Pocket and inflation: What you need to know

Inflation is on many people's minds these days, and at Pocket, it's no different.

Except that, unlike the wider economy, we at Pocket are able to manage our own economics to be able to provide the greatest possible outcomes for the greatest number of stakeholders.

You may have heard about some governance changes in Pocket that address inflation, and this may understandably bring up some concerns. Whether you're a node runner looking to maximize your returns, an app developer using Pocket to connect your dapps to the blockchain, or just an interested party looking at the sustainability of Pocket, you may have questions.

In this post, we're going to address those questions you have regarding the recent changes that Pocket’s DAO implemented to address inflation.

Some background on node running

Pocket Network operates a two-sided marketplace. On one side, infrastructure providers ("node runners") run nodes, or access to blockchain data, for connections to Ethereum, Harmony, and over 30 other blockchains. On the other side, web3 application developers gain access to a robust and fault-tolerant decentralized system for querying blockchain data.

When an application that uses Pocket asks for data from a blockchain and a node provides this data, it is known as a "relay".

Node runners stake POKT, our utility token, and pay for hardware and network costs in order to serve those relays. In return, node runners receive a reward for providing those relays, in the form of POKT.

The amount of POKT generated per relay is determined by the parameter RelaysToTokenMultiplier, and from the time of the genesis block was set to 0.01 POKT per relay.

Why do we do things this way as opposed to through micropayments? To reduce transaction costs. These payouts are “block rewards”, meaning they are generated when a new block is confirmed. Block rewards don't require a transaction on the blockchain, which dramatically reduces the number of transactions that nodes have to validate. Because nodes don't have to validate node payouts, Pocket is able to more effectively compete on cost terms with other similar services.

Now, as you may be able to foresee, when the number of relays served increases, so too does the amount of total POKT generated over the system. This means the POKT token is in an inflationary state.

This isn’t unexpected; in fact, it was envisioned from the start. The growth of Pocket Network’s economy can be divided into three phases: a “Bootstrapping Phase”, during which applications’ service is subsidized and nodes earn outsized rewards; a “Growth Phase”, during which bootstrapping has successfully sparked the flywheel of growth and inflation must be controlled; and a “Maturity Phase”, during which application stakes are burned in proportion to the relays they use and the global supply of POKT stabilizes.

The recent massive growth in relays has marked the network’s transition from the Bootstrapping Phase to the Growth Phase, which means that the global supply of POKT has been accelerating and that inflation control measures are now required.

The pros and cons of inflation

Inflation isn't necessarily a good or bad thing; like red wine, it’s healthy in moderation. For example, economic policy makers seek to manage and control inflation but they do not eliminate it entirely. Because we usually think about inflation in the context of established nation-states, we are used to small (almost stable) inflation rates. Pocket Network, on the other hand, is a brand-new economy, and as such, it seeks to scale its productive capacity rapidly and distribute its currency (POKT) to enough producers (node runners) to encourage and meet demand.

As we have been focused on growing the productive capacity of our network, we have incentivized node runners through generous POKT token incentives, and this has been quite successful; we now have over 30,000 node runners, with more being added daily. Our bootstrapping incentives have been instrumental in seeding the supply side of Pocket Network’s two-sided marketplace.

However, in the last few months our daily relays grew exponentially to 200-300M per day, which had the effect of scaling our bootstrapping incentives into excessive inflation, which can have unintended consequences that impact the long-term sustainability of the network.

We were entering the Growth Phase of the network and it was time, as was planned from the start, for the DAO to set a policy on inflation management.

Enter the DAO

Pocket Network is governed by a DAO, whose constitution empowers it to control all aspects of the protocol and ecosystem.

The DAO is completely public and transparent, and anyone can claim a vote in the DAO; they just need to prove their stakeholder status.

In December of 2021, a proposal was raised to manage the amount of inflation in Pocket. A separate proposal was soon offered providing more detailed figures regarding how inflation would be managed.

You can read the original proposal, along with a very spirited debate. (You don't need to be a member of the DAO to voice your opinions, only to vote!). This proposal (and a related proposal with more specifics) were eventually put to a vote, and were approved at 100%, with 67% quorum.

WAGMI

Here's what the proposal entailed.

