network has 50% of them on stake. So 50% of its total supply is at stake.

So this network will basically be worth US$4 billion — 50% of it is staked, that means US$2 billion is staked, and then US$100 million of gas is being produced in the network or fees produced in the network. These US$2 billion worth of stakers make 5% a year. I’m talking about US$100 million per year in terms of the transaction fees. And it’s easier to rate and gauge the valuation of proof-of-stake networks. Plus, you can add premium, whatever, in the stock market, to people. And so that’s how in future you will be valuing proof-of-stake networks.

Lau: And because it’s multi-chain, you actually have many, many networks that are actually fueling the ultimate value. I guess this is why all of a sudden Silicon Valley and all the VCs are perking up and paying attention.

Nailwal: Hopefully so, yes.

Lau: We’re talking as well now that Ethereum London hard fork is live. And Polygon really took advantage of the time when gas fees were high, when the system was a little laggy and really created that kind of increased, frictionless and seamless and cheaper, frankly, way to transact on Ethereum. And now with Ethereum London hard fork, doesn’t that undermine what you’ve built?

Nailwal: No. So first of all, I think there’s confusion. London fork is not ETH 2.0. ETH 2.0 is still at least two to three, perhaps some people say five years away from here. London fork is basically an activation of one important gas calculation way. The way gas markets work on the Ethereum. London hard fork basically introduces EIP-1559, which essentially has a new mechanic. Previously we had a simple gas auction market. Whoever pays the highest gas, he gets his transactions to include. But now, because people then start paying higher and higher and nobody really knows how much minimum I should pay, they created this new mechanism, which is very complicated to get into. But basically now you have a base fees mechanism and on top of that, you can pay some small tip. But you get to know [that] this is the base fees. Then they burn those base fees. Due to that, overall, there’s a lot of enthusiasm in the Ethereum community and all that.

But coming back to Ethereum 2.0 scenario. Even if let’s say Ethereum 2.0 is live, in an optimistic case, let’s say in two, two-and-a-half years from now. Even then, basically, Ethereum 2.0 is [when] you are going to have 64 shards of Ethereum. Each shard will act as the current Ethereum chain, or maybe a little bit more optimized. So the current Ethereum chain has roughly 13 transactions per second. Let’s assume that it becomes 30 transactions blockchain, like it grows double and each chain with proof-of-stake becomes 30 transactions per second. Sixty-four shards will still make it like 1,800 transactions per second. And now with Ethereum 2.0, the expectation of Ethereum is the global settlement layer or the global computer. Visa, for example, has 50,000 transactions per second alone, which is only processing Visa transactions. Here on Ethereum, you are expecting that there will be games, there will be financial markets, there will be exchanges. Everybody will be executing on this with 1,800 transactions per second? No, right?

So the point I’m trying to make here is, that even when Ethereum’s scalability grows by a factor of a hundred — which has to be seen, even in the short run, like two, three years —  the demand is already thousands of X than that. And you would need these secondary level scalability solutions — or subnets, if you will — where people would be running their business logic, their applications, and they will be settling back to Ethereum. 

For example, Reddit is choosing some layer-2 solutions right now. The layer-2 solution that Reddit is choosing, Reddit alone can consume daily hundreds of TPS alone, like if an application like Reddit goes big on Ethereum engine. So that’s why Reddit has chosen a layer-2. That’s why you will always need these secondary layers or subnets on top of Ethereum where applications will run. 

Lau: So let’s pull out for more general audience here, investors and more from the traditional space. Obviously, the valuation of Polygon is super-interesting. This entire world and the opportunity of layer-2 and the interoperability — as you say — the smart contract, the smart computing that changes the business logic is another. Where do you see this space in the next 12 to 24 months? And why is this space super-important to pay attention to? And I think you flagged some of them, which is, first it was DeFi, then it was NFTs. Now it’s metaverses. And who knows what’s next in all of it. Where do you see it’s going?

Nailwal: We have so many product market fits. NFT itself is such a big use case. Gaming, for example, on Netflix, there is a documentary that the gaming industry in total is, like, so big that it is actually the entire Hollywood industry, entire [National Football League], entire [National Basketball Association] combined. And then multiple such industries combined, the gaming industry is bigger than that. If you see the upcoming generation, gaming is so big, they spend so much of their time of their lives in gaming and these metaverses. I talk to my cousins who are like, let’s say 10 years younger than me. They’re more confident about their pseudo-identity that they have like “Anex” and “ADX” or different kinds of names. So these people are going to be blockchain-native. 

