Talking about the inflation of Polkadot DOT

An Overview of Polkadot DOT's Inflation

Author: KIKO; Source: PolkaWorld

“DOT inflation rate is too high” is often criticized about Polkadot. And the worse the market conditions, the louder the complaints.

In our previous user surveys, inflation was also one of the focal points of concern for everyone; underneath the articles we publish, there are often comments complaining about inflation.

However, we have found that there seem to be some misconceptions about the understanding of the DOT inflation mechanism. So in this article, I will talk about:

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• What is the inflation rate of DOT?

• What is the mechanism of DOT inflation?

• Why is there inflation? Are there any benefits to inflation?

• How will Polkadot 2.0 affect inflation?

• Is it possible to reduce inflation?

I hope to answer everyone’s doubts.

What is the inflation rate of DOT?

A common saying is that the inflation rate of DOT is 10% per year, but the actual inflation rate is slightly lower than this number.

Indeed, DOT is increased by 10% every year, but because a portion of the newly issued DOT flows into the Treasury and the remaining funds from the Treasury are periodically destroyed, the actual inflation rate is lower. Since the creation of the Polkadot Treasury in 2020, a total of 13.88 million DOT have been burned.

As a whole, DOT is inflationary, and the total supply of DOT is continuously increasing. According to Subscan data, the current total issuance of DOT is 1.373 billion.

How does Polkadot’s inflation mechanism work?

Where does the inflated DOT go? The main destinations are two: a portion is used to reward stakers (validators/nominators), and a portion enters the Treasury.

The distribution ratio between the two is determined by the staking rate of DOT, specifically, based on the difference between the staking rate and the ideal staking rate. When the staking rate is equal to the ideal staking rate, all inflation is allocated to stakers; when the staking rate deviates from the ideal staking rate, a portion of DOT will flow into the Treasury. The greater the deviation, the more funds flow into the Treasury, and the fewer rewards stakers receive.

This mechanism can incentivize the behavior of stakers and maintain a reasonable staking rate for the Polkadot network. Because both excessively high and low staking rates are not conducive to the network’s development.

Currently, the staking rate of DOT is 50.35%, and the staking reward APY is 14.97%, which still amounts to 7.43% after deducting inflation.

Does DOT have a burning mechanism?

Many people think that DOT only increases and does not burn, but this statement is actually incorrect because DOT does have a burning mechanism (although it may not be very obvious).

DOT currently has only one mechanism for destruction, which is that the treasury will destroy 1% of the total treasury balance every 24 days (one treasury payment cycle).

How much is this number? In recent spending cycles, approximately 440,000 DOT has been destroyed each time.

DOT Destroyed in Recent Spending Cycles

Source: https://www.dotreasury.com/

From the total quantity perspective, the largest destination for treasury funds is actually destruction, which honestly, I didn’t think of before. From the beginning until now, 58.48% of the DOT in the treasury has been destroyed, and the remaining is used for proposals, bounties, tips, and various expenses.

Polkadot Treasury Total Revenue and Total Spending Analysis Chart

Source: https://www.dotreasury.com/

What are the advantages and disadvantages of DOT’s inflation mechanism?

From the description above, we can actually see why Polkadot designed such an inflation mechanism, because it has certain advantages. In fact, a certain level of inflation can promote economic prosperity (think about what happened during the last round of interest rate cuts by the U.S. Federal Reserve). However, everything has two sides, and this inflation mechanism also has some disadvantages.

Advantages of inflation:

1. A portion of the inflationary DOT is given to validators/nominators as staking rewards, incentivizing them to stake and protect the security of the PoS network, and users don’t have to pay excessive gas fees.

2. A portion of the inflationary DOT goes into the treasury, and the treasury funds are reallocated to the ecosystem through OpenGov’s governance voting, supporting the development of infrastructure, community building, marketing activities, developer tools, etc. A robust ecosystem will attract more projects to the Polkadot ecosystem, increasing the utility of DOT and therefore the demand for DOT.

