Solana: A Comprehensive Guide to Scaling Solutions

Summary

• Solana's focus on rapid transaction processing and scalability has led to the emergence of valuable use cases, drawing significant interest in the cryptocurrency market.
• Even amid a bear market, Solana's ecosystem has demonstrated substantial expansion in sectors such as DeFi, liquid staking, consumer applications, DePIN, and privacy protocols.
• In Q3 2023 Solana's market capitalization surged by 17% underscoring its promising outlook for future growth.

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We openly acknowledge that our bullish sentiment towards the broader crypto space is rooted in the advantages of decentralization. Ethereum (ETH-USD) has prioritized decentralization before scaling, and we believe this focus positions Ethereum well for attracting the most valuable and trustless use cases in the long term, particularly in transactions like trading and real estate.

On the other hand, Solana (SOL-USD) initially prioritized speed over decentralization, and we've gradually come to recognize that this approach also presents numerous valuable use cases. Notably, Solana is gaining momentum in terms of price action, and historical crypto cycles have shown that such momentum can serve as a decent indicator of what will perform well during a bull market. In a nutshell, it appears wise to consider building a position in Solana at this point.

The following insights are sourced from Messari Research, which has done an excellent job summarizing the Solana ecosystem. While adoption metrics currently resemble those of a bear market, signs of stabilization are emerging. On a more optimistic note, developers are actively working on Solana, and its speed may pave the way for the next significant adoption wave in the crypto space. Therefore, having exposure to Solana in your portfolio is worth considering.

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Key Metrics

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In early June, the SEC made regulatory complaints against Coinbase and Binance in Q2 2023, which included SOL among other assets, triggering a sharp 34% decrease in SOL's price.

However, SOL rebounded more robustly than the other tokens categorized as securities by the end of Q2, maintaining its momentum into Q3. After a brief dip, potentially influenced by the potential liquidation of Alameda/FTX's SOL (details provided below), SOL concluded the quarter with a $8.4 billion market capitalization, representing a 17% increase quarter-over-quarter. Notably, SOL outperformed assets of similar market capitalization, climbing from 10th to 7th in rank over the quarter.

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Growing Revenue and Inflation Dynamics

Regarding revenue, which encompasses all fees accrued by the protocol, there was a 19% growth in USD terms, reaching $4 million, and a 10% increase in SOL terms, totaling 185,400 SOL. In Solana's system, half of these fees are burned, while the other half is allocated to block producers. Currently, the burning of tokens has not substantially curbed inflation, which remained at 5.8% by the quarter's end. This inflation rate specifically measures new token issuance for validator rewards and does not account for other token releases.

The inflation rate is slated to progressively decrease by 15% each epoch year until it stabilizes at 1.5%. At the time of this writing, 71.6% of stakable SOL supply is staked, with these holders opting to avoid dilution from issuance. It's worth noting that tokens held by Solana Labs or the Foundation are not all considered circulating, despite not being locked. With a higher nominal yield than inflation and not all tokens staked, SOL's annualized real yield rate closed the quarter slightly positive at 1.1%, marking a 31% increase over the previous quarter.

While all initially distributed SOL tokens are readily tradable, secondary transactions that involve re-locking tokens, like grants or token acquisitions, can introduce inflationary pressures. Notably, Alameda and FTX purchased more than 57 million SOL tokens from the Solana Foundation and Solana Labs. However, these tokens are subject to various unlock schedules, with the average unlocking expected in Q4 2025, though the locked accounts might be sold over the counter. In a pretrial hearing on September 13, FTX received approval to liquidate its cryptocurrency assets, leading to a period of negative price action for SOL, particularly in the derivatives market. This situation coincided with a substantial rise in open interest, primarily on the short side, resulting in near-yearly lows in funding rates. However, SOL rebounded at the end of the quarter and into Q4.

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Network Analysis

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Network activity, as gauged through non-voting transactions and individuals who pay fees, exhibited a decline quarter over quarter and reached its lowest levels for the year (excluding the network disruption on February 25, 2023). The average daily volume of non-voting transactions contracted by 25% from the previous quarter to 24.7 million, while the daily count of fee-paying participants dropped by 37% quarter over quarter to 94,100.