And 12 to 24 months, it’s still a very early time. But I feel that in 24 months, a very big supercycle is going to come, which is enterprises. I think Paul Brody and Ernst & Young have done really great jobs at educating the enterprise community that private blockchains are misnomers. It’s like saying a dead alive man — it doesn’t exist. And as an enterprise, you really need to derive some value out of these blockchain solutions, it has to be on a public blockchain.

Now, you need privacy. You need scalability. Yes, we all are building on it. So I feel in 18 to 24 months, there will be fewer enterprises which will have actual value generating use cases on these blockchains. And most of them then would probably be funded by or kind of being run on some sort of zero-knowledge technology. That’s why we at Polygon also, we have invested so much of our time, energy and resources in the last six months in the zero-knowledge space, and then now we are in a stage where in two to three months you will see Polygon will emerge as the powerhouse of zero-knowledge in the whole industry, because we have accumulated so much of themes, acquisitions and whatnot, that now we will come out with our stuff.

Remember what I said, that we spend a lot of time in building and all that. And when we are ready, then only we come out to a certain extent, then only we come out public. So zero-knowledge technology, very big, and enterprise, very big. And then in the short run, NFTs, we are going to run this entire show of bringing the traditional world to blockchains.

Lau: But that speaks to also the competition. I mean, to your point, these innovations are scaling the ecosystem of Ethereum at such a fast pace. I’m curious what your take is on the various projects jumping in right now to kind of challenge you guys at Polygon to scale Ethereum. Do you think that more options are better for the ecosystem or do you think it’s creating yet another Wild West that we at Forkast.News are always tracking the hackers. They exploit the rug pulls. What do you think it’s going to do for the ecosystem?

Nailwal: We at Polygon are like hardcore Ethereum fans also. So for us, like any other people building Ethereum scaling technology, it’s a net positive for the ecosystem. Even we are reaching out to the teams who are building these layer-2 solutions: “If you want, Polygon ecosystem with validators and all that can run your solutions also, or a copy of your solution where people can use your solution on our chain.” Also, and there can be mechanics to do that. So on Ethereum side, we are very much confident and happy if more people are adding value to Ethereum. 

The other thing I think you might also be alluding to is that Ethereum competitors, like some of the applications trying to build Ethereum-competing solutions are on there. And I think all of them are very, very early stage. And all of them actually are trying to build Ethereum implementation, like everyone is trying to build some sort of [earned value management] on their chains so that they can say that, “Hey, we are also close to Ethereum.” Because the fact of the matter is 95% to 99% of all the developers in the space are Ethereum developers. When you say somebody calling themselves a blockchain developer, it is most likely when you dig down, he’s more of an Ethereum developer.

So it is, like, that huge the dominance of Ethereum. Even now, like, even though a lot of other chains are throwing so much money on these different kinds of solutions, although it’s a strong statement, I have not met many self-respecting teams who want to build on these chains. Like, self-respecting team means some team which actually genuinely wants to build a product and genuinely wants to acquire users and build a business model. I’m not talking about the team who just want to do some sort of token and then they are taking some grant and doing a token, and then the token does its own financial market cycle and people make money and all that. Those applications I see, but good applications, I see very, very few. I could probably count on my fingers that who are building on those.

Lau: I think increasingly the knowledge in the spaces is expanding, and that credibility is being built by where people are migrating, where people choose to create their dApps and to develop, which speaks to Polygon. This is why it really seemed like an overnight sensation that took a decade, because all of a sudden there were so many projects that seemed to be launching on Polygon.

I’m curious, and just to even pull out a little bigger outside of what you’re building, you’re building something that is integral in blockchain. And yet, you come from a country in India that is so uber-talented, that has talent like you. And yet, we had the Reserve Bank of India ban crypto firms and blockchain firms from banking. And now, we also have policy that is waiting in the wings that policymakers and lawmakers are still debating about. And there’s a lot of concern about India and where it’s going. Where do you see it? 

Nailwal: I think most of that is media sensationalism, actually. I’m from India and generally, I would say 95% of any team that is building out of India either know me or I know them and I know what they are doing to reach out to me for the investments and all that. And I’ve not found even a single team which is trying to build some technology-related solution being haggled by the government. Nobody has been touched upon by the government.

The government is only trying to curb or kind of trying to figure out how to stop this, speculation or kind of gambling, which nobody can deny that a lot of retail loses their money in this. And then know when people see this 100%, 200%, 300% returns, a lot of retail ends up doing activities like, putting their student loans or the house and mortgage and try to do that. So the government is trying to do that.

Plus, it also definitely promotes a lot of black markets, which India has a history of. Like, some people say that we have a US$5 trillion economy. I mean, now like maybe a US$3 or US$4 trillion dollar economy. And we have the equivalent of that in the black markets, which is in the cash and not on the books. The government has been trying to do that. The moment you introduce crypto into that, boom. All 10 years of hard work and that building technology and all that, everything goes for the south. So they are trying to protect that, although they will have to realize soon that this is like the genie out of the box. You can’t do anything about it. You have to join them.

