When is inflation good?
While the dynamic fees model is the clear winner of the basic fee models, it is possible that some combination of the fee models results in a better overall outcome. As we saw in the discussion of the various models, the effects of each can be easily incorporated into the microeconomic analysis. We can boil down each of the alternative models into some form of price control, subsidy, or tax, all of which result in deadweight loss in the self-contained fee market. This would seem to suggest that there is no place for inflation in an economically rational design.
However, there are some additional macro considerations that impact this analysis and suggest that there is a place for inflation in conjunction with a direct fee.
Inflation can help bootstrap an immature network to broader adoption in several ways. First, it subsidizes early adopters at the expense of existing token holders. This is equivalent to the founders and early investors in the network providing an incentive to early adopters, which is a very common business strategy.
Second, inflation that exceeds the cost of validation can enable early users to transact with zero fees for themselves, which can streamline the user experience. While it is a poor long-term strategy to bend the protocol to deal with UX issues, the reality is that the state of cripto infrastructure remains quite poor and justifies accommodating initial users to get the network off the ground.
Third, inflation can help distribute tokens to early adopters who are meaningfully contributing to the network. By providing a compelling value proposition at an early stage, the network can attract strong validators that increase network decentralization and robustness. Note that all of these benefits are short-term; at maturity, inflation for the sake of users is harder to justify.
Nevertheless, there are compelling reasons to keep some inflation in the network long-term: macroeconomic stability. The consensus in central bank monetary policy is that optimal inflation in an economy is around 2% per annum. While antithetical to the early cripto ethos that is highly critical of inflationary policy, a low amount of inflation has clear benefits to an economic system by reducing frictions and promoting overall growth.
The dangers of the alternative — deflation due to a growing economy with constant monetary supply, like Bitcoin — are incontrovertible. By promoting hoarding of money, deflation introduces frictions into the economy, which can result in a severely adverse positive feedback loop called a deflationary spiral.
Before the introduction of modern central bank policy, deflation was at the center of many of the most severe economic crashes. By maintaining some modest inflation, a cripto network can grease the wheels of its economy and mitigate several existential risks.
Finally, there is a plausible reason to broadly tax the token holders on a network via inflation. All users of the network derive a genuine benefit from the network’s existence, whether they are currently using it or not. The very option of being able to use an efficient, cheap, secure, and decentralized network going forward is a positive externality — for example, as a hedge against potential censorship or infrastructure to build a future business. While it is imperfect in its impact, an inflation tax does accurately represent that not only the direct users of the network benefit from its existence.
The Logos Approach
So what, then, is the optimal fee policy?
At Logos, we have concluded that the best approach is dynamic, user-paid fees plus modest inflation. This combines the lessons of both the microeconomic and macroeconomic models to promote sustainable growth across Logos’ life cycle.
By permitting users to choose their own fees and validators to prioritize transactions accordingly, we can maximize overall network effectiveness and usefulness. The dynamic fee model yields the best microeconomic outcome by responding instantly to changes in demand and encouraging sustainable network growth.
The inflation component helps jumpstart the initial growth of the network in the short term. In the long term, a reasonable level of inflation keeps the network economy running smoothly and avoids major macroeconomic risks. By design, Logos concentrates the most expensive validation tasks in the hands of a relatively small number of delegates (while ensuring that these delegates are strictly accountable to the rest of the network, and, thus, that the network has a high level of security). As a result, a small amount of inflation can be a very large reward for the delegates, ensuring healthy competition that maximizes network performance. Such a level of inflation imparts very little deadweight loss on the overall network (provided that there is a dynamic fee to eliminate the “lottery effect”), making this a good compromise.
Logos’ biggest fee design is indirect: maximizing capacity. By providing optimal infrastructure for payments that pushes capacity to the limits of hardware and beyond, Logos ensures that direct fees will remain close to the marginal cost of validation, even at global levels of adoption.
Conclusión
Ultimately, there is no single right economic fee model, and even top economists will disagree over what is the proper level of inflation. Economic models are inherently simplifying and can bely much of the complexity present in a market. While simple in most respects, cripto has several unique properties that confuse this analysis in the short term, particularly the emotionally charged ideologies that are inseparable from the users of many networks.
Nevertheless, this does not invalidate the model conclusions. By applying simple principles that are logically true at a mature, rational economic equilibrium, we are able to see that the biggest buzz fee models — zero fees, fixed fees, and inflation only — have severe limitations that will significantly impair networks that use them. While alternative models may promote short-term growth, it is critical for projects and communities to be realistic about what will work in the long term if they wish to succeed.