Recent discussions about NNS treasury, APY changes, network expansion and storage costs had me thinking about the current tokenomics and whether the IC has potential to become deflationary at some point in the future.
Why do I think deflation is an important aspect to consider?
It’s safe to assume a majority of ICP holders and stakers invested in the project not only cause they believe in the idea of a decentralized internet but mainly for monetary gain, the IC’s security model and liveness are also based on the assumption the token has at the very least a stable or slightly bullish price action, if that weren’t the case:
- the NNS would break cause the stakers’ locked value depreciates no matter what, so stakers are no longer incentivized to act in the network’s best long term interest but to extract as much value as possible in the short term.
- A depreciating and inflationary token would benefit late adopters in the NNS, who will be able to buy Voting Power at a cheaper prices.
- A sustained downward trend would lead the ICP in a death spiral due to how node rewards are minted, if such a scenario were to happen the network might not be sustainable anymore.
The ICP has 2 types of inflation: Governance rewards and Node rewards, so let’s see how they work and whether it’s possible to eventually achieve deflation.
Governance rewards are calculated by a % based on a descending curve applied on total supply.
For simplicity’s sake I’ve considered the “best case scenario” (no node rewards, low price, inflation at end of curve(5%) calculated on genesis supply, not current or future), that’d be:
20.000.000 ICP yearly inflation (400 mil at genesis @ 5% APY)
1 ICP = 4$ = 4,8 XDR
1XDR = 1T Cycles
If ICP price were 4$ that’s 96.000.000 XDR worth of cycles to be burned yearly to counter governance inflation or 96.000.000T cycles/y, in the last 7 days 30.000.000.000 cycle/s was the top according to the dashboard, so 933.120T cycles/y (30.000.000.000 x 60(m) x 60(h) x 24(d) x 30(M) x 12(y))
Even in this optimistic scenario burn rate should more than 100x to counter inflation, it gets even worse as price increases, cause number of tokens minted stays the same but amount of ICP burnt per XDR is reduced. So is deflation possible?
Well it depends on how much of the current total network capacity (or CTNC) 30 bil cycles/s is: 1%, 2%, 50%? I honestly don’t know, BUT unless it were a considerably high percentage, e.g 90%, there might still be hope cause the % is based on the current capacity, so while we can’t use more than 100% of it, the IC itself can become bigger by adding more subnets and by doing so increase the max theoretical cycle burn rate.
More subnets equal more nodes, which result in more minted tokens to pay providers, it is therefore fundamental to figure out the factor by which cycle burn increases as the network grows. Deflation is only possible if:
- Subnet avg. cycle burn / (1T * XDR/ICP avg.) > Subnet rewards
- Subnet’s burn surplus (difference between avg. cycle burn and subnet rewards) * n of subnets (n being a realistic number) >= Issuance
The providers’ rewards vary based on country and in future based on specs too, for simplicity’s sake let’s assume all nodes are paid the lowest rate: 873 XDR/month, a subnet has 13 nodes in it atm, that’s 136.188 XDR/y worth of ICP per subnet or 4.766.580 XDR for the entire network (136.188XDR x 35 subnets) or 4.766.580T cycles/y.
Taking into account the registered spike of 933.120T cycles/y we find out the cycle burn rate must 5x just to offset the node rewards minting, I’m not sure whether that is doable, it depends on how much of the CTNC 933.120T cycles/y is, if the percentage is too high and a 5x isn’t possible, e.g > 20%, then increasing node count will only make things worse cause even if the network were used at 100% 24/7, it still wouldn’t be enough to burn more tokens than minted to pay for the subnets.
In such a scenario the only way to make deflation possible would be to increase cycles cost per operation without penalizing devs to harshly, as that might cause cycle burn rate to drop.
I’ll assume the 5x is possible because it’s coincidentally pretty close to the same estimate @Kyle_Langham gave a while ago and I trust in his verdict, still more analysis should be done to figure out the cycle burn to mint ratio per subnet with realistic usage metrics, keeping that ratio higher than 1 and as high as possible without impacting operational costs for devs is crucial to the network’s profitability.
I’d also like to mention a scenario related to how storage costs are currently calculated which might heavily impact cycle burn to mint ratio per subnet for the worse, for brevity’s sake here is a link: Question regarding RE EXC-1168: add non-subsidised storage cost on 20+ node subnets (behind the flag) - #17 by Zane
Mind you NNS inflation is fixed regardless of token price, but ICP burnt per XDR decreases as token price goes up, therefore even if the IC burnt more than it minted for node rewards, the network’s usage and capacity will have to increase alongside price to offset the governance rewards and keep deflation going.
I foresee even with a good cycle burn to mint ratio per subnet this is what might happen:
- More tokens are burnt than minted → price increases
- Price increases → less tokens are burnt
- Network growth can’t keep up with price growth → More tokens are minted than burnt → Price decreases
- ICP price stays at range in which total supply doesn’t significantly increase or decrease.
It’d be interesting to do forecasts and figure out where that balance could be reached with different outcomes, e.g if IC were as big as AWS and cycle burn to mint ratio per subnet were x.
Staking is considered by some as a form of deflation and while it might look like it, especially if the tokens are staked for 8 years, this conviction might prove fatal in the long term, here is why:
Governance Rewards are based on a curve, which will eventually plateau at 5% in a few years: 5% of total supply.
In a rational market token price will increase if:
Cycle burn rate > Node rewards mint rate
Total cycle burnt yearly / (1T * XDR/ICP avg.) >= Issuance (ICP tokens added to the circulating supply, max is 5% of total supply, min is 0)
Max Issuance: if both 1 and 2 are true, NNS driven inflation decreases as supply shrinks and scarcity increases irreversibly.
Min or low Issuance: if both 1 and 2 are true due to low issuance caused by locked tokens, the scarcity increases on paper as long as they remain in the NNS, inflation increases due to total supply growing every year and the price might still increase due to the “temporary” scarcity, but eventually investors will want to cash out that value and the newly dissolved tokens flooding the market combined with the increased baseline inflation could cause major dumps and start a chain reaction.
It would then be preferable if as many tokens tokens were burnt and total supply shrank rather than having too many tokens locked and an increasing total supply.
Despite calculating metrics using the best case variables for deflation’s sake, the results aren’t promising, so unless I’m missing something or have committed mistakes along the way, we might have a problem on our hands.
I truly believe this is a very important topic that needs to be discussed as it entails many aspects of the IC’s future: network’s profitability and security, investors’ and stakers’ financial prospects, operational costs for devs.
I hope to have conveyed my thoughts clearly, if there is something you haven’t understood or I got wrong, feel free to tell me, I’m looking forward to hear what the community has to say.
Thanks for reading