Solana Network Considers Proposal to Adjust SOL Inflation Mechanism

A proposal by Multicoin Capital, an early investor in the Solana blockchain, suggests shifting Solana's SOL token inflation from a fixed schedule to a market-based model. This adjustment could potentially lower inflation, impacting both token holders and those who stake their SOL.

Currently, Solana issues SOL tokens to validators who maintain the network. These validators then distribute a portion of these tokens, along with MEV (Maximum Extractable Value) rewards, to users who stake their SOL. Multicoin’s proposal aims to maintain a target staking rate of 50% for network security and decentralization. If the percentage of staked SOL exceeds 50%, the issuance of new SOL would decrease, reducing staking yields. Conversely, if less than 50% is staked, issuance would increase to incentivize staking through higher yields. The inflation rate would fluctuate between 0% and a maximum based on the current Solana issuance curve.

Solana's initial inflation rate was set at 8%, decreasing by 15% annually until it reaches 1.5%. Currently, the inflation rate is approximately 4.8%, according to Solana Compass. Solana co-founder Anatoly Yakovenko has previously stated that this fixed-rate model was inspired by the Cosmos blockchain, viewing inflation as a form of “accounting” that redistributes value rather than creating or destroying it. Newly issued SOL is distributed to stakers, while the holdings of non-stakers become relatively less valuable.

Multicoin argues that reducing SOL inflation is necessary for several reasons. They believe that distributing new SOL solely to stakers contributes to network centralization. High inflation can also diminish SOL’s utility in decentralized finance (DeFi) due to the high opportunity cost of not staking. Additionally, only 9% of staked SOL is currently liquid. Lowering staking rewards could also reduce selling pressure in regions where staking rewards are taxed as income. Multicoin believes that even though SOL issuance doesn't inherently create a cost for the network, the negative perception associated with the dilution of unstaked SOL warrants limiting inflation.

While Ethereum's success in reducing its token issuance after transitioning to a proof-of-stake system is cited as a positive example, the challenges Cosmos faced with its market-based inflation mechanism for its ATOM token serve as a cautionary tale. Multicoin’s partner, JR Reed, clarified that the proposal draws inspiration from perpetual swaps and their use of funding rates, rather than Ethereum’s specific approach.

A key consequence of Multicoin’s proposal would be a potential decrease in SOL staking yields, which have historically remained above 7%. While increased MEV rewards could potentially offset the impact of lower inflation, staking SOL may ultimately offer lower returns if the proposal is implemented.