Lau: Yeah, I get it. But where is that fine line where you don’t come down too hard? Certainly, we’re talking black and white. That’s what people hear, there’s a lot of gray space. But where is that fine line? Because potentially MATIC could be banned. I think it’s going to be so expansive. And how are you going to get that value out?

Nailwal: First of all, for MATIC network, for example, although the research center initially was in India, but then we never really had any crypto binding into that. Our company, token company, everything was out of India. And secondly, we were not doing any business. It’s like a technology company doing some research in India. It’s not like the real business being done there.

And then we as co-founders, like now we have a co-founder from Europe, all of us three co-founders are out of India, in various locations. We have our teams in Europe, in U.S. now, we have a big team and, like various other parts of the world. So Polygon or MATIC Network is very, very decentralized in that sense. Like nobody can really force anyone to do anything on that.

But on the other side, also, on regulations side. I definitely feel that government will come with a stronger regulation, which will make it harder for people to trade and all that. But then they also know that this is going to be a big market. So they are not touching the technology aspect of it. Like we do hundreds and hundreds of hackathons. We have never faced any problems in India. And those are like proper blockchain hackathons. So I don’t see that there is any problem with that.

One more thing. Polygon, for example, is a multi-chain environment. Generally, any other solution you see, they have one particular kind of chain. So because of that multi-chain environment, the government of India, for example, in the state of Maharashtra — which I think will have almost one-third of the population of U.S., I mean, almost 100 million people — all of their [reverse transcription polymerase chain reaction] tests [for Covid-19] are checked on blockchain, on Polygon. So they have built an application which uses, if you move from one place to another, somebody has done a PCR test, they put it on blockchain. And it’s being used on Polygon blockchain.

And since we are a multi-chain ecosystem, we actually see a different kind of structure. We feel that we are still not in those stages, but sooner or later we will reach the stage where we will be working with the Indian government and helping them to build out some of these blockchain infrastructure. So on the technology front, I’m not worried at all. On trading front, definitely, there will be some more stronger regulation. I don’t expect an outright ban at all. From where I see.

Lau: But even your personal choice of living outside India — and I promise your family did not put me up to asking you this question — is indicative of what would happen if India was a little bit more receptive and more crypto-friendly and this kind of impasse was resolved, do you think you’d ever go back? And do you think that potentially, the environment, the ecosystem, the brain trust in India could thrive in India instead of having to leave it?

Nailwal: Yeah. This fact, I completely agree. Soon, the Indian government has to realize that the brain drain in the blockchain space is so big because you are not building for your local users. So you’re not delivering food to the houses. You are actually building for the globe. You’re not bound with anything local. It’s so easy for entrepreneurs to simply take a flight and go out of India. Brain drain is going to be very big.

You use the right word, this impasse, or kind of this uncertainty around it. Like, for example, I would never want to live out of India. I want to go back to India, work from there to the ecosystem there. But then due to this uncertainty, and I’m not saying there’s anything positive or negative, this uncertainty, nobody knows. Polygon is now so big, like a top 20 project worldwide, we can’t take any kind of chances as responsible co-founders into it.

So even though now, we don’t control any part of the network, we only do some research side of things, but then it can be perceived very negatively. That’s why we decided that, “Okay, we’ll decentralize ourselves. We’ll be outside. Our teams are pretty global and all that. But you are very right. If Indian government provided the clarity and we could do it all in India, I’m not sure, like maybe a larger amount of our workforce now, which will be like only 40% Indian, it could remain like even more like 70%, 80% percent Indian — which India is losing on those jobs.

Lau: Well, maybe welcome back those prodigal sons and daughters to India one day. Sandeep, thank you so much for joining us. Deep-diving into Polygon into this incredible world, and the secret to your success being production-ready at a time when the ecosystem needed it most. You were a product market fit and you were a solution to a problem. Sandeep, thank you so much for joining us. That’s Sandeep Nailwal from Polygon.

Nailwal: And we keep coming back so I mean, we had one success. Two, three kinds of levels of success previously. But now the next stage for us is the zero-knowledge. So hopefully that will move on.

Lau: We’re going to welcome you back to the show and talk about zero-knowledge proof that is 100%. You’re welcome back any time.

Nailwal: Thank you so much.

Lau: Sandeep, it was great having you. And thank you everyone for coming to spend some time with us on Word on the Block. It was great to have you here. I’m Editor-in-Chief Angie Lau. Until the next time.

Nailwal: Thank you.