This is why the Stellar Lumens inflation system has failed

  • A new report from Coinmetrics examines why Stellar Lumens’ inflation system, which was abolished in October 2019, failed.
  • The report says that the XLM payouts were made to too few and incorrect recipients.

In a new report, Coinmetrics examined the reasons behind the phasing out of the Stellar Lumens (XLM) inflation system and the impact on Stellar’s on-chain metrics. As the study notes, every crypto network has a different way of dealing with inflation. Bitcoin, for example, has a maximum supply and the halvings, both of which are set out in the protocol. The output of Ethereum has been adjusted several times since 2017 and recently reduced from 3 ETH to 2 ETH per block (plus Uncle Reward).

The Stellar network had a unique inflation system until October 2019, where XLMs were created and distributed to XLM holders at a rate of 1% per year. Each Stellar account (with at least 0.05% of the supply) could name an “inflation target” account that the XLM received. However, since the Stellar Foundation (SF) controlled 80 percent of the supply, much of the inflation spending was transferred to the SF.

When the inflation process was originally developed, it was intended to support the development and growth of the stellar ecosystem. The reality was different. In the blog post announcing the abolition of the inflationary process, the SDF stated that the new offering, which “was supposed to support the development and growth of the ecosystem,” had failed, effectively admitting that the old system was not working.

As Coinmetrics writes, the inflation pools created to hit the 0.05% limit were claimed by people who were not actively working on development projects. Exchanges like Binance and Poloniex have also given in to the process and distributed their proceeds to their XLM holders. In total, the report identified 1,087,306 addresses as target for inflation payments, which is only 18.3% of the accounts created before the inflation process ended.

Coinmertrics Stellar

Source: https://coinmetrics.substack.com/p/coin-metrics-state-of-the-network-cd7

The graphic above shows that only a few thousand took part in the inflation process and benefited from it, as Coinmetrics writes:

This means that only 18.3% of the accounts ever created before the end of the inflation process took part. While this is only a fraction of the accounts, it is likely a large chunk of the offer as many of the largest accounts participated.

As described above, the largest amount went to the Stellar Foundation (98%). However, these were only 834,000 XLMs, which is around $ 41,000 at current price. Efficient financing of the project was therefore by no means possible. However, the money should not support the SF, but external projects. Coinmetrics therefore drew the following conclusion:

With 98% of the newly created money going to the SDF, even though they controlled 80% of the total supply, the inflationary process arguably exacerbated inequality.

The stellar inflation process was an interesting economic experiment. His analysis draws parallels to current top issues such as the Cantillon effect. It also helps to show that each network has quirks that need to be considered in order to better understand its activity and usage.

After the inflationary process ended, the Stellar Foundation decided to “burn” 55 billion XLM (out of 85 billion XLM it owns). This reduced the offer to 50 billion XLM. The decision was to increase the value of each XLM token.

At the end of December last year, the Stellar Development Foundation also published a funding plan for the next 10 years. A large part of the approximately 30 billion XLM that the foundation still owns will be used for the further development of the project and for use case investments.

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