Blockchains not only need to be technically good. Besides the protocol and implementation levels, a key element in the success of a decentralized system is having different and independent groups using it, operating it, and governing it. The economic incentives in decentralized systems to achieve such participation by all these different groups have gained attention from researchers who are now interested in “tokenomics”, as a new field of study.
In this article, we are going to explore Solana economics, focusing on the stimulus to network node operators, or validators. We conducted an analysis of the inflation model, the costs and rewards to validators and stakers, as well as the current network activity levels. We also estimate the minimum stake required of a validator in order to break-even, and estimate the impact of different market scenarios, considering the most important variables and how they affect validator profitability.
For this purpose, we built the Solana Validator Dashboard and the Solana Validation Cost Estimator.
The Solana inflation design has defined SOL emissions as starting at 8%, and decreasing by 15% every year. The model was activated on February 10th, 2021 with the payment of 213,841 SOL.
As of July 2022, Solana’s inflation rate is around 6.8%. The staking yield is equivalent to 9.1%, as 75% of the total supply is currently staked (i.e. total inflation rewards are distributed to staked tokens only, resulting in a dilution of non-staked tokens). The rate does not reflect the yearly emission rate. It can be considered a target instead, and the mechanism behind it is broken down below.
Solana’s inflation model considers 400ms block times even though it is mentioned on Docs that the current implementation targets block times to 800ms. The recent average is around 650ms but with high variance.
Although Solana remains extremely performant to the everyday user, the difference in slot times directly impacts the economics and business viability of running a validator on Solana. Longer block times will result in smaller rewards, given a smaller number of epochs in a calendar year, decreasing the amount of SOL distributed to network participants.
In every epoch, Solana calculates the number of tokens instantiated for the inflation pool. The result will be the amount of SOL tokens to be distributed to validators and stakers as inflation rewards, according to the voting and staking status from the previous epoch. 0.45 SOL is the approximate amount currently allocated and distributed among eligible validators in each slot — 195 thousand SOL per epoch.
Block times impact inflation rewards as the function will taper the initial rate (8%) given how many slots have passed since inflation activation on Mainnet — as a proportion of how many slots fit in one year.
Considering an average block time of 650 ms, the inflation being distributed in every epoch is equivalent to a 4.1% yearly rate and the stake yield falls to 5.5%, instead of the 6.8% and 9.1% previously assumed.
Also relevant to validator economics will be the commission. In fact, stake owners, a.k.a. delegators, earn the inflation rewards. Validators earn a portion of it represented by the commission. In the plot below, we can see that a common fee for public nodes is around 10%. There are only 81 nodes charging a 5% fee or smaller. 100% commission is assumed to refer to private nodes (100 validators).
Block reward from transaction fees varies according to network activity. Recent average is around 0.01 SOL per slot. Total per epoch increases with voting power, as the number of slots attributed to the validator is based on the proportional stake.
Theoretically, as inflation decreases with time, validators’ rewards would be supplemented by the increase in transaction fees. The assumption can eventually become a truth as the network matures. Some plots below show that currently this is an unfair assumption:
1- The market’s cyclic nature — the number of non-vote transactions will not necessarily be growing over time. Total transactions (vote + non-vote) picks in Oct21, around 180 thousand in one day. And falls to less than 100 thousand transactions in Apr22.
2- Solana network has invested in growing the network of validators. The plot below shows the number of unique rewards recipients (addresses).
3- As a consequence of voting power dilution and lower network activity, rewards obtained from transaction fees decreased for validators in an individual perspective.
We split the cost into i) hardware, colocation, and bandwidth, to host the validator and ii) personnel, which can vary significantly. The official recommendations can be found on the Solana Documentation.
The vote is an affirmation that a block it has received has been verified, as well as a promise not to vote for a conflicting block. — Solana Docs
Validators are expected to vote on the validity of the state proposed by the slot leader. A validator node, at startup, creates a new vote account and registers it in the network. On every new block, the validator submits a new vote transaction and pays the transaction fee (0.000005 SOL).
