Solana rose to prominence after launching its blockchain in March 2020, surpassing US$77B in market capitalization at its peak on November 6, 2021. Since then, a confluence of headwinds have impaired the value of the ecosystem, reducing its market cap by ~87% and total value locked by ~97%. Some of these challenges (such as network outages and bugs) could be considered growing pains of an early stage technology platform still technically in beta, while others (such as tightening financial conditions and crypto-specific insolvencies) are better characterized as exogenous factors.
Perhaps most notably, the sentiment shockwaves emanating from the recent collapse of FTX have had an outsized impact on Solana, given the network’s historical association with (and funding from) the now-defunct exchange. While the Solana community was rightfully surprised by these events, this former association has nonetheless contributed to dampened perceptions of the network.
Taking a step back, the fundamental characteristics which make Solana an architecturally differentiated layer-1 blockchain remain intact. While many of its competitors – including Ethereum – have been forced to scale their networks’ transactional capacity through second- and third-layers, Solana was intentionally designed for native scalability at the base layer. By augmenting its proof-of-stake (PoS) consensus mechanism with a unique timestamping function called proof-of-history (PoH), Solana has been able to process as many as 65,000 transactions per second (TPS)(achieved on testnet), making it one of the highest throughput blockchains in the industry.
Because these technical capabilities are possible within a single global state (as opposed to multiple layers), Solana offers enhanced composability to developers building applications on the protocol. These sources of differentiation represent important catalyzing forces that can attract and retain developer talent, an area where the protocol has historically shown strength (a sentiment recently echoed by Vitalik Buterin, co-founder of Ethereum).
In this report, we assess the mechanics of the Solana protocol and its competitive positioning in the layer-1 blockchain space. Despite a significant decline in value from its prior peak, user activity on Solana and its pipeline of development initiatives remain relatively robust. Further, Solana has maintained a focus on improving the resiliency of its infrastructure, implementing upgrades targeted at reducing spam transactions and eliminating network outages. In our view, the technological differentiation exhibited by Solana will continue to act as a foundational element of the protocol’s value proposition. The ecosystem’s focus on performance for users and composability for developers may play an important role in driving future adoption and network growth.
The native asset of Solana is SOL. Validators can participate in network security by staking SOL in order to receive rewards in the form of newly issued SOL as well as a portion of transaction fees (50% of transaction fees are burned, with the remaining 50% awarded to the leading validator processing the given transaction). While Solana has recently introduced local fee markets allowing for transaction prioritization, the standard fee is fixed at a low rate (0.000005 SOL per signature, or ~1/100th of a cent in USD). In terms of new issuance, Solana set the initial annualized inflation rate at 8% in February 2021, scheduled to decline by 15% every 180 epochs (roughly one calendar year) until it reaches its long-term inflation target of 1.5% (estimated to occur in 2031).
The initial supply of SOL (detailed in Chart 1) was 500M tokens and since inception, new issuance awarded to validators has grown the total outstanding supply of SOL to 540M tokens at current. The annualized issuance rate of SOL is currently ~6.36% and will vary depending on network performance. Because of the low static fee structure, the vast majority of a given validator’s staking rewards come from new issuance, meaning the potential staking yield is primarily a function of the (1) current issuance rate and (2) total amount of staked SOL as a percentage of total supply. Staking yields will also vary depending on commission rates (charged by validators to delegators) as well as a given validator’s uptime during the period.
At current, ~70.36% of all eligible SOL is staked, equating to an average annualized staking yield of ~6.92% (per Staking Rewards). As the rate of new issuance continues to decline according to the aforementioned schedule, validators will increasingly rely on transaction fees for compensation which suggests network activity will need to increase meaningfully over time in order to foster a more robust fee market.
Chart 1. Initial SOL supply
Prior to the public auction in March 2020, Solana held four separate funding rounds (as detailed in Table 1). Since inception (inclusive of fundraising rounds subsequent to the public auction) Solana has raised a total of ~US$376M from private investors. While Solana has historically garnered a reputation for being a heavily “VC-backed” blockchain, the reality is that there are not many legally-compliant alternative fundraising mechanisms for this type of early stage protocol. Moreover, some layer-1 competitors have raised even more money than Solana, including NEAR, which has raised a total of ~US$524M from private investors since inception.
