Is Solana’s inflation rate high? | Featured Report

Original title: "Is Solana's Inflation Too High?"
Original author: Lostin
Original translation: zhouzhou, BlockBeats

Editor's note: Solana's inflation issue has sparked widespread discussion in recent years. Currently, the inflation rate of the Solana network is about 5.07%, and the network staking rate has reached 65%. In the inflation model, users obtain rewards by validating nodes, and the circulation of tokens gradually decreases over time. Although Solana's staking return rate is attractive, there is still uncertainty about the long-term impact of its inflation on token prices. Future adjustments to the inflation plan may further affect the sustainability and economic model of the network by reducing issuance or changing the inflation mechanism.

Below is the original translation:

Sincere thanks to 0xIchigo and Michael from Laine | Stakewiz for reviewing earlier versions of this article, and Zantetsu from Shinobi Systems for providing some data.

Operational Methodology:

All SOL tokens come from two places: the genesis block or protocol inflation (also known as staking rewards). In contrast, transaction fee burns are the only protocol mechanism that can remove SOL tokens from circulation.

Token issuance is described by the three key parameters of the inflation schedule: the initial inflation rate (8%), the deflation rate (-15%), and the long-term inflation rate (1.5%). Inflation on the Solana mainnet officially started on February 10, 2021 at epoch 150. The current inflation rate is 5.07%.

Proof of Stake inflation causes non-stakers to have a smaller share of the network relative to stakers, and this dilution effect actually transfers wealth from non-stakers to stakers.

Solana’s staking rate is 65%, which is relatively high compared to other networks in the industry. The total staked amount is currently 380 million SOL, and this amount has remained relatively stable since epoch 202 in July 2021. In most epochs, seven-digit amounts of SOL are staked and unstaked.

The key variables when calculating staking yield are the inflation rate and the percentage of SOL staked. Nominal Staking Yield (NSY) can be calculated using the following formula: NSY = Inflation Rate * Validator Uptime * (1 - Validator Commission) * (1 / SOL Stake Percentage).

On December 14, 2023, total fees burned as a percentage of staking rewards exceeded 1% for the first time, and peaked at 7.8% in March. Over the last 100 epochs, fee burns have averaged 3.2% of total staking rewards. After the implementation of SIMD-96, deflationary pressure from burning tokens will become negligible.

In many jurisdictions around the world, receiving inflation rewards in the form of additional tokens is considered a taxable event, which can lead to selling pressure due to tax obligations. This impact is difficult to quantify.

Proof-of-Stake (PoS) inflation has led to long-term and persistent downward price pressure, distorting market price signals and hindering fair price comparisons.

Long-tail independent validators and ecosystem team validators tend to exhibit lower staking reward commission rates and rely less on inflation commissions than other validator groups, including exchanges and institutional validators.

Since December 2023, alternative sources of income for validators, including MEV commissions and block rewards, have increased significantly. This growth provides a potential way for a sustainable validator group in the future to reduce its reliance on inflationary commissions for operating expenses. However, it remains to be seen whether these alternative sources of income can remain high in the long term.

Introduction

This report provides a comprehensive analysis based on data and facts, aiming to clarify the doubts (FUD) and misinformation surrounding Solana's inflation plan. The analysis is divided into three parts: past, present, and future.

Past:A review of Solana's token economics before inflation, detailing key events including token sales, unlocks, and early token burns.

Present:A quantitative assessment of the current inflation plan and de-inflation factors, including transaction fee burns, penalty slashing, user-related losses, and rents. The possible impact of the upcoming SIMD-96 protocol update is also discussed.

Future:Arguments for and against Solana’s current Proof-of-Stake (PoS) inflation rate are explored, and potential adjustments to the existing inflation schedule are considered.

Important Definitions

First, we will formally define several important terms that will be used throughout this report. Readers who are already familiar with these Solana-specific definitions can skip this section.

Total Current Supply: The total amount of SOL tokens that currently exist, including locked and unlocked tokens. More technically, the Total Current Supply is the total amount of tokens generated minus the total amount of tokens destroyed. At the time of writing, the current Total Supply is 583 million.

