13.03.2024
Alongside tokenomics and burning mechanism, history of outages, and FTX ties, the Solana ecosystem's biggest potential risk lies in its high exposure to memecoins.
The meteoric rise of Solana, born just four years ago, has been extraordinary. Since late 2020 transactions have surged from 2.39 million to 29 million, while daily active addresses soared from 22,000 to 829,000. With a peak of over 160 core developers, Solana fueled a remarkable surge in DEX volume, smashing records to reach $3.2 billion. Platforms like Orca and Jupiter exemplify this trend, commanding 14% of the DEX total market share. Now a Top 5 cryptocurrency by market capitalization, Solana's lightning-fast and cost-effective transactions position it as a fierce competitor to Ethereum, earning it the badge of potential "Ethereum Killer." Yet, despite this undeniable potential, Solana contends with persistent controversies surrounding its tokenomics, ecosystem structure, and a troubling history of network outages.
Source: Artemis
Tokenomics: The Inflationary Challenge.
Like many Proof-of-Stake blockchains, Solana deploys an inflationary model where new SOL tokens are minted into circulation, mainly as rewards for validators who participate in securing the network. While this inflationary model serves as an incentive mechanism (the point of the validator participation in the PoS model), it poses a risk to existing SOL holders by inherently diluting the value of their stake and holdings over time. Solana's inflationary model balances incentivizing network security (through validator rewards) with balancing price stability and potential deflation.
The long-term success of this model depends on two factors:
The Disinflationary Schedule: The 8% starting rate, with subsequent annual 15% decreases, is a long-term play to control inflation. While designed to reach a stable 1.5% inflation rate, the network is susceptible to considerable dilution of existing holdings in the short and medium terms, mainly if growth is not continuous.
Staking, staking, staking: Staking SOL offers validators a way of protecting their stake from inflation by earning rewards. However, the whole point of the deflationary process is that, at some moment, the staking rates could decrease as the network evolves and stabilizes.
This relies on the burning and disinflationary process. The 50/50 transaction fee burn is a critical deflationary component. In Solana's burning mechanism, 50% of transaction fees are permanently removed from circulation, and the other 50% goes to the validator as a reward.
Beyond its core function of reducing circulating supply, Solana's burning mechanism can be viewed as an alternative method for distributing newly created SOL (through inflation) to validators. Essentially, it’s critical this new issuance wouldn’t get immediately into the circulating supply.
However, its effectiveness relies entirely on a continuous and substantially increasing volume of transactions. That’s the main reason Solana’s developers have the adoption of the network as a core mission. If network activity stagnates or declines, the burning mechanism's impact diminishes, leaving inflation the dominant force.
Source: Artemis
Ecosystem: Memecoins, Volatility, and Long-term Sustainability.
Solana's network is experiencing a surge in new daily addresses, which means more users are genuinely using the network, potentially for decentralized applications (dApps), NFTs, or memes, which is likely the case.
Source: The Block Memes in the Solana ecosystem have risen, leading the Decentralized exchange Volume to an all-time high. This indicates a synchronization of surges on TVL, daily transactions, daily new addresses, and stablecoin liquidity.
Recently, memecoins projects have exploded in the Solana ecosystem. A memecoin with intentionally misspelled celebrity names (Jeo Boden for Joe Biden) surged in popularity, reaching $49 million in market cap, pumping almost 12,000% in three days. Memecoins like Bonk and dogwifhat have a combined market cap nearing $4 billion, and these tokens are the two biggest Solana ecosystem projects by capitalization. When memes are the primary drivers of liquidity, daily transactions, and total value locked (TVL), in a decentralized finance (DeFi) ecosystem, there is a significant risk once the "memes dumping process" begins. Suppose the hype surrounding a meme or narrative starts fading away and the selling pressure intensifies. In that case, it can lead to a rapid decrease in the price of the native cryptocurrency of the ecosystem, in this case, SOL.
This selling pressure triggers a negative effect, as the declining price creates distrust among holders, and they start selling their assets. As a result, there is a sustained decline in the value of the native cryptocurrency and decreased liquidity, daily transactions, and TVL.
In this scenario, inflation becomes the dominant force in the ecosystem. The burning mechanism, which reduces the token supply and supports its price, becomes less effective when the selling pressure increases. As the process of minting tokens is created through block rewards, the increased supply, coupled with the reduced demand, can lead to inflationary pressures, which leads to the continuing erosion of the price, squeezing the liquidity.