Validators usually own (a portion or the total of) the staked tokens, a.k.a. self-staking. In this case, the cost of tokens depends on the average price of acquisition. For the purpose of the current analyses, we will consider the validators only to own 100 SOL at a US$ 50 price.
The Solana Foundation promotes the growth of the validator set through the Solana Delegation Program. Applications require small validators to achieve the “baseline” criteria, which includes running a node also on the Testnet, in order to receive 25,000 SOL. Those who meet the baseline criteria and also the “bonus” criteria can receive an extra (dynamic) amount in the delegation. A recent post on stake delegation strategies and why delegation programs are needed, goals, and criteria can be found in How can networks nurture decentralization?
In summary, Solana validator’s profitability depends on the current inflation rate, block times — reflected on the number of epochs in one year, the voting power, the total supply, the number of transactions, the cost structure, and the SOL market price.
For the three operational levels stated above, we will look at three different economic scenarios: optimistic, average, and pessimistic, with the average scenario being the closest to the current values.
The average market price in one year is fixed at $50 for the purpose of break-even analysis. Different price scenarios can be evaluated in a further session.
We found that the 40,000 SOL to break even would be a realistic amount for a small validator, on an average scenario, close to current levels. The number grows to 253,000 SOL for the medium setup. A professional validator would need more than 1.3 million SOL staked.
For a validator with a 0.01% stake, we estimate a 25 SOL reward from transaction fees in one year. The voting process costs around 200 SOLs per year for each node operator. Therefore, small validators are dependent on inflation rewards to achieve break-even, and ideally, become profitable. Around 350 thousand SOL staked would be needed to fully cover the voting cost, when considering rewards from transaction fees only.
Although the number of validators may be considered high compared to other Proof of Stake networks, 71 accounts are responsible for 57% of the total 365 million SOL staked.
The majority of validators currently stake between 80 and 90 thousand SOL, as seen in the plot below. There are at least 138 (7%) instances of the validator client with stake amounts smaller than 40 thousand SOL, the estimated break-even level for a small validator.
Simulation shows that medium and professional validators are more sensible to fluctuations in the SOL market price than small-size validators. Considering SOL average price in a year to be $75, the break-even level decreased by more than 30% for medium and professional levels and only 7% for small validators. A similar effect is found if the average price drops to $25.
Solana validators and stakers have seen rewards decreasing with higher block times compared to the projected rewards from the initial inflation model. As additional factors, the network experienced a contraction in non-vote transactions during the latest months and the expansion of the validator set.
According to the break-even levels discussed above, an 8.85% inflation target would be the rate level to reflect an effective 5.5% emission in one year, considering 650 ms block times (6.3% if 550 ms block times). Assuming 75% of total supply is delegated to validators, staking yield would become 7.1% in one year and the minimum amount in stake to break even drops by 24%, to 32 thousand SOL.
The inflation rate is even more relevant for small validators’ profitability, compared to transaction fee rewards. Adjusting the inflation model according to the actual network configuration would reinforce the interest of those validators staking less than 40 thousand SOL. Supposing the 8.85% rate simulation above, approximately 21 more validators (1.12%) would reach the break-even level — that is the number of validators currently in range 30-40 thousand SOL in stake.
In this study, we explored the variables behind the Solana validator economics, estimating profitability levels for different market scenarios.
Fee markets are now live on Solana but the adoption of the priority fee by dApps and general users at the moment is low, with the proportion of around 4% of transactions paying a higher fee than the fixed rate. It has been in an uptrend since launched, in late July.
Go to the Solana Validator Cost estimator in getguesstimate to explore the relevant variables, their interactions, and correlations. Thanks, Ruud, Chorus One engineer, for building it.
“Look below the surface and you will find that all seemingly solo acts are really team efforts.” —John C. Maxwell
This article was brought to you by Chorus One. With meticulous review by Felix Lutsch and Ruud.
Chorus One is one of the largest staking providers globally. We provide node infrastructure and closely work with over 30 Proof-of-Stake networks.