Token Inflation
DOT is an inflationary token. On the Polkadot network, inflation is set to be 10% annually, which is distributed as staking rewards based on the amount staked vs. ideal staking rate, and the remainder goes to the treasury.
INFO
DOT went through redenomination in 2020 that saw the DOT token supply increase by 100 times.
The current token supply on Polkadot is 1363762563.488 DOT (Over 1.2 Billion DOT).
It is essential to understand that the primary objective of DOT inflation is to incentivize network participants through Nominated Proof of Stake (NPoS) and to grow the network through funding the on-chain treasury. There is an opportunity cost of keeping the DOT tokens idle with the current inflation model as the tokens get diluted over time. Economics and game theory suggest that setting an ideal inflation rate is essential for incentivizing the network participants as well as the growth of the network, and any deviation from it can have negative effects. Reducing the inflation rate could limit growth while increasing the inflation rate could break the incentive model of the token. Hence, token inflation rate is not a forever fixed value, and inflation can be updated in the future through on-chain governance based on thorough tokenomics research.
Inflation Model
The chart below shows the inflation model of the network. Depending on the number of staked tokens, the distribution of the inflation to validators and nominators versus the treasury will change dynamically to provide incentives to participate (or not participate) in staking.
There is a dynamic ideal staking rate (in the figure set to 0.5 or 50%) that the network tries to maintain. The goal is to have the system staking rate meet the ideal staking rate. The system staking rate would be the total amount staked over the total token supply, where the total amount staked is the stake of all validators and nominators on the network. The ideal staking rate accounts for having sufficient backing of DOT to prevent the possible compromise of security while keeping the native token liquid.
Source: Research - Web3 Foundation
x-axis: Proportion of DOT staked
y-axis: Inflation, annualized percentage
Blue line: Annual inflation rate of NPoS, i.e. total amount of tokens minted to pay validators and nominators.
Green line: Annual rewards rate for stakers. For instance, 0.2 corresponds to 20% of annual returns on the staked tokens. You can determine the current annual staking rewards rate by looking at the top bar of the staking overview on Polkadot-JS UI.
Assuming that the ideal staking rate is 50%, all of the inflation would go to the validators and nominators if 50% of all DOT are staked. Any deviation from the 50% - positive or negative - sends the proportional remainder to the treasury. Deviation from the ideal staking rate are referred to as staking inefficiencies. Thus, the treasury does not currently receive a substantial inflow of funds at the ideal staking rate. See this page for more information about treasury inflow sources.
For those who are interested in knowing more about the design of the inflation model for the network, please see here.
Ideal Staking Rate
The ideal staking rate can vary between 45% to 75% based on the number of parachains that acquired a lease through an auction (this excludes the System parachains), based on the implementation here.
Briefly, the ideal staking rate can be calculated as follows:
0.75 - auction_proportion
where auction_proportion is obtained by computing min(auctioned_slots, 60) / 200. The auctioned_slots are all the auctioned slots without the slots for system parachains.
Assuming there are 48 filled slots, of which three are dedicated to system parachains (Asset Hub, Bridge Hub and Collectives), there are 45 auctioned slots. The auction_proportion is thus 45 / 200 = 0.225. The ideal staking rate is 0.75 - 0.225 = 0.525.
If the amount of tokens staked goes below 52.5%, then staking rewards for nominators increase, incentivizing them to stake more tokens on the network. On the contrary, staking rewards drop if staked tokens exceed the ideal staking rate. This results from the change in the percentage of staking rewards that go to the Treasury.
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