Node Provider Inflation Spiral
Please note that aside from raw data, this article is purely speculative with the intention of provoking thought & conversation. This article covers hypothetical scenarios at predetermined price points extrapolating from current metrics to observe potential futures. This article is not financial advice, nor should the scenarios within be considered as fact.
This stems from a conversation with a fellow ecosystem member regarding how Node Providers are rewarded for their contribution to the network - being a pre-determined payment of $SDR in the form of $ICP. If you are unaware what $SDR is; it is a stable currency that consists of a basket of real-world currency’s - it has no association to cryptocurrency & acts as a real world “stablecoin”. While explaining the concept, I began to think deeper about the implications of this functionality;
This meant that each Node has a dollar value assigned to it, that must be paid out - and is automatically done so in the form of $ICP.
This thought immediately drew parallels to the TERRA LUNA scenario. This refers to when the UST stablecoin lost its 1:1 dollar peg, and token holders were forced to “burn” UST to “mint” 1$ worth of LUNA - regardless of the cost of UST or LUNA itself, per the protocols parameters.
This resulted in an inflationary spiral - UST was exchanged directly for LUNA, increasing the supply, which was then sold to exchanges due to market circumstances, decreasing the demand of the token while increasing selling pressure. Hundreds of millions of LUNA tokens were minted & consequently sold, causing a complete collapse in the token price - all due to an algorithm that demanded a predetermined fiat price in the form of cryptocurrency.
While the Internet Computers’ functionality in discussion (Node Provider Rewards) does not exactly align with the functionality that resulted in the collapse of UST & LUNA, - given Node Provider Rewards are distributed on a monthly basis & the IC can scale the amount of Nodes rather robustly (although if a “scale-down” scenario was forced, this would directly degrade subnets, network speeds, and the dApps hosted upon them) - parallels can certainly be drawn in the algorithmic fiat-cryptocurrency exchange functionality.
This of course piqued my interest; I was curious where exactly the breaking point was, - it needed to be calculated in order to prevent an irreversible catastrophic event for the network as a whole - which leads into the rest of the article. To reiterate, please note that this article purely speculative & extrapolative based upon information that is currently publicly available, and is only meant to reflect an extrapolative future assuming consistency in the current trajectory of the protocol.
To determine the stress the network would undergo, I first had to determine the amount of Node Provider Rewards distributed on a monthly basis.
To do so, I’ve gathered Node Provider Addresses from within the following proposals (indicating automated payouts for Node Providers listed), recorded most recent payouts, and utilized the figures to calculate a dollar value reward for each node provider.
However, this is not an extensive list, as the previous proposals include a total of 94 Addresses of Node Providers, while the Internet Computer Dashboard claims there is 96 Node Providers (at the time of writing).
This is most likely attributable to the “Participant Management” topic, in which Node Providers are seemingly added & removed from the network - however, this has no correlation to rewarded Node Providers, as this is handled solely through the “Node Provider Rewards” topic.
It should also be noted that Node Providers with a consecutive history of minting “0 ICP” rewards were removed from the information collected. These Node Providers are most likely inactive, or perform at degraded speeds - earning them rewards of “0 ICP” - as such, they are not relevant to the study, as it is based upon extrapolation of current data.
Aggregating the Node Provider information within the previous proposals produces the following results;
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The majority of Node Providers are pattern based. Those who sell rewards, do it consistently & regularly. The same can be said for those who keep rewards. This allows data to be extrapolated from past actions.
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94 Node Providers are enrolled in “Automatic Reward Minting”
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Of 94 Node Providers, 66 receive rewards on a regular basis. The remaining 28 consecutively mint “0 ICP” Rewards.
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Of 66 Node Providers receiving rewards, 20 Node Providers keep rewards, while the remaining 46 sell them to exchanges to maintain operation.
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In August 2023, the sum of Node Provider rewards was 583,577 ICP. Of which, 275,287.49037424 ICP (47.2%) was sold to exchanges by Node Providers, while 308,289.51 ICP (52.8%) was kept on-chain.
Node Provider Reward Data can be found within the spreadsheet below:
From here, Exchange Data must be recorded & inspected in contrast to the “Node Provider Sell-Off”. The most relevant information to the study will be volume of exchanges, and the supply held within exchange wallets, as this determines liquidity available & required for healthy trading action. Please note that the following data does not include all exchanges, but rather the most prominent in terms of volume & liquidity. Additionally, this is only a collection of active wallets tied to exchanges - there is a possibility that exchanges have unidentified & uncategorized cold wallets that were not included.
Aggregating Exchange Information from CoinMarketCap & the Internet Computer Blockchain Explorer produces the following results;
Utilizing the data provided, it can be observed that Monthly Node Provider Selloffs equate to about 31.5% of daily spot volume.
Alternatively, the quantity of $ICP sold to exchanges on a monthly basis represents about 17.5% of the liquidity held by exchange hot wallets.
This is useful to depict the impact of volume & liquidity, as a recurring pattern of decline in price can be identified coinciding with the monthly Node Provider Reward Schedule.
With the core factors identified, we can begin to extrapolate this data to determine when Node Provider Rewards begin to exceed available exchange liquidity - the scenario most likely to result in a collapse in price.
With the extrapolative values laid out, it is clear that Node Provider Rewards are currently on the brink of unleashing unprecedented levels of inflation, given market trends continue.
This raises the question:
Should the Node Provider Rewards Minting Algorithm undergo modification to prevent the impending inflation spiral?
written by accumulating.icp August 28th
I think this is a misunderstanding - to find these values I utilized the 1st & 14th of each month, aligning with the price points referenced.
It’s brute work tracing ICP movements. Kudos for doing it!
I will have to look out for this behaviour in the future when doing analysis’.
