Solana's Inflation Is Too High

This episode delves into the intricacies of Solana's inflation debate, revealing why a key proponent believes the network is overpaying for security and how future proposals aim for a more economically efficient model.

Revisiting Solana's Inflation Reduction Proposal

• The discussion kicks off with an analysis of a significant, albeit unsuccessful, proposal from early 2024 aimed at changing Solana's inflation schedule. The guest, who advocated for this change, explains that the proposal sought to replace the current inflation curve with a market-based mechanism designed to lower inflation.
• Despite strong support, the proposal did not pass. The guest notes, "62% of the stake that voted...voted for it. 75% of the stake voted, which is 50% more turnout than any vote ever in Salana...we had a majority, just not quite enough to make it over the 66% threshold."
• The guest maintains the conviction that Solana's inflation is too high, indicating that the network is essentially overpaying for its security.
• Strategic Implication: For investors, understanding the mechanics and outcomes of such governance proposals is crucial, as they directly impact tokenomics and long-term value. The high turnout also signals significant community engagement on economic issues.

The "Leaky Bucket" of Current Inflation Policy

• The guest elaborates on the core argument for reducing inflation, framing it from a fundamentals-based valuation perspective. A key concept introduced is the "leaky bucket of inflation," which highlights inefficiencies in the current system.
• This "leaky bucket" comprises unnecessary costs, notably taxes. The guest points out that the US government profits significantly from Solana's inflation policy—to the tune of $200 to $400 million annually, depending on SOL's price—simply because new tokens are created and distributed to existing holders, triggering a taxable event.
• The guest argues, "we don't need to pay that because we're paying ourselves...the goal of like any of these things is cut costs."
• The assertion is that Solana's network is already very secure, sometimes even exceeding Ethereum's security in terms of staked value (SOL stake times price vs. ETH stake times price), yet Solana pays disproportionately more for it.
• Actionable Insight: Crypto AI researchers and investors should consider how protocol-level economic policies, like inflation, can create "value leakage" to external entities (e.g., governments via taxes). Optimizing these can free up capital, analogous to optimizing resource allocation in AI model training.

Market-Based Inflation and Staking Return Volatility

• The guest revisits the proposed market-based mechanism for inflation adjustment. This mechanism would dynamically alter inflation based on network revenue (REV). REV (Revenue) in this context likely refers to network transaction fees or other forms of on-chain economic activity.
• The proposal suggested that when network revenue is high, inflation should decrease (reducing payments to entities like the US government). Conversely, when revenue is low, inflation could increase to maintain security incentives.
• A criticism of this model was that it might increase the uncertainty of validator returns. The guest refutes this, explaining the mechanism acts as a "shock absorber, not like a shock amplifier." If a surge in network activity (e.g., "Trump launches another coin") boosts revenue, staking rewards would rise, attracting more stakers, which in turn would trigger the mechanism to lower inflation, thus stabilizing actual returns.
• The guest acknowledges a "fundamental like mathematical misunderstanding from the critics" and emphasizes the need for clearer explanations in future proposals.
• Strategic Implication: Dynamic, market-based mechanisms for protocol parameters like inflation represent an evolving area in crypto-economics. For AI projects on-chain, understanding how such mechanisms impact network stability and cost is vital.

Lessons Learned and Future Proposal Strategies

• Reflecting on the previous attempt, the guest outlines a revised approach for future inflation-related proposals.
• Key lessons include the need for much clearer communication, especially when explaining financial concepts like real versus nominal returns to a technically diverse audience.
• Future proposals will likely feature a more gradual rollout, possibly over two years, to be "a gentler thing."
• A significant current focus is on building out governance infrastructure. This is crucial because of previous concerns where some stakers felt their votes weren't properly represented by the validators they staked with. The aim is to enable individual stakers to vote their stake directly, irrespective of their validator's choice.
• The guest states, "we're just kind of hoping that that infrastructure which is getting built out by some teams will be there so that anybody who has stake can...vote your own stake as well."
• Actionable Insight: The development of more granular and direct governance tools is a key trend. For AI researchers looking at decentralized governance for AI models or DAOs, Solana's experience offers valuable lessons in community engagement and infrastructure needs.

Clarifying Real vs. Nominal Yield in Staking

• The interviewer prompts an explanation of the difference between real yield and nominal yield, a common point of confusion in staking. Nominal yield is the stated percentage return (e.g., 7-8% APY on SOL staking), while real yield accounts for the dilutive effect of inflation.
• The guest uses an analogy: if all SOL were staked and 5% new SOL were created and distributed, stakers would have more SOL, but their fraction of the total supply would remain unchanged. This is similar to a government printing money and giving everyone more currency—prices would simply adjust, and real purchasing power wouldn't necessarily increase.
"Every time if you hold Salana in your account and Salana is inflating at 5% a year, then your fraction of the network is going down by 5% a year. And so you need to account for that in your ultimate...return on investment."
• Technical Clarity: Understanding this distinction is fundamental for investors to accurately assess the true returns from staking activities, beyond the advertised APY. It's about the change in one's proportional ownership of the network.

Considering Alternative Proposals and Technical Hurdles

• The conversation touches on a new proposal, possibly from Galaxy Research, suggesting validators vote on the extent of inflation reduction.
• The guest doesn't inherently oppose this idea but highlights the technical challenge of enabling individual stakers to override validator votes, especially with over a million stake accounts. Implementing a system where stakers can specify a continuous value for a parameter (like an inflation rate) is even more complex.
• The guest expresses a desire for less contentious governance processes. The binary outcome of the previous vote led to high contention. A system allowing for a continuum of choices might foster more consensus.
• The guest states, "If it was a continuum, maybe it would have been less contentious, which would be nice."
• The priority remains enabling direct staker voting before bringing forward a new comprehensive proposal.
• Strategic Implication: The technical feasibility of advanced governance mechanisms is a bottleneck. Progress here could unlock more nuanced and representative decision-making in decentralized networks, relevant for both L1s and complex AI governance structures.

This discussion underscores Solana's ongoing efforts to refine its economic model, particularly by addressing inflation to enhance capital efficiency. For Crypto AI investors and researchers, the key takeaway is the critical interplay between tokenomics, governance, and network security, which directly impacts the viability of platforms hosting decentralized applications.