Here's How Stellar Lumen's Inflation Scheme Is Flawed

Here's How Stellar Lumen's Inflation Scheme Is Flawed
  • A report from Coinmetrics dated 7 January 2020 noted the failed inflation mechanism of Stellar (XLM).
  • In Stellar’s inflation mechanism, new lumens are added to the network at a rate of 1% per year and this is distributed to any account that receives over 0.05% of the votes from other accounts with a minimum balance of 100 XLM. 

Every year, 1% of the base supply of lumens tokens are created and distributed to "inflation destinations". Account holders could choose other accounts to receive the new tokens with the belief that tokens would go to the accounts with high potential developments. The inflation mechanism was a way to address certain criticisms that cryptocurrencies were deflationary, and to give people the incentive to collaboration and make decisions on allocating the inflation tokens.   

However in September 2019, the Stellar Development Foundation (SDF) removed the inflation mechanism as it was not offering much functionality to network participants. The inflation mechanism was meant to send extra funds to projects through community vote, but most of the users have been joining pools to claim inflation for their own benefit.

Many people don't have sufficient XLM to constitute the minimum 0.05% of supply required to receive inflation tokens, but can band together in inflation pools to accumulate the 0.05% needed. The inflation pools then distribute the inflation tokens received equally to its members, with some inflation pools charging a token fee for this service. The two largest pools were Lumenaut and XLM Pool. Exchanges such as Binance and Poloniex also participated in this process and distributed the inflation tokens to their members who held XLM balances.

Only 18.3% of accounts even designated an inflation destination and these were mainly exchanges, inflation pool accounts or SDF account addresses.

In fact, the Coinmetrics report pointed out that the SDF received 98% of all inflation tokens as a result of the mechanism. This meant the SDF had voted itself as the inflation destination since it holds 80% of XLM supply. Over the 5 years that Stellar has been in circulation, SDF has amassed over 5.4 billion XLM from the inflation mechanism. The inflation process had run 280 times and only 23 different addresses shared 5 billion of XLM as inflation destinations.

Yet SDF has also burned 5 billion XLM and set aside another 50 billion XLM for airdrops ever since Stellar halted its inflation mechanism. This brings down their control to 30 million of the remaining total of 50 million XLM supply.

The Coinmetrics report further states that only 834,000 XLM has gone to community projects, which defeats the objective of the inflation mechanism. Since November 2019, the SDF has spent about 340 million XLM on growth and development out of the 30 billion it manages.

The halt in the inflation mechanism as also drastically reduced the activity in Stellar as people are no longer receiving inflation tokens.

Indeed, it seems that the inflation mechanism has been a failed experiment in economics as the inflation tokens were not going towards the purpose it was meant.

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