Circulating Supply: The total amount of SOL tokens circulating on exchanges, on-chain protocols, and user wallets, including staked and unstaked SOL. The Circulating Supply is 466 million. More formally: Circulating Supply = Current Total Supply - Non-Circulating Supply Non-Circulating Supply: Non-Circulating Supply mainly consists of two forms: SOL tokens locked in staking accounts, and SOL tokens in unlocked staking accounts held by Solana Labs or Solana Foundation. SOL in staking accounts is usually due to SOL investments or grants from the Solana Foundation. Each staking account has an unlocking date set according to the vesting arrangement. Second, there are SOL tokens directly owned by Solana Labs or the Solana Foundation, which are held in an unlocked staking account. The Foundation currently uses a large portion of this (currently 51 million SOL) for its delegation program. At the time of writing, the non-circulating supply is 117 million.

Locked Tokens: Locked Tokens are those tokens held in staking accounts that have conditions set so that they cannot be withdrawn before a predetermined date. These locking parameters are based on a specific UNIX timestamp, or epoch, and are set by the designated custodian when the account is created. Locked staking accounts can be undelegated, split into smaller accounts, and re-delegated to other validators. However, these tokens cannot be withdrawn or transferred to other addresses until the lock period expires. While any user can create a locked staking account, this practice is primarily used by the Solana Foundation to distribute tokens and grants, and these allocations often come with specific performance requirements or time locks.

The Past: Pre-Inflation and Early Token Economics

On March 16, 2020, 500 million SOL tokens were minted in the Genesis Block of the Solana Mainnet Beta Cluster. During its first year of operation, Solana had no inflationary staking rewards. On March 24, 2020, 8 million SOL tokens were sold to non-US buyers via a Dutch Auction on CoinList. The auction raised only $1.76 million, with a final liquidation price of $0.22 per token. Tokens from this public auction, plus a smaller tokens distributed through a series of airdrops on Binance, make up Solana’s initial circulating supply.

Solana Genesis Block Allocation Chart, extracted from the original Public Auction Buyer Profile

Solana has faced significant challenges raising capital during this period compared to many of its peers in the industry. For example, Algorand successfully raised $60 million six months ago through a similar CoinList auction, while Hedera Hashgraph raised $100 million eighteen months ago from institutional and high net worth individual investors.

“We tried to raise more bridge funding before we launched in 2020, but it wasn’t successful. We had to lay off a third of the team to extend our funding. We launched as quickly as possible in March, and the pressure was very high... We announced the auction, and two days later, on March 16, 2020, all markets collapsed. The world was in chaos, and we only had six or seven months of funding left.”

This period of low funding shaped many important early decisions.

“It forced me to adopt a specific strategy, which in hindsight was the right one... If we had as much funding as our competitors, I probably would have followed their lead and supported the EVM; we had to support the EVM... It turned out that the best decision we could have made was to build a runtime that was purely optimized for performance.”

Pre-auction Private SAFT Sale (

Solana's unlocking plan

In May 2020, in response to early community concerns about lending tokens to market makers, the Solana Foundation permanently removed its holdings of 11.365 million SOL, reducing the total supply to 11.36 million SOL. 488.64 million.

Currently: Solana’s Inflation Plan

According to community voting, Solana Mainnet Beta’s inflation officially launched on February 10, 2021, at slot 64800004 (epoch 150), with the first payment of 213,841 SOL.

The inflation schedule is a deterministic description of the token issuance schedule, which includes three key parameters:

Initial Inflation Rate (8%): The starting inflation rate when inflation first starts

De-Inflation Rate (-15%): The rate at which inflation is reduced each epoch year

Long-Term Inflation Rate (1.5%): The stable long-term expected inflation rate

At the time of writing, Solana’s inflation rate is 5.07%. This can be viewed using the command “solana inflation” in Solana’s CLI Tool Suite or the RPC method “getInflationRate”.

Solana’s inflation schedule (source)

An epoch year consists of 182.5 epochs, which is the number of epochs contained in a year if each epoch lasts exactly two days. An epoch has 432,000 slots, and the minimum time per slot should be 400 milliseconds. However, because block times are variable, epochs can often extend beyond this two-day minimum by several hours (e.g., the most recent epoch 661 was 2 days and 4 hours). In earlier years, Solana’s mainnet cluster often experienced slower three-day epochs (e.g., epoch 322 was 3 days and 3 hours), which significantly extended the progress of the inflation schedule when measured in standard years.