Table 1. Solana fundraising summary (pre-public auction)
It is worth mentioning that ~31% of the SOL supply is not yet circulating. It consists of SOL to be unlocked according to various vesting schedules associated with early investors as well as SOL owned by Solana Labs and the Solana Foundation (which are not subject to lockups but are not considered circulating). Perhaps most notably, the largest holder of locked SOL is the now-defunct Alameda Research, which holds over 47M SOL (~28% of all non-circulating supply) that is scheduled to be unlocked between March and July of 2025.
In a certain sense, the advent of the Solana protocol helped catalyze the proliferation of alternative layer-1 smart contract platforms observed in recent years. A technically ambitious project, Solana was able to gain initial traction by offering a differentiated environment for both users and developers that could theoretically challenge the network effects of established incumbents, namely Ethereum. During the bull run of 2021, for example, the network’s capacity for cheap and fast transactions attracted new users as other blockchains became prohibitively expensive to use.
Ultimately, while it is possible that a “multi-chain” future for crypto will consist of several interoperable, specialized blockchains that can effectively co-exist from a market share perspective, the current state of affairs is more directly competitive. Layer-1 blockchains are currently competing to capture as much mindshare as possible from a common, albeit growing, pool of capital and users. While the intensity of this competition may be less apparent in the midst of an ongoing bear market, Solana has seemingly captured a surprisingly sticky amount of mindshare since its inception and the ecosystem is aptly focused on bolstering their technological advantages.
It is worth reiterating that the Solana community was just as stunned by the collapse of FTX as the broader market. Founder Anatoly Yakovenko believes Solana’s perceived linkages with FTX have historically been overstated, recently noting that their largest contribution to Solana was the development of the decentralized order book called Serum, which has since been forked and is now a community-led effort called OpenBook. That said, we believe that the network’s historical growth and subsequent decline in market capitalization and total-value-locked (TVL) are perhaps less relevant to the forward-looking analysis of Solana than they otherwise would be. Accordingly, the competitive positioning of Solana is better understood by focusing on activity-driven metrics such as transactions and active users, in relation to aggregate network value (note that these metrics are not resistant to Sybil attacks which can result in multiple fake addresses and thus may overstate activity).
Chart 2. Ratio of market capitalization to daily transactions (rolling 30D average, US$)
Chart 3. Ratio of market capitalization to daily active users (rolling 30D average, US$)
As shown in Charts 2 and 3, the activity on Solana in terms of transactions and active users (adjusted for market capitalization) compares favorably to that of Ethereum at current. This data suggests that Solana may be undervalued relative to Ethereum with respect to the level of underlying activity on the network. Said another way, while Solana’s current market capitalization is just ~4.3% of Ethereum’s current market capitalization, the amount of daily active users on the network represents ~43.7% of Ethereum’s daily active user base (~150k for Solana versus ~344k for Ethereum). Furthermore, Solana processes roughly ~17x the amount of daily transactions as processed by Ethereum (~17.7M for Solana versus ~1.0M for Ethereum), which may be largely attributable to its overtly low-cost fee structure which creates a more frictionless environment for user activity.
Zooming out, it is important to recognize that the overarching investment thesis for Solana is largely predicated on the technological merit of the protocol. Unparalleled transaction throughput (at very low cost) combined with an architectural design allowing for native scalability on the base layer represents a legitimate alternative to the layered approach taken by Ethereum and its EVM clones. In order to be successful over the long-term, however, we believe the Solana ecosystem must maintain a focus on the technical capabilities of the platform and aim to offer products and services that simply cannot be executed on other blockchains due to higher latency or less composability. By leaning into the differentiation of their technologies, Solana may be better positioned to attract and retain developer talent which could help drive future user adoption and network activity.
