SIMD-0228: Introducing a Programmatic, Market-Based Emission Mechanism

proposals/0228-market-based-emission-mechanism.md

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+---
+simd: '0228'
+title: Introducing a Programmatic, Market-Based Emission Mechanism Based on
+Staking Participation Rate
+authors:
+  - Tushar Jain
+  - Vishal Kankani
+category: Standard
+type: Core
+status: Review
+created: 2025-01-16
+---
+
+
+## Summary
+
+
+SIMD-0228 Introduces a Market-Based emission mechanism based on staking
+participation rates. This is the first of two SIMDs intended to make Solana
+emissions more market oriented. This SIMD proposes a market-based mechanism to
+dynamically determine Solana emissions.
+
+
+## Motivation
+
+
+As Solana matures, stakers increasingly earn SOL through mechanisms like MEV.
+This income stream reduces the network's historical exclusive reliance on token
+emissions to attract stake and security. According to Blockworks
+(https://solana.blockworksresearch.com/), in Q4 2024 MEV, as measured by Jito
+Tips, was approximately $430M (2.1M SOL),representing massive quarter-over-
+quarter growth. In Q3 Jito Tips were approximately $86M (562k SOL), Q2 was
+approximately $117M (747k SOL), and Q1 was approximately $42M (300k SOL).
+
+
+Given the level of economic activity the network has achieved and the subsequent
+revenue earned by stakers from MEV, now is a good time to revisit the network’s
+emission mechanism and evolve it from a fixed-schedule mechanism to a
+programmatic, market-driven mechanism.
+
+
+The purpose of token emissions in Proof of Stake (PoS) networks is to attract
+stakers and validators to secure the network. Therefore, the most efficient
+amount of token issuance is the lowest rate possible necessary to secure the
+network.
+
+
+Solana’s current emission mechanism is a fixed, time-based formula that was
+activated on epoch 150, a year after genesis on February 10, 2021. The mechanism
+is not aware of network activity, nor does it incorporate that to determine the
+emission rate. Simply put, it’s “dumb emissions.” Given Solana’s thriving
+economic activity, it makes sense to evolve the network’s monetary policy with
+“smart emissions.”
+
+
+There are two major implications of Smart Emissions:
+
+
+Smart Emissions dynamically incentivizes participation when stake drops to
+secure the network.
+Smart Emissions minimize SOL issuance  to the Minimum Necessary Amount (MNA) to
+secure the network.
+
+
+This is good for the Solana network and network stakers for four reasons:
+
+
+High inflation can lead to more centralized ownership. To illustrate the point,
+imagine a network with an exceedingly high inflation rate of 10,000%. People who
+do not stake are diluted and lose ~99% of their network ownership every year to
+stakers. The higher the inflation rate, the more network ownership is
+concentrated in stakers’ hands after compounding for years.
+
+
+Reducing inflation spurs SOL usage in DeFi, which is ultimately good for the
+applications and stimulates new protocol development. Additionally, a high
+staking rate can be viewed as unhealthy for new DeFi protocols, since it means
+the implied hurdle rate is the inflation cost. Lowering the “risk free”
+inflation rate creates stimulative conditions and allows new protocols to grow.
+
+
+If Smart Emissions function as designed, they will systematically reduce selling
+pressure as long as staking participation remains adequate. The inevitable side
+effect and primary downside to high token inflation is increased selling
+pressure. This is because some stakers in different jurisdictions have taken the
+interpretation that staking creates ordinary income, and therefore they must
+sell a portion of their staking rewards to pay taxes. This selling is a
+significant detriment to the network and does not benefit the network in any
+way.
+
+
+
+
+In markets, sometimes perception is as important as reality. While SOL inflation
+is technically not cost to the network, others think it is, and that belief
+overall has a negative impact on the network. Inflation causes long-term,
+continual downward price pressure that negatively distorts the market’s price
+signal and hinders fair price comparison. To use an analogy from traditional
+financial markets, PoS inflation is equivalent to a publicly listed company
+doing a small share split every two days.
+
+
+
+
+Historically, issuance curves have remained static due to Bitcoin’s immutability
+ethos—a “Bitcoin Hangover” so to speak. While immutability suits Bitcoin’s
+mission to become digital gold, it doesn’t map to Solana’s mission to
+synchronize the world’s state at light speed.
+
+
+In summary, the current Solana emissions schedule is suboptimal given the
+current level of activity and fees on the network because it emits more SOL than
+is necessary to secure the network. An issuance curve set by diktat is not the
+right long-term approach for Solana. Markets are the best mechanism in the world
+to determine prices, and therefore, they should be used to determine Solana’s
+emissions.
+
+
+
+
+## Detailed Design
+
+
+### Five variables drive Solana’s staking market:
+Yield for stakers (y)
+Issuance Rate (i) - SOL emitted
+SOL staked (N)
+MEV in SOL terms (MEV)
+Validator commissions (c)
+
+
+These variables are mathematically related:
+
+
+
+
+y = ((i+MEV)/N)*(1-c)
+
+
+Currently, the network has a fixed issuance rate (i) while the number of SOL
+staked (N) fluctuates based on market conditions. MEV also fluctuates based on
+market conditions.
+
+
+When considering new models for issuance, this relationship is critical.
+
+Programmatic, Market-Based Emission Mechanism Based on Staking Participation
+Rate
+
+
+A dynamic, market-based rate can be determined using the following factors:
+
+
+The Staking Participation Rate (s = SOL staked / Total SOL in existence) should
+be based on what is needed for consensus safety.
+The network should reduce issuance if the staking participation rate is higher
+than the target rate and increase issuance if it is lower.
+There should be a ceiling on the inflation rate as a protection mechanism.