For example, as of August 30, 2024, Solana is currently at epoch 663 as I write this. This is the 513th epoch since inflation started at epoch 150 on February 10, 2021, which is equivalent to 2.81 epoch years, but spans 3.55 standard years.

The following chart models the current total supply based on an inflation schedule starting with an initial 488.6 million SOL (500 million minus 11.3 million burns) in February 2021.

The original community forum discussion on how these specific parameters were chosen is no longer accessible. However, at the time, Solana co-founder Anatoly Yakovenko revealed some clues in an interview.

“I don’t think the inflation parameters will be much different from Cosmos because our validator set has a lot of overlap with that network, almost the same people. Also, Cosmos’ inflation schedule seems to work well, so we don’t have to experiment. When things work for other networks, we will definitely borrow those ideas.”

In addition, an early brief outline of staking rewards in the Solana GitHub repository also mentioned the impact of Casper FFG.

Inflation Distribution Mechanism

Delegated Proof of Stake (DPoS) consensus mechanism is natively integrated in Solana. Users can directly access the staking interface through wallets, ecosystem dApps, and various comparison platforms. Token holders can easily stake SOL to the validator of their choice and unstake at the end of each epoch. In addition, they can also delegate tokens to a staking pool or purchase Liquid Staking Tokens, which is actually equivalent to staking. Delegating tokens to a validator implies trust in the validator, but does not give the validator ownership or control over the tokens.

Staking rewards are first divided based on the points earned within an epoch. Each time a validator votes for a block that is subsequently confirmed and becomes final, the validator receives a point. A validator's share of total points (i.e., their points divided by the sum of all validators' points) determines the proportion of rewards they receive. This proportion is also weighted by the amount staked. If a validator has 1% of the total stake and their points are average, then the validator will receive approximately 1% of total inflation rewards. If their points are above average, the rewards will fluctuate accordingly. Voting points are a quantitative measure of an individual validator's participation and correctness in the consensus process. Validators being offline (i.e., inactive) or out of sync with the chain will significantly affect their rewards.

Inflation rewards are calculated and distributed to delegators’ staked accounts at the end of an epoch. The resource consumption of distributing over a million staked accounts is high, which slows down the network and causes frequent consensus forks at the end of an epoch.

Validators charge a percentage commission for their services as part of the delegator’s inflation reward. This commission is typically in the single digits, but can theoretically be anywhere from 0% to 100%. There are currently over 200 private Solana validators whose staked funds may be fully owned and self-delegated by the operating entity. These fully self-staking SOL validators can be identified by their 100% commission rate.

The following formula describes the notional staking yield from inflation rewards:

Notional Staking Yield = Inflation Rate * Validator Online Rate * (1 - Validator Commission) * (1 / SOL Staking Percentage)

The SOL Staking Percentage is defined as:

SOL Staking Percentage = Total SOL Stake / Current Total Supply

Staking yields will fluctuate over time as inflation, validator performance, and total active stake change over each epoch.

For a deeper dive into Solana’s staking mechanics, check out our Helius Staking Blog article.

Proof of Stake Inflation Model

Anatoly Yakovenko pointed out in the Lightspeed podcast: "The biggest criticism is that Solana's inflation rate is too high, and it is a cost to the network. From a mathematical perspective, inflation is actually transferring value between non-stakers and stakers. It is indeed a cost for non-stakers, but at the same time it is a benefit for stakers. The market will balance this out in some way."

Overall, Proof of Stake (PoS) inflation reduces the network share of non-stakers relative to stakers, and this dilution actually transfers wealth from non-stakers to stakers. This phenomenon can be demonstrated with a simplified model with the following parameters:

Total token supply: 10,000

Market capitalization: $1 million

Annual inflation reward: 5%

Initial token holders: 6 users, each holding the same number of tokens

Staking ratio: 66% (4 stakers, 2 non-stakers)

This model shows how as inflation occurs, stakers’ tokens increase in relative terms, while non-stakers’ shares are diluted, resulting in a redistribution of wealth.

Initially, each user holds 1,667 SOL tokens, representing 16.7% of the network share and a market capitalization of $166,666. Over the course of a year, 500 new tokens will be distributed to stakers as inflation rewards. After a year, the four stakers will each own 1,792 SOL tokens, a nominal increase of 125 tokens (7.5%), and their network share has grown by 0.4% to 17.1%. Meanwhile, the two non-stakers have the same number of tokens and their network share has fallen by 0.8% to 15.9%. Assuming the total market value of the network remains constant at $1 million, the value of each SOL will drop from $100 to $95.23. However, the total value of each staker's network share will increase by $3,968 (a 2.4% increase). Correspondingly, the value of each non-staker's token will decrease by $7,936 (a 4.8% decrease).

