Revitalizing the Polkadot ecosystem starts with reducing inflation

TL;DR

• Polkadot's current annual inflation rate is approximately 8% , with a total supply of 1.6 billion tokens and only 20 million destroyed. High inflation leads to static capital, hindering the development of the entire ecosystem.
• The community has proposed three inflation reform plans, aiming to reduce the inflation rate to the level of mainstream PoS public chains (3% ~ 6%) by 2026.
• Reducing inflation will reduce staking returns in the short term, but combining LST (liquidity staking token) with DeFi incentives can drive funds from native staking to LST and derived DeFi scenarios.

Polkadot’s Current Dilemma

Since the launch of the Polkadot (DOT) network, the inflation mechanism has been a core topic of community discussion. Currently, the total supply of DOT is approaching 1.6 billion , with a cumulative destruction rate of only 20 million , a very low percentage. Despite the community's approval of Proposal Ref #1139 in October 2024, which reduced the inflation rate from 10% to 8% and fixed the annual issuance at 120 million , the actual results remain suboptimal. At the current rate, it will take at least 10 years to reduce the annual DOT inflation rate to around 4.3% .

The main long-term problems facing Polkadot’s economic model include:

1. High inflationary pressure and excessively high native staking rewards : Continuous issuance creates selling pressure on the market price, making it difficult for DOT to establish long-term scarcity and value anchoring. High staking APYs (annualized yields) have attracted a large number of DOTs to native staking or nomination pools, but these funds are unable to participate in DeFi and lack secondary utilization.
2. Lack of application scenarios : Currently, all new DOTs are generated through protocol inflation (also known as staking rewards). DOT destruction is limited to small amounts of transaction fees and Coretime revenue. The Polkadot ecosystem's TVL is approximately $400 million, far lower than other public chains. The lack of killer applications to drive mass adoption further limits DOT's secondary uses beyond governance and staking, as well as its burn mechanism. This makes it difficult for the ecosystem to form a virtuous cycle, with the token's value primarily dependent on inflationary rewards rather than real demand.

High pledge rate and low capital utilization rate

In the current PoS ecosystem, except for Ethereum, other public chain ecosystems are facing the problem of "high staking rate but low LST penetration rate".

According to Staking Rewards and Dune data, compared to Ethereum's staking rate of about 29.67%, the staking rates of other PoS public chains are basically above 50% - the total staking rate of the Sui network is as high as 73.51%, the total staking rate of the Solana network is as high as 67.26%, the total staking rate of the Polkadot network is 49.2%, the total staking rate of the Aptos network is 96.46%, and so on.

However, the penetration rate of Ethereum's liquidity staking and re-staking market is around 36%, and the largest LST protocol Lido accounts for 24% of the staking market share; Solana's LST penetration rate is around 8.7%, and the largest LST JitoSOL accounts for around 4% of the entire staking market share.

Let’s take a look at Polkadot. The current number of staked DOTs has reached 789 million, but the total amount of DOT staked on Bifrost, the largest Polkadot LST protocol, is only 19 million, and the penetration rate of liquid staking tokens (LST) is only about 3%.

Most DOT holders are engaged in native staking or nomination pools. They do not choose liquidity staking, and do not participate in lending, LP or cross-chain liquidity mining. The utilization rate of ecological funds is extremely low.

The main reason for the current high staking rate and low LST penetration rate is that the excessively high native staking APY will limit the development of DeFi protocols. The demand for DOT is concentrated on staking rather than utility, while other use case scenarios within the ecosystem are extremely thin, and the income opportunities and yields that can be provided are also very limited. As a result, even if users hold LST assets, there are almost no more scenarios, so users have less motivation to participate in liquidity staking and DeFi activities, forming a vicious cycle.

The Impact of the Inflation Reduction Proposal on Polkadot

Polkadot uses the NPoS consensus mechanism, and a high staking rate indicates stronger network security. If lowering the inflation rate leads to a decline in the native staking APY, this may, in the short term, lead to a certain degree of direct loss in returns for stakers, especially large stakers. However, from a long-term perspective, low inflation means stronger value support, helping to attract long-term holders and enhance economic security.

The impact of a public chain's inherent inflation rate on its own LST ecosystem cannot be underestimated. Take Ethereum, for example. ETH's native staking yield is only 3-4%. If, through a stacking strategy, even an additional 4% yield is achieved, it would double the original level. Combined with the EIP-1559 burn mechanism, net deflation can be achieved when the network is highly active. Therefore, ETH has formed a positive ecological flywheel : low inflation + high capital utilization → ecosystem project growth → increased fees and burn rates → increased price and scarcity.

The implication for Polkadot is that low inflation requires supporting DeFi incentives and DOT application scenarios ; otherwise, capital activity will be difficult to unleash. When native staking returns decline, users, seeking higher returns, will more actively turn to LST in search of scenarios that offer additional returns. This will help increase LST's penetration, promote more efficient capital allocation, and hopefully drive greater diversification and enrichment of the entire Polkadot DeFi landscape.

Inflation reduction is not the end

While reducing inflation, Polkadot needs to implement DeFi incentives as a buffer mechanism to achieve a "soft migration" of funds, releasing liquidity while maintaining network security. This will not only offset the short-term impact of declining staking returns but also increase overall ecosystem activity. Viable paths include:

1. Introducing DOT LST into more scenarios such as lending, limited partnerships (LPs), leveraged trading, and cross-chain mining will enhance fund composability and create a multi-layered yield structure. Currently, Bifrost's vDOT holds over 70% of the DOT LST market share, with a TVL exceeding $90 million. This will provide short-term yield compensation, mitigate the pain of declining staking APYs, and increase user motivation to hold.
2. Utilize bridges such as Hyperbridge and Snowbridge to promote cross-chain interactions from networks such as Ethereum and Solana to Polkadot and its parallel chains. Through treasury fund incentives, attract external users and funds into Polkadot and break liquidity silos.
3. Continuously injecting incentives into Hydration to attract external assets to the Polkadot network. The Gigahydration campaign, which used 2 million DOT incentives and lasted for 6 months, successfully introduced mainstream assets such as ETH, SOL, AAVE, and LDO, significantly increasing the ecosystem's TVL and user engagement.

It is both a dilemma and an opportunity

The core issue facing Polkadot is the contradiction between high inflation and high staking rates, resulting in static capital and insufficient ecosystem activity . In the absence of sufficient application scenarios and DeFi incentives, DOT's value capture relies primarily on inflationary rewards rather than actual usage demand, hindering the sustainable growth of the ecosystem.

For the Polkadot community, no matter which solution is ultimately chosen, Polkadot should find ways to increase the application scenarios and value capture mechanisms of DOT and actively build a complete DeFi ecosystem.

In the short term , a reasonable inflation adjustment plan (such as a medium-pressure model) combined with phased DeFi incentives will be the key to the transition; in the long term , only by continuously activating capital flows (DeFi, stablecoins, payments, liquidity staking, etc.) and incubating ecological applications that can attract more users, can Polkadot truly achieve stable growth and circulation of internal and external ecological value.

Polkadot is at a critical historical juncture. How to strike a balance between short-term pain and long-term sustainable growth will test the wisdom and consensus of the entire community.