The Solana blockchain has emerged as the cornucopia for memecoins thanks to its low transaction fees and network speed. While these factors have contributed to the initial success of memecoins on Solana, they also imply a challenge to their long-term viability.
Memecoins on Solana may seem appealing but lack intrinsic value and rely on hype and speculation. Their short-term success is not sustainable. Relying on memecoins could potentially lead to negative consequences for other projects on Solana and make the network susceptible to manipulation and volatility. The focus should be on projects with real-world utility and long-term potential for the Solana ecosystem's long-term health.
When an ecosystem relies on memes or short-lived projects instead of sustainable and scalable ones, growth and liquidity are on thin ice.
Network outages, the shadow of FTX, and rebuilding trust.
Solana's network has experienced outages; thus, the blockchain has become inaccessible and has to be stopped. These disruptions hinder transactions and cripple applications, damaging user confidence and raising questions about Solana's long-term reliability for critical infrastructure.
The central criticisms – a history of debilitating outages, reliance on manual coordination outside the blockchain, and the potential for manipulation by a single actor – fundamentally undermine the ideals of decentralization and resilience. Solana's reliance on manual restarts instead of automated recovery casts a long shadow on its claim to be a scalable blockchain. Because, in the end, if it has to be stopped and manually unblocked, is it still a blockchain?
Despite the outages, this is not the worst the blockchain has experienced. Solana's reputation and SOL value were damaged by its association with Alameda Research, a trading company founded by Sam Bankman-Fried (better known for FTX exchange), who was also a major investor and promoter of the Solana ecosystem. Alameda and FTX had a considerable stake in SOL and aggressively marketed Solana's blockchain.
Therefore, when the collapse of FTX brought to light Alameda's exposure to FTX's FTT token, displaying their vulnerability due to their significant holdings of SOL, the sell-off was triggered, and the discredited entities' collapse dragged the crypto market in their fall. d.
SOL experienced a precipitous decline in value, plummeting by 75% in a matter of days. This dramatic price drop sent shockwaves through the Solana Foundation and raised serious concerns about the long-term viability of the network.
Nevertheless, despite the challenges it faced, the Solana team continued to work on developing the blockchain and attracted potential investors and developers to the project. Slowly but surely, the Solana project regained some of its lost ground.
The deconstruction of the network and its reputation, once fragile, has to send trustworthy vibes to investors, developers, and validators. Any sign of concern or credibility issue can have devastating effects.
Developer figures.
In a January 9th report analyzing key 2023 network metrics, Solana affirmed a steady presence of 2,500 to 3,000 monthly active developers on its network throughout the past year.
Source: Solana on Twitter Data from Electric Capital's Developer Report, a blockchain development tracker, reveals a discrepancy: Solana's developer count was recorded at only 1,615 on December 31st, 2023, a considerable drop from its all-time high of 3,800 in June 2022.
Source: Electric Capital's Developer Report Solana needs to disclose its data transparently and effectively. In times of bull runs, the investors tend to forget their rationality. But when the market cools, only credible players can survive.
Solana's path forward.
Today, Solana is one of the world's most popular and fastest-growing blockchains, and, at the moment of writing, it ranks as the fifth cryptocurrency by market capitalization. Its variety and versatility of applications covers dApps, NFT marketplaces, and gaming platforms. SOL has recovered remarkably from its lows, and it’s a 70% increase away from its all-time high.
Nevertheless, this growth's sustainability can be questioned in light of the liquidity injection provided by short-term projects such as memecoins. Since memecoins tend to be part of pump-and-dump schemes, attracted by low fees and fast speed, most of this liquidity would not stay in the network.
The burning mechanism's Achilles' heel lies in its attempt to combat inflation. The constant influx of memecoins and the requirement for precise and consistent growth create a liquidity wave that overwhelms the mechanism's ability to counteract inflationary pressures effectively.
While Solana promises a highly cost-effective blockchain, its controversies must be addressed. Acknowledging the counter-arguments in favor of Solana's technology, the questions raised about its tokenomics, trustworthiness, and historical instability are red flags that need to be taken seriously. Solana must address these concerns to solidify its position as a viable and trustworthy blockchain in the long term.