This model shows how Proof of Stake (PoS) staking not only prevents dilution, but actually strengthens the network ownership of holders over time. Furthermore, this simplified scenario accurately reflects Solana’s current inflation rewards. With Solana’s current inflation rate of 5.07% and a total supply of 583M SOL, of which 378M SOL is staked (a 65% staking ratio), users can expect a similar annual value transfer through inflation rewards. Stakers gain approximately 2.4% in network ownership, while non-stakers lose approximately 4.8% of network ownership. Based on this simplified model, stakers should receive a nominal 7.5% SOL staking return per year, which is roughly in line with current actual returns. Of course, the reality is more complicated than this model, which we will explain in detail in the subsequent discussion.

It is important to note that the percentage gain or loss in network ownership is the same regardless of the absolute number of tokens held by a user. The two key variables are the inflation rate and the percentage of SOL staked.

SOL staked by epoch since genesis ( source

Solana has a relatively high stakes ratio compared to other industry networks, in part due to the ease and user-friendliness of its staking process. However, since reaching 370M SOL at epoch 202 in July 2021, the amount of SOL staked has remained relatively stable (as shown in the chart above), despite the inflation of total supply due to staking rewards.

Solana has a relatively high stakes ratio compared to other industry networks, in part due to the ease and user-friendliness of its staking process. However, since reaching 370M SOL at epoch 202 in July 2021, the amount of SOL staked has remained relatively stable (as shown in the chart above), despite the inflation of total supply due to staking rewards.

This means that Solana’s SOL staked percentage is slowly decreasing over time, which is a positive dynamic for stakers.

While the total amount of SOL staked has remained generally stable, there is significant volatility, with staked and unstaked SOL often reaching seven figures each epoch. This volatility is primarily driven by flows within the staking pools.

Weekly Staking Change ( Source)

As mentioned earlier, the current SOL staked percentage is 65%, with an inflation rate of 5.07%. Assuming the staking rate remains at two-thirds, we can plot a pre- and post-inflation adjusted chart of staking rewards, showing both nominal and inflation-adjusted returns.

Nominal and inflation-adjusted staking rewards assuming a constant 66% SOL staking rate

Disinflationary Forces

Next, we will analyze Solana’s disinflationary forces, of which we identify three types: transaction fee burning, punitive slashing, and user-related losses. In addition, we will consider the impact of Solana’s leasing mechanism on inflation. This section introduces the term “net inflation”, which is defined as follows:

Net Inflation = Gross Inflation - Gross Disinflation

Transaction Fee Burning

All charts and data in this section are based on a dataset provided by Zan of Shinobi Systems. The raw data is available in the spreadsheet (clickable). Readers are encouraged to perform their own analysis. Transaction fee burning is the only protocol mechanism that directly removes SOL and reduces the total supply. Previously, the fee burning mechanism consisted of destroying 50% of the base fee and 50% of the priority fee of all transactions in each block. The base fee (also known as the signature fee) is fixed at 5,000 lamports per signature, regardless of the complexity of the transaction - usually one signature per transaction. The priority fee is technically optional, but is becoming standard practice. These fees are priced in microlamports (millionths of a lamport) per compute unit.

Price Fee = Compute Unit Price (microlamports) x Compute Unit Limit

This structure will change with the passage of SIMD-96. According to the current release schedule, SIMD-96 will be implemented with Agave 2.0 shortly after Breakpoint in 2024. Going forward, 100% of priority fees will go to block producers, removing their incentive to make deals outside of the protocol.

Starting from Epoch 544 on December 10, 2023, there is a clear turning point in priority fees. The highest total fee burn occurred in Epoch 590 (starting on March 18, 2024), with a total of 13,212.31 SOL burned. In the last 100 epochs, the average total fee burn per epoch is 5,372.16 SOL.