Disadvantages of inflation:

1. The supply of DOT continues to increase. If demand remains constant, the purchasing power of DOT will decrease, which is not conducive to its market value. In a bullish market and fast-paced ecosystem development, a certain level of inflation can stimulate economic growth, but high inflation continuously is not very reasonable.

2. From a marketing perspective, even a 7.5% inflation rate per year sounds a bit high and may not be conducive to expanding the community.

What can we do in the face of inflation?

With such high inflation, what can DOT holders do?

Firstly, you can stake (nominate) your DOT. Currently, the APY for staking is around 14.9%, and after deducting inflation, there is still a 7.43% return, which is not bad. The risk is also relatively low (although stakers may be slashed if validators misbehave). Staked DOT has a lock-up period of 28 days, similar to how we deposit money in a bank for a fixed term to hedge against inflation.

Polkadot Staking Panel: https://staking.polkadot.network/

If you want to earn staking rewards and also keep the liquidity of your DOT, or if you want to participate in other DeFi projects, you can consider participating in liquidity staking. Bifrost, Acala, and other projects in the ecosystem offer this service. Bifrost also supports using the vDOT earned from staking for governance voting.

Bifrost: https://bifrost.app/

Acala: https://apps.acala.network/

Alternatively, you can explore more opportunities to earn rewards, such as participating in various DeFi projects within the ecosystem.

In summary, the key is to make use of your DOT and actively seek ways to earn rewards to counter inflation. This is actually one of the intentions behind the design of Polkadot’s inflation mechanism.

How will Polkadot 2.0 affect inflation?

Polkadot is moving towards Polkadot 2.0, and what possible impact will this have on DOT’s inflation? Let’s speculate boldly.

Firstly, with Polkadot 2.0’s more flexible and high-frequency allocation model for block space, and the use of DOT as a payment currency to purchase Coretime, the demand and liquidity of DOT will increase. The income from selling Coretime may become the core income of the Polkadot network. When the network’s income increases, the reliance on inflation may decrease, which may lead to a decrease in the inflation rate.

Secondly, the income from selling Coretime may be directly destroyed or partially destroyed. Community member Jonas has suggested burning the DOT income from Coretime, which would reduce the total supply of DOT and decrease inflation. However, how the income from Coretime will be handled has not been determined yet and requires community discussion and consensus.

Is it possible to directly change the inflation mechanism and lower the DOT inflation rate?

Technically speaking, it is entirely possible to change the inflation mechanism and lower the DOT inflation rate.

Under the OpenGov governance system, the decision on how the Polkadot network should develop is in the hands of DOT holders. Therefore, if the community believes that the current inflation mechanism is not reasonable, it has the right to propose a change.

Specifically, it would require initiating a referendum in OpenGov and proposing a new inflation mechanism and rate. After that, it would undergo a community vote. If the referendum is passed, the inflation rate can be reduced or a new inflation mechanism can be implemented.

However, changing the inflation mechanism is a significant adjustment to the token economic model and requires a comprehensive and sustainable plan, as well as careful decision-making.

In this regard, there is actually a precedent in the Polkadot ecosystem. Recently, the leading project in the Polkadot ecosystem, Astar, announced its adoption of a new token economy to lower the ASTR inflation rate.

Conclusion

Based on the analysis above, we can see that Polkadot’s inflation mechanism has its reasons for existence. For DOT holders, they can counter inflation through staking and other methods. In the future, the arrival of Polkadot 2.0 may lower inflation, and we will continue to pay attention to governance proposals related to inflation adjustments.

Here, I also dare to put forward some immature suggestions, just as food for thought.

Firstly, inflation rates can be appropriately reduced to a more sustainable level through OpenGov, or dynamically adjusted based on the actual situation.

Secondly, it is necessary to establish a more comprehensive criterion for treasury expenditure, ensuring that the inflationary DOT is invested in places that truly benefit ecological development.

Lastly, the utility and demand for DOT should be continuously increased. The upcoming Coretime purchase and secondary market trading will bring more demand and liquidity to DOT. In the future, more applications should be explored to increase network revenue and reduce reliance on inflation.

We will continue to update Blocking; if you have any questions or suggestions, please contact us!