In cases where applications cover gas fees on behalf of the end users, the number of fee payers does not accurately represent the user base. On the other hand, the average daily signers, which includes these users, experienced a comparatively milder decline of 23% quarter over quarter, reaching 235,500.

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The average daily count of new fee payers experienced a more pronounced decline quarter over quarter, plummeting by 76% to 11,400. It's worth noting that the second quarter's figure was artificially inflated by anomalous activity attributed to an unidentified program, which generated a substantial number of new addresses in mid-May. Subsequently, when the activity from that program ceased, those new addresses remained inactive in June, resulting in a notably low one-month retention rate of 2.5% for the May cohort. In contrast, the average one-month retention rate for the third quarter stood at 17.9%, aligning with the typical rate observed in the preceding year, excluding the May cohort.

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Solana transaction fees continued to maintain their position as one of the most stable and cost-effective options across all networks. In Q3'23, the average fee for non-vote transactions was just $0.0002. Priority fees played a crucial role in curbing network spam and cooperated with local fee markets to prevent any single popular contract from causing congestion within the network. The proportion of non-vote transactions utilizing priority fees has gradually decreased since the initial integration of this feature by numerous wallets and applications in Q1'23.

This quarter saw a 2% increase in the total staked SOL, bringing it to 404.9 million. Solana now boasts a substantial staking market cap of $8.2 billion, securing its second-place position, trailing only Ethereum. The amount of SOL staked has nearly returned to the levels observed before the FTX collapse.

Solana's Nakamoto coefficient declined by 12% quarter over quarter, now standing at 29, although it continues to rank among the top players in the industry. The number of validators witnessed a slight uptick, increasing by 5.5% over the same period, reaching a total of 1,984. In their October validator report, the Solana Foundation revealed its intentions to implement alterations to the delegation program, aiming to promote a focus on node quality rather than sheer quantity. Currently, the delegation program holds over 73 million SOL.

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The Nakamoto coefficient represents the minimum number of nodes required to disrupt the network. This concept can be applied not only to all nodes collectively but also across various dimensions that are crucial for the robustness of a validator network. These dimensions encompass the distribution of stake by geographic location, hosting providers, and clients.

Solana validators are now active in 34 different countries, marking a 10% increase quarter over quarter and a substantial 27% growth year over year. The United States leads the way with a significant 29% share of the total stake, approaching the critical threshold of 33.3%. This results in a geographic Nakamoto coefficient of 2 for Solana. In light of this, the Solana Foundation, as mentioned in its recent validator report, intends to address the increased stake share in the U.S. over the past year as it nears the 1/3 threshold.

Solana validators are spread across 312 distinct data centers, reflecting a 10% quarterly increase and a substantial 34% annual growth. This configuration gives Solana a data center Nakamoto coefficient of 6.

The hosting provider Nakamoto coefficient for Solana is 3, encompassing TeraSwitch, AWS, and OVH, as outlined in the validator report.

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Performance, Upgrades, and Roadmap

Validators began switching to the V1.16 upgrade at the end of August. Some small bugs appeared which were ironed out with the help of the community. By Epoch 510, which began on September 28, a supermajority of stake was running the new software. Validator operators noted significant reductions in memory after the upgrade. Beyond RAM optimizations, other new features in V1.16 include:

• Support for SPL Token22 Confidential Transfers. Confidential Transfers use zero-knowledge (zk) proofs to encrypt balances and transaction amounts of SPL transfers. Users can provide read access to other accounts, enabling confidentiality without sacrificing on auditability. Confidential Transfers will be enabled on mainnet beta in late 2023.
• Improved efficiency for verifying zk-proofs and support for 128 elliptic curve operations (equivalent to EIPs 196-198).

For more on V1.16’s upgrade process and features, refer to this Helius article.

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V1.17, estimated for early Q1’24 mainnet launch, will bring even more zk support, potentially including Poseidon syscalls.

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The Solana network's remarkable uptime since the February 25 outage is approaching an all-time high. This achievement is attributed to various upgrades and new technical features implemented over the past year, including QUIC, stake-weighted QoS, and local fee markets.