+
+
+We imagine the Target Staking Participation Rate (T) as a governable variable
+and recommend a target staking participation rate of 50% for the following
+reasons:
+Beyond 67% incremental staked SOL does not add any incremental security
+guarantees because a supermajority of all SOL has voted on any given block and a
+long range attack is impossible. This “excess stake” explicitly inhibits network
+economic activity and hampers growth.
+Below 33%, we potentially risk network safety because a supermajority of all SOL
+has explicitly not voted on any given block and this opens the edge case
+possibility of long range attacks.
+
+
+It also proposes the following bounds for the issuance rate:
+Upper Bound: The current Solana issuance curve (decreasing at a rate of 15% per
+year and will stop decreasing once nominal inflation is 1.5%).
+Lower Bound: 0%
+
+
+Increases or decreases in inflation should be proportional to the magnitude of
+the difference between the actual staking participation rate and the target rate
+(for example, 50% as per this proposal).
+
+
+This approach would allow for a more dynamic response to fluctuations in staking
+participation. By aligning inflation adjustments with the actual deviation,
+network issuance better reflects the network’s real-time economic and security
+conditions.
+
+
+Inflation adjustment function:
+
+
+Δi= k * Δs
+
+
+Δi = Inflation change for the new epoch
+k = Speed Co-efficient
+Δs = Staking Participation Rate (s) at the start of epoch – Target Staking
+Participation Rate (T)
+
+
+inew = max (0%, min (current issuance curve, ilast + Δi)
+
+
+ilast = Inflation in the last epoch
+inew = Inflation in the new epoch
+current issuance curve = inflation defined by current Solana issuance curve
+
+
+This proposal sets k = 0.05 per annum. So, for each extra percentage point
+higher/lower in staking participation rate, inflation would come down/go up by
+0.05% p.a. in the next epoch. With the current staking participation rate of
+~70%, the network would see a reduction of inflation of 1% p.a. in the next
+epoch. On the other hand, with a hypothetical staking participation rate of say
+40%, the network would see an increase of inflation of 0.5% p.a. in the next
+epoch.
+
+
+The max function ensures that inflation is at least zero, and the min function
+ensures that the inflation does not rise above the current issuance curve.
+This design offers several key benefits:
+Consensus Safety: Adjusting inflation based on staking participation ensures
+sufficient validator incentives to maintain network security, prioritizing
+consensus safety.
+Market-Based Flexibility: The model adapts to the network's economic activity,
+making it more responsive to changing market conditions. It’s possible to
+imagine a future where stakers are earning enough from MEV that no SOL emissions
+are necessary.
+Validator Retention: It accommodates Solana-aligned validators who are willing
+to stake even with lower emissions, recognizing that they can earn more through
+MEV in higher economic activity ecosystems.
+This dynamic approach balances the need for a secure, decentralized network with
+the flexibility to thrive in a competitive market.
+
+
+
+
+## Alternatives Considered
+
+
+### Alternative Design 1: Pick another fixed curve
+A simple alternative would be to adjust the issuance rate to a fixed number,
+determined by community inputs. However, this approach presents several risks:
+Lack of Market Mechanisms: Setting a fixed rate ignores the dynamics of free
+markets and the network’s real-time economic conditions.
+Arbitrary Adjustments: Using another arbitrary number risks undermining the
+integrity of the system and may lead to decisions that are disconnected from the
+network’s needs.
+Erosion of Trust: Relying on fixed adjustments could erode trust in the
+community’s decision-making process, especially if future changes seem
+disconnected from market realities.
+Compromised Consensus Safety: A fixed issuance rate, especially in uncharted
+territory, could undermine consensus safety, as it would not be dynamically tied
+to staking participation or broader network health.
+
+
+### Alternative Design 2: Fix Target Staking Yield
+MEV has become a significant revenue source for stakers. One can consider
+changing the issuance rate by factoring in MEV tips, maintaining the same
+target yield as the original curve but offsetting it by the 30-day moving
+average of MEV tips.
+New Issuance Rate (i) = Target Staking Yield − 30-day moving average of MEV tips
+MEV tips reflect real revenue for validators and stakers, allowing the system to
+adjust to market conditions:
+Hot Markets: Higher MEV tips allow for lower emissions.
+Cold Markets: Increased emissions compensate validators, maintaining network
+security.
+This approach is inspired by central bank monetary policy, adjusting inflation
+based on economic conditions.
+But the big challenge with this design is that it incentivizes MEV payments to
+move out of sight of the tracking mechanism, thereby rendering the design
+completely ineffective.
+For an abundance of clarity, we are not proposing any design which requires
+measuring MEV payments.
+
+
+## Impact
+
+
+Implemented thoughtfully, this design could have a major positive economic
+impact on the overall health of the Solana economy.
+
+
+## Security Considerations
+
+
+Targeting a staking participation rate of 50% ensures sufficient stake for
+consensus safety while maintaining the network’s security and decentralization.
+
+
+Below 33%, we potentially risk network safety because a supermajority of all SOL
+has explicitly not voted on any given block and this opens the edge case
+possibility of long range attacks. It is important to note that these long range
+attacks are entirely theoretical and we have not seen one in practice. There are
+other mechanisms in Solana to protect against long range attacks.
+
+
+This proposal is the first in a series of steps to make Solana’s consensus more
+secure and economics more market driven. The successor to this proposal is
+another SIMD that introduces the concept of long-term staking, which seeks to
+improve network security. The option to unstake SOL on a relatively short notice
+(i.e., a short cool down period) poses a potential risk to networks’ stability
+and safety, particularly in extreme circumstances where a significant amount of
+SOL is unstaked within a brief timeframe. The combination of these two SIMDs
+address these concerns while improving network security and economic activity.
+
+
+
+