Total SOL Fee Burn by Epoch (Priority + Signature Fees) before SIMD-96

Fee burns first exceeded 1% of total staking rewards in Epoch 546, which began on December 14, 2023, and peaked at 7.8% in Epoch 590, which began on March 18, 2024. Over the last 100 epochs, fee burns have averaged 3.2% of total staking rewards. However, if we simulate fee burns with the SIMD-96 rule change (removing priority fee burns), the total amount burned has never exceeded 1% of total staking rewards at any point in Solana’s history. If the changes to SIMD-96 were implemented in the last 100 epochs, total issuance would increase by 2.81% (e.g., an epoch with 5% net inflation would rise to 5.14%). Previously, validator community members estimated that this increase in total issuance could be slightly higher, at 4.6%.

Analysis of net inflation per epoch (defined as total staking rewards minus total fee burns) shows that new SOL token issuance far exceeds the impact of token burns in the protocol. Furthermore, with the implementation of SIMD-96, the already limited impact of token burns will be further reduced to almost negligible.

In the Solana forum discussion about SIMD-96, a comment by 7LayerMagik (Overclock validator) summarized the impact of SIMD-96 on inflation:

“This SIMD will make it much harder for transaction fees to create significant deflationary pressure. While transaction fee burns may currently be masked by the issuance of inflation tokens, it is still possible that fee burns will have a larger impact in the future — however, this SIMD makes them even more insignificant in that regard. Whether deflationary pressures matter is up for debate.”

One final point worth noting is that unlike inflation plans, which are formally voted on by the community, the initial decision to burn 100% of the tokens will be made by the community. The 50% priority fee is not subject to a formal governance or consensus process.

User-Related Loss

User-Related Loss is a broad term that refers to situations where SOL is permanently lost through unfortunate means such as user error, security incidents, program vulnerabilities, or loss of private keys. For example, previous estimates suggest that approximately 0.76% of the total Ethereum supply (912,296.82 ETH), worth approximately $2.3 billion at the time of writing, has been permanently lost due to similar events. More than half of these losses can be attributed to a 2017 security incident, which resulted in the freezing of more than 500,000 ETH.

Lost ETH by type (source)

Bitcoin is another notable example with data to back it up. There are approximately 1.75 million Bitcoin wallets that have not been used in a decade or more, collectively holding 1,798,681 BTC, valued at approximately $106.3 billion at the time of writing. This figure excludes approximately 30,000 wallets believed to be associated with Bitcoin creator Satoshi Nakamoto. These long-dormant coins represent 8.3% of the total fixed supply of 21 million Bitcoins. While it’s impossible to know for sure, given the many high-profile cases involving users unable to access their Bitcoins due to lost or forgotten keys, it’s likely that many of these coins are lost forever.

As Solana network activity grows, user-related losses will inevitably occur. Storing private keys securely for long periods of time is challenging, and even professional wallet service providers can make mistakes. Additionally, token holders may not transfer their private keys before death, resulting in the loss of tokens.

Punishment Slashing

Programmed punitive slashing is not currently implemented, although such a mechanism was considered in Solana's early economic design. The official documentation describes a manual social slashing process, which has been tested on the testnet: "…after a security breach, the network will be paused. We can analyze the data, identify the responsible parties, and recommend slashing their stake after restart."

For completeness, we include slashing in our analysis as one of the known ways that proof-of-stake networks reduce token supply. However, due to the low frequency of this occurrence, the impact of slashing on the overall inflation rate may not be significant. Additionally, some initial proposals for automatic slashing suggest freezing staked tokens for a number of epochs, rendering them ineligible for rewards, rather than slashing principal directly. As a result, these methods may not actually reduce token supply.

Rent Mechanisms

While rent is not a true disinflationary force, it is still worth discussing in this context. All Solana accounts must hold a minimum “rent-free” SOL balance, which is required to pay for storage fees and ensure that the account remains active in the validator’s memory. This minimum balance requirement is proportional to the amount of data stored and is fully refundable when the account is closed. Solana's rental rate is network-wide and is set to the number of lamports per byte per year according to a runtime constant. For example, a standard user token account (an associated token account) has a rent-free balance of 0.002 SOL. This mechanism helps reduce state bloat and incentivizes users to close unused accounts.

Many programs automatically manage rent refunds for users, and there are multipleapps that help users get rent back from unused accounts. However, despite these tools, many Solana users still don’t have a good understanding of how rent works. Additionally, some apps fail to provide users with an easy way to reclaim their rent.