Solana's impressive performance, particularly the Solana Virtual Machine (SVM) and its tech stack, has garnered interest from external parties. Notable developments involving the SVM include:

1. MakerDAO: Founder Rune proposed exploring the use of the SVM to power the Maker Protocol and its subDAOs. He cited Solana's technical excellence, multiple client implementations, robust ecosystem, and history of being forked for app chains like Pyth as reasons for considering Solana's codebase. It's important to note that any such implementation is in the early stages.
2. Eclipse: Initially a rollup-as-a-service provider using the SVM, Eclipse shifted to becoming a general-purpose Layer 2 (L2) platform powered by the SVM. While some saw this as a potential win for Ethereum, many Solana community members welcomed the move.
3. Rome: The Rome Protocol, which leverages Solana as a shared sequencer, was introduced. This shared sequencer network will be deployed as a smart contract on Solana, with each rollup using it represented by their own Neon EVM deployment. Neon EVM is an EVM engine deployed as a smart contract on Solana, but it received some initial criticism from the Solana community for its tokenomics.

Additionally, two days after Neon's launch, Solana Labs released Hyperledger Solang, a compiler enabling developers to write Solana programs in Solidity. While Neon allows developers to create EVM contracts that can run on Solana, Hyperledger Solang allows developers to write Solana programs using Solidity instead of Rust or C.

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Ecosystem Analysis

Over recent quarters, we've witnessed significant expansion within the Solana DeFi ecosystem, particularly from emerging protocols that identify themselves as part of 'Solana DeFi 2.0.' This designation signifies their dedication to steering clear of the predatory, low-float tokenomics that characterized the previous cycle. Furthermore, many of these protocols have not yet introduced their native tokens.

MarginFi, a leading example, introduced a points system on July 3, rewarding users for depositing, borrowing, and referrals. Their TVL surged by 743% QoQ, making MarginFi Solana's sixth-ranked DeFi protocol with $22 million TVL. Towards the end of the quarter, MarginFi launched its liquid-staking token, LST.

Cypher, a perpetuals exchange, adopted a points system in mid-July, but experienced an exploit in early August. To help affected users, Cypher accelerated its CYPH IDO, allocating over 50% of CYPH to the community.

Solend, a major lending platform, introduced its points program in early August, linking it to its existing token, SLND. This led to a 43% QoQ TVL growth to $57 million, supported by the points system.

Other noteworthy DeFi developments include:

• Phoenix, an on-chain central limit order book exchange, officially launched in August and saw substantial trading volume for the SOL/USDC pair, despite a lower TVL.
• Drift, a perp DEX, achieved impressive Q3 growth, ending with $17.3 million TVL, marking an 87% QoQ and 976% YTD increase.
• Solflare wallet launched a MetaMask Snap with nearly 19,000 downloads, allowing users to store Solana tokens and NFTs, bridge from EVMs to Solana, and access Solana apps.
• Jupiter introduced its V3 in July, enhancing price discovery with the Metis routing algorithm and offering new features like limit orders and a bridge comparator.
• Maple Finance returned to Solana in early September, offering a cash management solution with a $4.2 million TVL by quarter-end.
• Circuit launched Circuit Vaults' private beta and secured funding from investors, including Multicoin. It partnered with Drift to allow users to deposit into the Supercharger Vault.
• Various other developments, such as tBTC integration, Credix's USDC receivables pool, Kamino Creator Vaults, Zeta V2, and the EUROe stablecoin launch

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Liquid Staking

With a substantial portion of SOL not actively participating in the ecosystem due to its high staking rate and low liquid staking rate, various liquid staking protocols are implementing incentive programs to address this challenge, aligning with the DeFi ecosystem's trends.

Blaze, a liquid staking protocol, initiated a points system in early August, rewarding bSOL holders and boosting their rewards for DeFi activities. Subsequently, it launched its token BLZE and airdropped it to users based on their points, with 64.5% of BLZE supply designated for airdrops. Blaze's SOL TVL surged by 1,234% QoQ to 452,000 SOL ($9.2 million as of September 30, 2023).

Jito introduced its points system in mid-September, rewarding JitoSOL holders and experiencing a 227% QoQ TVL growth to 2.4 million SOL ($48.8 million as of September 30, 2023).

Marinade, an established player in liquid staking, launched a rewards program in mid-September to stay competitive. It also introduced Marinade Native, a stake automation platform that directs stake to top-performing validators without fees or smart contract risks.

