Solana: A Viable Competitor to Ethereum?

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TLDR;

• Solana is a blockchain platform that is designed to host scalable, decentralized applications (DApps).

• Solana uses a Proof of History (PoH) consensus mechanism, which is designed to speed up transactions on the blockchain, whilst maintaining decentralisation.

• Solana's tokenomics model is also designed to be sustainable in the long term.

• SOL has seen recent positive price movement, which could show its emergence as a viable competitor to Ethereum.

Introduction

Solana, created in 2018, is a blockchain platform that that is designed to host scalable, decentralized applications (DApps). Like Ethereum, it is both a crypto currency and smart contract platform. Its founders, (Yakovenko, Fitzgerald, and Akridge), were concerned that blockchain would not be scalable due to the time required to confirm new blocks of transactions. As such, they wanted to create a platform that would provide high-speed, low-cost transactions. In 2017, Yakovenko wrote a white paper on the Proof of History (PoH) mechanism that would attempt to achieve this. It became the backbone of Solana. This review will explore the PoH mechanism, and look into the usage and tokenomics of Solana.

Background:

Bitcoin was initially created to effectively solve the issue of decentralization. The aim was that anyone in the world, could send funds to a stranger without the need of a payment intermediary such as Visa, or Paypal. The technology that makes decentralised transactions possible, is called a blockchain. However, this decentralization comes at a price, and that is the speed of the transaction versus centralised networks. the Visa Network, for example, can process tens of thousands of transaction per second, whereas Ethereum (another major decentralised platform) can only process around 15 per second. It is this issue that Solana, and the PoH mechanism, aim to solve.

Proof of History:

To review Solana’s PoH, and the benefits it brings, it is first important to take a look into what preceded it. Bitcoin, for example, uses a consensus mechanism called Proof of Work. This uses miners to validate each transaction and produce new BTC. Ethereum, on the other hand, uses a Proof of Stake mechanism. Here, network participants “stake” their own crypto to get a chance to validate transactions and earn newly minted crypto and fees.

In both cases, this is a time-consuming process, because all the computers in the system need to come to a consensus on certain parameters. A major one of these is the time the transaction took place. The Bitcoin network conveys this well. BTC miners are fundamental to the network as they time-stamp each individual transaction. These are then bundled into blocks, which are confirmed by the entire network of computers every ten minutes. Here you can see the issue that all blockchains face with scalability, as a network of nodes must agree on the timing and sequence of events.

Solana uses a combination of Proof of Stake and Proof of History. The PoH mechanism is specifically designed to keep time between computers on a decentralized network without the individual computers having to come to a consensus. It does this by using a cryptographically secured clock, which runs through the entire Solana network and creates a historical record. This proves that an event has occurred in a specific moment of time. Block producers trust this clock and so do not have to wait for other validating nodes to come to a consensus to confirm new transactions. As such, it can produce blocks faster and handle more transactions as the network scales.

Features of Solana:

Ethereum is another popular blockchain platform and a competitor of Solana. By comparing these two decentralized platforms, the benefits of PoH are clear:

Here, the improved transaction speeds are obvious with Solana able to process circa 3.3k more transactions per second than Ethereum. This speed leads to less congestion on the network, which not only makes the Solana ecosystem scalable but also reduces the transaction fees ($1 vs $0.01).

However, it is not all positive. Due to the relatively small number of validators on the Solana network, it is not as decentralized as Ethereum. This has been a concern to investors and traders alike. In addition, there are more DApps, DEXs, and NFT marketplaces built on Ethereum, which gives it and more mature ecosystem and greater security. Over the past three years, Solana has experienced a number of security breaches, which have hindered its progress in competing with Ethereum. These risks are fairly uniform for emerging crypto applications, and Solana has been working tirelessly to improve on them.

Usage of Solana:

Over the past month, Solana (SOL) has emerged as the stand-out performer in the recent crypto market rally. Although it has fallen off in the last 24 hours, at the time of writing its price stands at $22.38 with a market cap. of $9.27 billion. This is an increase of 29% and 24% respectively in the last month. The social engagement for Solana is also up by 40.4% in the last month according to Lunarcrush. The recent positive price movement in SOL is likely due to several factors. These include the growing popularity of Solana DApps and NFT marketplaces, as well as the increasing adoption of Solana by institutional investors, and the overall bullish sentiment in the crypto market. We can see from data provided by defillama (shown below) that Solana’s Total Value Locked (TVL) has steadily increased over the course of 2023, whilst Ethereum’s TVL has remained flat this year.

In addition, Coinshares reported on Monday that their Solana fund had the largest weekly inflows since March of last year, reaching almost $24 million. This is particularly notable as Coinshares’ funds are institutionally focused, so this data indicates an increase in institutional interest for the Solana token over the past week or so.

These factors, combined with Solana's strong fundamentals, suggest that the platform is well-positioned for continued growth in the future.

An interesting pair to watch going forward is SOL/ETH. As discussed above, Ethereum is the traditional platform for decentralized applications. Yet, SOL has seen greater positive price movement in the past month. Should we see a break-out in SOL/ETH, it could signify that the market is recognizing Solana as a potential alternative to Ethereum across certain use cases.

One potential threat to Solana’s growth is the court documents that revealed FTX/Alameda held a substantial amount of SOL. Currently, there are about 71.8 million SOL, equal to $1.16 billion, locked in FTX. This is about 17% of SOL’s circulating supply and 13% of its total supply. There is a lot of uncertainty around these holdings with the outcome and eventual release potentially impacting the token’s future.

Tokenomics

Solana has a unique tokenomics model that is designed to balance inflation and deflation. The total supply of SOL is uncapped, but the inflation rate decreases over time. The initial inflation rate was 8% in February 2021, and it is scheduled to decrease by 15% every 180 epochs (roughly one calendar year) until it reaches its long-term inflation target of 1.5%.

Solana's inflation is used to fund the following:

• Staking rewards: Stakers are rewarded with SOL for helping to secure the network. The staking rewards pool is generated from inflation.

• Transaction fees: A portion of every transaction fee is burned. This burning process helps to reduce the supply of SOL and makes it more deflationary.

• Foundation: The Solana Foundation is a non-profit organization that supports the development and adoption of Solana. The Foundation receives a portion of the inflation to fund its operations.

The Solana tokenomics model is designed to be sustainable in the long term. The decreasing inflation rate will eventually lead to a deflationary environment, which will help to support the value of SOL. It has been praised by some for its focus on sustainability and deflation. However, others have criticized the model for its complexity and for the fact that the Foundation receives a significant portion of the inflation.

Conclusion

Solana is a promising blockchain platform that is designed to host scalable, decentralized applications (DApps) and has the potential to revolutionize the crypto industry. The Proof of History mechanism used by Solana solves the issue of transaction speed on the blockchain. By creating a network with high transaction speeds, there is less congestion which leads to very low transaction fees. Solana's tokenomics model is also designed to be sustainable in the long term.

We have seen this positive outlook reflected in the recent price movement of SOL, which has climbed steadily over the last month. It will be interesting to see how this price action develops against Ethereum moving forward.

These factors, combined with Solana's strong fundamentals, suggest that the platform is well-positioned for continued growth in the future.

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