DOT is an inflationary token by design. Its 10% yearly supply inflation has the goal to punish passive holders that don’t stake and imparts opportunity costs on crowdloan participants. Both staking and crowdloans come with a lockup period for the tokens (28 days in staking, up to roughly 2 years in crowdloans) – so the inflation could also be seen as a cost for having liquid tokens. Inflation is distributed between stakers and the treasury (image credit to @filippoweb3):
Inflation being 10% seems great for bootstrapping the network and is roughly in line with other chains in their early stages (BTC from 2013-2016, ETH from 2016-2018). As the network matures, we might want to reduce it. So I wondered – what would happen if we set this parameter at -10% instead?
The necessary changes would be that passively held DOT or DOT contributed to crowdloans “melt” at -10% p.a., while staked DOT don’t (at the ideal staking rate and minus a commission rate for nominators as is the case today). The treasury would be treated as it is now – meaning, at the ideal staking rate, its funds melt at the same rate as a normal holder, and more slowly above/below. Its income would come from transaction fees and slashes (and perhaps coretime sales in the future).
Economic network security considerations would also change. Each DOT would, ceteris paribus, become more valuable in its purchasing power as the total supply decreases over time. Loss aversion might cause more people to stake their DOT versus passively losing through inflation. A real-life example of this would be the different reaction from the public when banks in some European countries charged an actual negative interest rate to EUR savers (around 2021) compared to when “only” real rates were negative (e.g. interest rates at 0% and inflation at >0%). The liquidity imbalance would also shift, as there are less natural/forced sellers of DOT – for example, through the obligation to pay income taxes on staking rewards. How such a system would be treated tax-wise depends on local tax laws, but no staking rewards → no staking income tax seems logical.
How this would work out if actually put into practice, I don’t know – and I’m sure I’ve missed quite some nuances that would make implementing this tricky or unfeasible altogether. However, it is not that different from the situation of today, only that certain aspects are less hidden: Non-stakers and crowdloan participants already implicitly pay for the staking rewards of stakers through inflation, and all DOT holders collectively pay for inflation spent by the treasury.
This is mostly meant as a thought experiment and I would welcome all contributions on why this would be a horrible or great idea. I think that when discussing changes to Polkadot’s inflation policy, even more gradual reductions or increases, it helps to consider rather extreme cases to visualize how each stakeholder would be incentivized to act and how incentives change as the inflation parameter shifts.