A post on the Jupiter DAO forum points out the problem of high rental costs caused by large-scale on-chain DAO voting

Each rental payment represents a temporary lockup of SOL, which constitutes a user-related loss if it is not recovered. While the rental amount for a single account is very small, these small losses can accumulate to a considerable total when considering all applications and users. In the future, ZK compression technology may partially alleviate these high account costs.

The Future: Is It Time for a Change?

“It’s just some numbers moving around in a black box… The current inflation schedule is probably too high indeed. Even if you cut it tenfold, everything would be fine. I think at the end of the day these costs aren’t that important.” - Anatoly Yakovenko (source)

In this final major section, we’ll first briefly quantify the remaining non-circulating supply unlocking schedule. We’ll then discuss arguments for modifying Solana’s token issuance, including the concept of “issuance as a network cost,” the tax inefficiency of inflation, the downward price pressure of inflation, the punitive effect on network usage, and the rise of alternative validator revenue sources. After that, we’ll explore some practical ways to adjust the inflation schedule and reduce inflation.

Unlocking of Future Non-Circulating Supply

Over the past three years, Solana’s locked-up staking unlocking rate has been relatively stable, decreasing from a peak of 96 million SOL in September 2021 to 48 million SOL in September 2024, an overall reduction of 50%.

Locked Staking History (Source)

At least 43.5 million SOL tokens remain locked in staking accounts, representing 7.5% of the current supply. This includes 41 million SOL tokens sold to large industry entities such as Galaxy Digital and Pantera during the FTX Asset bankruptcy proceedings earlier this year. Some companies, such as Neptune Digital Assets, have publicly announced the details of their purchases - Neptune purchased 26,964 SOL at $64 per coin. 20% of these tokens will be unlocked in March 2025, and the remainder will be unlocked linearly every month until early 2028. This unlocking schedule is consistent with the on-chain locked staking account data (see chart).

Future Staking Account Unlocking (Data Source)

Below, we will present several reasons for adjusting Solana's issuance.

Issuance as a Network Cost

A common argument against Proof of Stake (PoS) inflation is that inflation is an explicit cost to the network, and token issuance constitutes part of the blockchain's "profitability", calculated according to the following formula: Profit = Destruction - Issuance. However, this argument is incorrect. Inflation cannot be understood in this way, it is actually just a redistribution of wealth between all token holders and stakers, and all token holders have equal rights to receive this cash flow.

The only network cost associated with inflation is the portion of value that flows from stakers to validators, which is then used to pay operating expenses, as shown in the figure below.

Solana Value Flows, adapted from this source

We can begin to quantify this value flow by looking at the total staking reward commissions paid to validators, which currently stands at around 44,000 SOL per epoch. However, this figure is greatly inflated by the presence of private self-staking validators, which pay a commission rate of 100%.

Total staking reward commissions paid to validators by epoch

Tax Inefficiency

In many jurisdictions around the world, inflation rewards in the form of additional tokens are considered a taxable event, similar to stock dividends. Such income is generally taxed as income tax when received. This tax burden may cause stakers to have to sell some of their tokens each year to pay taxes, creating constant selling pressure. Quantifying this impact is extremely difficult due to the complexity and wide variation in tax laws around the world. Even within the same jurisdiction, the tax liability of individuals can vary significantly. In addition, because staking is permissionless, it is difficult to trace token ownership back to an individual.

Jito’s blog post mentions that rebasing Liquid Staking Tokens (LST) may help reduce this tax burden:

“Non-rebased LST on Solana may allow users to claim rewards without triggering a taxable event as the number of LST tokens in the wallet does not change (consult a financial professional for advice specific to your situation).”

However, conversions between SOL and staked SOL may themselves constitute taxable events. Additionally, as we explored in our previous SFDP report, overall adoption of LST on Solana remains low. 94% of staked SOL is currently natively staked, with only 6% of SOL (24.2M SOL) staked via liquid staking, up from 17M SOL at the beginning of 2024 and 12.4M SOL a year ago (95% year-over-year growth).

Downward Price Pressure

Inflation can cause long-term, sustained downward price pressure, which distorts market price signals and prevents fair price comparisons. An analogy from traditional financial markets can be used to explain: PoS inflation is similar to a public company doing a small stock split every two days. Charts, dashboards, casual observers, and marginal retail investors do not usually consider the impact of inflation in their analysis.