Outside of metrics related to network activity, another important barometer for gauging the forward-looking potential of Solana is the level of developer activity across the ecosystem. Chart 4 details a comparison of developer activity between Solana and Ethereum, based on data from Github. Following a period of outsized growth for Solana in late 2021/early 2022 (that meaningfully surpassed that of Ethereum), developer activity on Solana subsequently declined back below that of Ethereum in May 2022. Currently, Github data suggests there are 63 active developers working on Solana, versus 133 active developers working on Ethereum (according to The Tie, where “active” is defined as developers who commit code 5+ days of a month).
That being said, Solana itself has recently disputed this data, making the argument that the entirety of the developer community working within the ecosystem is not captured by Solana-specific Github repositories. By their calculations, the number of active developers working on Solana full-time (defined as developers who commit code 5+ days of a month) is 120. They also noted that certain repositories and organizations on Github are private, and thus would not be captured by these metrics.
Additionally, a recent developer activity report released by Electric Capital takes a broader approach and suggests higher totals for both networks – 383 full-time developers for Solana versus 1,873 for Ethereum as of mid-December (full-time defined as developers who commit code 10+ days of a month). Nevertheless, even the potentially conservative lower bound of 63 active developers for Solana would again suggest relative strength versus Ethereum after adjusting for the large discrepancy in market capitalization of the networks.
Chart 4. Developer activity trends (Solana versus Ethereum)
Key protocol initiatives
As previously mentioned, the technological differentiation of Solana is at the core of its forward-looking value proposition. To the ecosystem’s credit, they have continued to build innovative products, services and pieces of infrastructure to support the capabilities of the protocol despite a plethora of headwinds and negative sentiment. Some of Solana’s key protocol initiatives which could help bolster the network’s technical advantages are detailed below.
- QUIC: a new version of Solana’s data transfer protocol (previously the user datagram protocol, UDP) which provides validators greater flexibility in organizing transaction data and promises to reduce the frequency of spam transactions
- Local fee markets: allows users to prioritize transactions with higher fees paid to validators and could help foster a more robust fee market, which could disincentivize spam transactions
- Stake-weighted Quality of Service: ensures validators will be able to transmit transaction data in proportion to their share of stake
- Jito-Solana: a modified validator client created by Jito Labs, analogous to Flashbot’s MEV-boost on Ethereum (also introduced a liquid staking derivative called JitoSOL)
- In testing
- Token-22: a new token standard that will facilitate enhanced functionality like embedded royalties for NFTs and confidential payments
- Firedancer: an independent, C++ validator client created by Jump Crypto aimed at increasing the efficiency of the Solana network and creating a more redundant/diverse validator environment (to be deployed gradually throughout 2023)
- Concurrent Merkle trees / account compression: an account data compression method developed by Solana Labs that aims to decrease data storage requirements and costs
- Runtime v2: a new version of Solana’s runtime (the environment where smart contracts are executed) that will support the Move programming language and help foster a more efficient, auditable and cost-effective programming environment for developers
Another notable initiative for Solana is their forthcoming mobile phone, Solana Saga. The development of a crypto-specific mobile stack promises to allow users to securely store private keys and seamlessly navigate decentralized applications, all from a singular device. Importantly, this infrastructure will allow developers to build applications outside the purview of incumbents that extract value from the web2 application environment. Early versions of the device were sent to interested developers in mid-December for testing, ahead of the public release anticipated for 1Q23.
Solana was not immune from the broad distress observed throughout crypto markets in 2022. More specifically, the collapse of FTX had an expectedly inordinate impact on the Solana ecosystem in terms of market sentiment. Nevertheless, the fundamental value proposition of the Solana protocol persists from a technical perspective. A blockchain optimized for high throughput, de minimis costs and native scalability, Solana represents a legitimately differentiated approach within the layer-1 landscape. Given the ecosystem’s relative strength in terms of current network activity (e.g. transactions, users, development), we believe Solana is well positioned to reassert itself as a genuine layer-1 competitor.