It was decided to debut the idea of WAGMI, or Weighted Annual Gross Max Inflation. A mouthful, to be sure, but it specifies something very concrete: the target annual inflation rate.

WAGMI would be set to an annual inflation figure, in POKT, from which the RelaysToTokensMultiplier parameter would be adjusted over time to target this amount.

In short, the returns a node will earn for every relay it performs will be adjusted to match a desired total inflation rate.

This rate was set at the onset of the proposal to target a 100% annual inflation rate. In practice, this meant an immediate adjustment of the `RelaysToTokens Multiplier` from 0.01 POKT per relay to 0.008461 POKT per relay.

You may not immediately see how we came up with this, so here’s an explanation.

If we’re targeting a 100% annual inflation rate, then we need to know the current supply of POKT, since we’ll be looking to create exactly that much over a year period. That current supply is approximately 945 million POKT as of the time of the proposal passing.

We need to divide that amount by the total number of relays per year. But since that number is highly variable, a good approximation would be to calculate the 30 day trailing average of relays, and then extrapolate that over a year.

At the same date as above, we had a 30 day trailing average of approximately 306 million relays, or 111.69 billion relays per year. (!)

So the mint rate should be equal to the total amount of POKT divided by the total relays, or:

Mint rate = Total amount of POKT per year / Total number of relays per year

 = 945000000/111690000000 =0.008461

Now, this was just a starting point. The short term goal was to target a maximum inflation rate of 50%, not 100%. However, making such a rapid change in the rewards structure could have undesired effects on network stability, and may negatively impact node runners who have invested heavily in hardware, and it was agreed to phase this in over time.

So, it was decided to lower the target inflation rate from 100% to 50% in 10% increments on an approximately monthly basis. You can see the schedule below:

Feb 28, 2022: 100%
Mar 26, 2022: 90%
Apr 25, 2022: 80%
May 25, 2022: 70%
Jun 24, 2022: 60%
   Jul 24, 2022: 50%

After that point, the plan is to reevaluate the inflation situation and adjust accordingly via a new proposal. Until a new proposal is voted on and passed, the 50% target inflation rate will remain.

Because the number of relays is variable, it’s not possible to know in advance what the resulting mint rate will be for each of these adjustments. We will publish these updated rates as soon as we can calculate them.

A product of our own success

While at first glance one might view this change as a reduction in rewards, it should more accurately be seen as an investment in the sustainability of the project and its reward structure as a whole.

In addition, because the RelaysToTokensMultiplier is now dynamic and based on the number of relays, it provides a hedge against the possibility of lost rewards should the number of relays go down. So far, we haven't had to deal with that possibility on a grand scale, but we don't wish to penalize node runners if the demand-side of Pocket should vary over time.

That we are targeting inflation at all should be a signal as to the viability of Pocket as a powerful and robust solution to the problem of node architecture. If we had lots of nodes but nothing to relay, we wouldn't be in this situation, and if we had tons of demand but few nodes, we would have a different challenge.

The way we see it, we're undergoing a natural shift in our ecosystem, where we stabilize the Pocket economy while remaining flexible enough to manage growth effectively.

What's next

We've spent the majority of time here discussing node runners, but what about app developers? Are there any changes on the horizon for them?

The answer is yes, but not immediately.

At the moment, when an application stakes POKT based on the amount of relays the application needs, that POKT is locked up forever, or at least as long as the application needs those relays.

However, we anticipate introducing an “application burn rate” in the future. This would mean that the staked POKT would eventually be burned, making applications pay for their usage, much like how a vehicle burns fuel when it is operated.

This has the added benefit of potentially balancing the amount of POKT minted (to nodes) and the amount of POKT burned (from applications), eventually creating a steady state for the ecosystem, where node runners who sell POKT to cover their infrastructure costs would be matched in roughly equal proportion by apps that are utilizing POKT.

We're not planning on implementing this until the release of v1, so please make sure to keep up with the latest developments in Pocket by joining our Discord or by subscribing to our newsletter.

We hope this has answered your questions about the recent changes to our rewards structure, and has allayed your concerns. Our node runners are the backbone of our system, and they shoulder much of the responsibility for ensuring that Pocket runs smoothly for the applications that connect to it. We want to ensure that they are adequately rewarded for doing this, not just today, but sustainably going forward as we build the future of Pocket.