A favorable price chart is the best advertisement for the ecosystem, not only for traders, but for all ecosystem participants. In a psychology-driven market like cryptocurrency, price is a coordination point and a signal of ecosystem health. Strong price performance is always the best marketing - price drives the narrative.

Consider two different scenarios. I currently hold 100 SOL, each worth $100, with a total value of $10,000.

Scenario A: I choose to stake these SOL and wait a year. Although the price fell by 5% during the period, as a staker, I received 12% inflation rewards. I now hold 112 SOL, worth $95 each, with a total holding value of $10,650.

Scenario B: I choose not to stake. The price of SOL has increased by 5% in one year. I still hold 100 tokens, worth $105 each, with a total holding value of $10,500.

In **absolute terms**, scenario A makes me slightly better. However, scenario B feels more satisfying because of the increase in price, even though this perception is irrational. The psychological effects of price are often overlooked or underestimated because these factors are inherently difficult to quantify. People often tend to make decisions or policy judgments based on quantitative data, even though qualitative factors may be equally important or even more important.

Punish Network Usage

Proof-of-Stake (PoS) inflation effectively penalizes users who actively use SOL on-chain, such as participating in liquidity pools, NFT trading, or placing orders - the opposite of what a network seeking to grow should incentivize. While Solana’s mature and robust Liquid Staking Token (LST) infrastructure can partially mitigate these negative effects by allowing SOL to be actively used without dilution, it also introduces additional costs. These costs include friction in the user experience, fragmentation of liquidity between different tokens, potential slippage when converting between LSTs, and the burden on users to understand the staking mechanism to protect themselves from the indirect costs of dilution.

Some respected industry commentators have argued that a majority of the native token should be productive, and that the ideal staking ratio should be closer to 10%.

Balancing High State Costs

Downward price pressure from inflation could help mitigate Solana’s high state storage costs. These costs were set when the price of SOL was well below current levels. The Solana developer community often complains about the high cost of deploying programs on-chain, which often costs hundreds or even thousands of dollars in SOL.

Solana Developer Community Members Express Their Opinions (X Platform Post)

Viable Alternative Sources of Validator Income

As described in our previous SFDP Report, validators have three main sources of income: MEV (Maximum Extractable Value) commissions, block rewards, and commissions on staking rewards.

A validator’s operating income source depends on its staking situation.

MEV commissions and block rewards have increased significantly since December 2023. In the fee burn section of the report, we discussed the data on priority fees. The following chart shows the growth of MEV.

Jito Daily Tip Growth in 2024 (Dashboard)

The ratio of these three income sources will vary from validator to validator, depending on the validator’s total stake, commission level, percentage of self-delegated stake, commissions paid to staking pools or projects like Marinade Finance’s staking auction market, and overall performance metrics like inactivity rate and voting delays.

However, it is easy to identify the groups of validators that benefit the most from high inflation, including highly staked exchange validators that serve off-chain retail users and some institutional-focused validators. These validators typically have relatively high commission rates, such as Coinbase (8%), Binance Staking (8%), Kraken (100%), and Upbit (100%). Institutional examples include Everstake (7%), Twinstake (10%), Hashkey (7%), and P2P (7%).

On the other hand, ecosystem teams (e.g. Jupiter 0%, Solflare 6%, Mrgn 0%, Helius 0%) and independent validators (e.g. Melea 0%, StakeHaus 0%, Shinobi Systems 3%, Laine 5%, Solana Compass 5%) typically exhibit lower commission rates and benefit less from inflation commissions. This is because these validators, especially the long-tail independent validators, must compete for market share by targeting those active stakers on the chain that respond based on the annualized yield (APY). Such stakers are the most price sensitive and seek the highest returns.

Overall, alternative revenue sources outside of inflationary fees have grown significantly in 2024. However, it remains to be seen whether these alternative revenue sources can remain so high in the long term. Meanwhile, the validator groups that benefit the most are higher-fee exchanges and institutional validators, which make up a disproportionate share of the network's super-minorities and super-majority.

This section uses data from Solana Beach as the source of staking commissions. For further exploration of validator groups, see our previous SFDP report.

