Will the proposal to modify Solana's inflation model help boost the price of SOL further?

Author: shushu, BlockBeats

Yesterday, the market capitalization of SOL surpassed BNB, once again becoming the fifth largest cryptocurrency by market cap. Meanwhile, Multicoin Capital, an early investor in Solana, released a Solana governance proposal aimed at modifying the network's current inflation model and reducing the inflation rate of its native token SOL. The proposal, numbered SIMD-0228, seeks to adjust the issuance rate of SOL to a dynamic and variable model, making it more market-oriented.

The proposal sets a target staking rate of 50% to enhance the network's security and decentralization. If more than 50% of SOL is staked, the issuance will decrease, thereby suppressing further staking by lowering yields; if less than 50% of SOL is staked, the issuance will increase to raise yields and encourage staking. The minimum inflation rate will be 0%, while the maximum inflation rate will be determined based on the current issuance curve of Solana.

In Solana's mechanism, inflation refers to the issuance of SOL by the network to the validating nodes that run the Solana software and help build the blockchain. The validating nodes then distribute these issuance rewards along with a portion of MEV rewards to users who delegate their staked SOL.

Currently, Solana's inflation mechanism is fixed, meaning that the rate at which SOL is issued as staking rewards is static and does not change based on market conditions. However, if the proposal is approved, the network's inflation rate will become variable and will be adjusted according to market dynamics.

Why This Proposal Was Released and Its Impact

Solana's inflation rate was initially set at 8% and is planned to decrease by 15% each year until it reaches 1.5%. Dune data dashboards show that the current inflation rate of SOL is about 3.7%.

Anatoly Yakovenko, co-founder of Solana, stated in the Lightspeed podcast that the idea of a fixed inflation rate is borrowed from the design of the Cosmos blockchain, where inflation is "just an accounting mechanism." Yakovenko is not particularly concerned about inflation, as the issuance process of SOL does not create or destroy value but merely redistributes it. Newly minted SOL is allocated to stakers, while the holdings of non-stakers are relatively diluted.

Nevertheless, Multicoin believes that reducing SOL inflation is necessary for several reasons:

Newly issued SOL is only allocated to stakers, which may lead to centralization of the network; a high inflation rate reduces the utility of SOL in scenarios such as DeFi, as the opportunity cost of unstaked SOL is too high; additionally, only 9% of staked SOL is liquid, and reducing staking rewards may also lessen the selling pressure in certain jurisdictions where staking rewards are considered income.

While technically, issuance does not impose direct costs on the entire network, the negative perception brought about by the dilution of unstaked SOL due to inflation is, in Multicoin's view, sufficient reason to limit inflation.

"Given the current level of network activity and transaction fees, the existing Solana inflation plan is not ideal, as it issues more SOL than necessary to secure the network," said the authors of the proposal, Tushar Jain and Vishal Kankani. "This mechanism cannot perceive network activity and does not incorporate it into the calculation of the inflation rate."

If the proposal is implemented and operates as expected, the authors believe it will "systematically reduce selling pressure as long as staking participation remains sufficient." Furthermore, "by aligning inflation adjustments with actual deviations, the network's issuance can better reflect the real-time economic and security status of the network."

This proposal also has an obvious impact—SOL's staking yield may decrease. Currently, the historical staking yield of SOL has remained above 7%, and if the issuance decreases, this yield will also decline. Although the growth of MEV rewards may partially offset the impact of declining inflation, overall, the returns from staking SOL may decrease.

What Does the Community Think?

This proposal involves multiple stakeholders in the Solana ecosystem, and the community's views on it are bound to be diverse.

Messari analyst Patryk believes the proposal should be passed, as Solana will evolve from "blind issuance" to "smart issuance," which would be a positive factor. He considers the SIMD-0224 proposal unfavorable for validators, neutral for stakers, and beneficial for SOL holders.

"Currently, the total staking rewards of Solana have far exceeded the minimum necessary amount to ensure network security. The network is mature enough and no longer requires such a high inflation rate. The SIMD-0224 proposal will change Solana's inflation rate from a fixed plan to a programmatic, market-driven model. This change will dynamically incentivize staking participation, similar to the model adopted by networks like @Polkadot. This will minimize inflation and bring the network's staking ratio closer to MNA."

Patryk believes this move may reduce the selling pressure on SOL and lessen the "tax burden" currently imposed on non-staked SOL holders.

However, Solana forum member Bji does not support this proposal. He argues that the primary purpose of inflation is to encourage more validators to participate and maintain the network's security, and that inflation rewards are meant to gradually decrease. Since Solana's plan is for transaction fees to gradually take on more of a role in incentivizing validators, this would reduce the need for inflation rewards as a supplement.

Currently, most validators earn more from transaction fees, priority fees, and MEV than from inflation rewards. Therefore, even if inflation rewards are reduced, validators' income will not be significantly affected, but stakers' rewards may decrease.

Bji states that if, as proposed, the inflation rate decreases by 50%, it would lead to a 50% reduction in staked SOL, which is not significant because everyone would reduce their staking by the same proportion; after all holders reduce their staking proportionally, the relative staking ratio held by validators would remain the same, so their voting power would not change materially. With no change in voting power, the network's security attributes would also remain unchanged. Therefore, there is no reason to set a specific inflation rate target for security purposes.

Some community members also express that yield-oriented stakers may lose motivation due to a 50% reduction in staking rewards, and as the total staking amount decreases by 50%, the cost of attacking the network would significantly lower. "If only 20% of the total supply is staked, the distribution ratio of staked SOL may remain unchanged, but this means attackers only need to purchase and stake 10% of the total supply to disrupt the network."

Currently, the community is in a wait-and-see and discussion mode regarding this proposal, with key figures in the Solana ecosystem, such as Solana founder Anatoly and Helius founder Mert, not having commented on it. However, the transformation of Solana's economic mechanism is a concern for every SOL holder, and Blockworks data analyst Dan Smith believes that "Solana has officially entered an era of economic transformation."