Staking Incentives

Anatoly Yakovenko (Source) once said: "Rationally, you need some stakers to choose the quorum. The quorum will not cause security violations such as network outages, but in a well-managed system, the quorum can't actually do much. You need some incentives to get people to stake and thus choose the quorum. You also need some punishment mechanisms, such as slashing, to ensure that people do a good job in choosing the quorum, that's all."

Inflation rewards encourage users to stake their tokens, thereby enhancing the security of the network. Although Solana's current staking rate is relatively high at 65%, significantly reducing inflation rewards may change the balance level of staking, which may lead to some unintended consequences, such as a decline in governance participation.

Modify the inflation schedule model

"One of my key principles has always been to either double a value or halve it. Don't waste time adjusting it by 5%, then 5%, then again... just double it and see if it produces the effect you expect." - Sid Meier, creator of the game Civilization. Source: Sid Meier's Memoir

In this section, we will explore several hypothetical scenarios that modify the inflation rate by adjusting three key parameters of Solana’s inflation schedule. This analysis aims to provide a clearer understanding of the impact of each parameter on the overall inflation rate.

Current Parameters:

Initial Inflation Rate: 8%

De-Inflation Rate: -15%

Long-Term Inflation Rate: 1.5%

These projections can be found in this spreadsheet.

We will explore the following scenarios:

Scenario A: Doubling the disinflation rate from -15% to -30%

Scenario B: Halving the long-term inflation rate from 1.5% to 0.75%

Scenario C: Immediately halving the current inflation rate from 5% to 2.5%

Scenario D: Halving the current inflation rate, doubling the disinflation rate, and halving the terminal inflation rate

Each scenario is designed to test the long-term impact of these key adjustments on the overall inflation rate, helping to understand how different strategies change the inflation dynamics of SOL.

Based on the current inflation rate of about 5% from September 2024, the total supply is 584 million SOL, simulating the impact over the next eight years. As shown previously, Solana’s token burn mechanism will have a minimal impact on supply after SIMD-96 is implemented, so it is ignored in this analysis. To simplify calculations, inflation is calculated on an annual basis, with epoch years treated as equivalent to standard years. In addition, a baseline is provided where the current inflation schedule remains unchanged.

Cut the long-term inflation rate in half (Scenario B) would have little impact on inflation over the next eight years. This change would only reduce total supply by 1 million by September 2032. Doubling the deflation rate (Scenario A) would result in a total supply of 678 million after eight years, a 5.3% decrease from the baseline. Halving the current inflation rate (Scenario C) would result in a total supply of 664 million after eight years, a 7.3% decrease from the baseline. Finally (Scenario D), the combination of halving the current inflation rate, doubling the deflation rate, and halving the terminal rate would result in a total supply of 629 million after eight years, a 12.2% decrease from the baseline.

Forecasts for Solana’s total supply based on four hypothetical changes to the inflation schedule.

Based on these supply increases, we can simulate their expected impact on Solana’s fully diluted valuation (i.e., token price current total supply) by holding other variables constant (i.e., the “ceteris paribus” assumption). To illustrate, we assume a starting price of $150 for the SOL token.

In our base case scenario, the current inflation reward schedule results in downward pressure on the price, causing the token price to fall 18.5% over eight years to $122.25. By doubling the deflation rate (Scenario A), the token price falls 13.93% over eight years to $129.10. Immediately halving the current inflation rate (scenario C) drops the price by 12.07%, to $131.90. Finally (scenario D), halving the current inflation rate, doubling the deflation rate, and halving the terminal rate drops the price by only 7.26% over eight years, to $139.10.

Projected impacts on the Solana price based on four hypothetical changes to the inflation schedule.

One direction for further research is to analyze the impact of these changes on the inflation commissions collected by the long-tail of independent validators operating, and the overall impact on the incentive mechanism for users to continue staking.

Conclusion

This article explored Solana’s inflation schedule and token issuance mechanism from the perspective of the past, present, and future. We analyze the current mechanisms used to calculate and distribute inflation and identify countervailing forces that could reduce inflation. Additionally, we assess the potential impact of SIMD-96, discuss the main arguments for adjusting the inflation rate, and analyze changes to the inflation schedule parameters through modeling assumptions.

Solana’s token launch has been subject to scrutiny with a fair amount of misunderstanding, and we hope this report can provide clarity on some of the key questions. Through these analyses, we aim to facilitate a more informed discussion and contribute to a constructive dialogue that drives positive change.

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