MarginFi introduced its LST token at the end of the quarter, offering a unique approach with a focus on higher staking yields and MEV-boosted rewards.

Additionally, the liquid staking ecosystem is enriched by protocols like Super Stake and Sanctum, both contributing to increasing Solana's liquid staking rate.

While these protocols compete for market share, their shared goal is to boost Solana's liquid staking rate. The Solana Foundation's plan to move some of its native staked SOL to liquid staked SOL could provide a significant impetus to this objective.

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NFTs

After a spike on the last day of Q2 from the Solana Monkey Business raffle, average daily NFT volume fell 57% QoQ to $1.1 million. Sales and unique buyers were both down QoQ as well.

Notable NFT developments from the quarter include:

• Tensorians, Meegos, Reavers, Gates of BroHalla, and VTOPIANS mints, among others.
• On September 23, virtual horse racing game Photo Finish LIVE’s over-two-year-old NFT collection became the top Solana collection by floor market cap. Activity was likely driven in anticipation of its fourth virtual Kentucky Derby (officially licensed), which occurred on September 23. However, by the end of the quarter, Mad Lads regained its position as the top collection by market cap.
• Magic Eden regained majority marketplace volume share over Tensor at the end of the quarter for the first week since mid-June. Tensor’s market share started the year at 1.2% and hit a high of over 74% in early August.

Source: Top Ledger

In the beginning of Q2, Solana introduced state compression, an upgrade offering a cost-effective method to store data on-chain through Merkle trees and posting the root hash on-chain. This feature found its first significant application in the compressed NFTs (cNFTs) standard, developed by Metaplex. The cost to mint and store 1 million cNFTs ranges from 5.3 to 63.7 SOL, compared to 24,000 SOL without compression.

During Q3, nearly 45 million cNFTs were minted, marking a remarkable 316% QoQ increase. DRiP played a prominent role in this growth, securing an 87.5% market share and partnering with artists for free NFT art mints. In mid-August, DRiP also announced a $3 million seed round led by Placeholder.

Dialect, a Web3 messaging application, embraced cNFTs for its Dialect stickers. Additionally, Tensor introduced its Tensorian cNFT collection in August, generating around $7 million in total trading volume for Tensorians and Tensorian Shards during Q3.

Since May 2023, Tensor has dominated the cNFT marketplace. However, Magic Eden recently joined the competition, adding cNFT support in mid-September. Despite this, Tensor has retained a substantial market share at 97.2% of the trading volume since Magic Eden's cNFT integration.

A new cNFT application emerged in early September with developer kiryl's cNFT multi-burning tool, introducing "Burning Man" quests to incentivize users to burn specific cNFTs for a chance at prizes

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Gaming

Beyond Photo Finish LIVE, other notable gaming developments include:

• Star Atlas SAGE Labs: Star Atlas launched early access for its SAGE Labs open-world game in late September, with users competing for $1.2 million in prizes. Since every action takes place onchain, SAGE has driven a notable portion of Solana’s overall transaction count.
• Bonk SVB: On August 1, meme coin Bonk launched Silicon Valley BONK (SVB), a sort of onchain raffle game where users compete to be the last to buy a key, receiving a portion of the funds from key purchases if victorious.
• The Heist Season 2: Popular idle game The Heist returned for its second season in mid-August, along with a new in-game currency and NFT collections. In mid-September, mobile support was added. The Heist led all NFT collections in Q3 volume.

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Social

One of the biggest stories across all crypto in Q3 was friend.tech, which displayed the potential for a social app to become crypto’s breakthrough use case. Solana’s social applications include:

• Access Protocol: Access is a creator monetization platform. It onboarded 21 new creators in Q3, bringing the total to 38. The total number of subscribers doubled QoQ to 227,000.
• Solarplex: Web3 social media platform Solarplex opened its V2 for early access in mid-August, garnering initial traction.
• SolLinked: In mid-August, Solana Labs cofounder Anatoly Yakovenko tweeted about a “LinkedIn version of friend.tech”. A little over a week later, developer darksoulsfanlol built it. SolLinked allows users to set up email and calendar accounts and set a price on an email response or calendar booking, using TipLink and USDC for payments.
• Friendzy: Friendzy is a more traditional friend.tech fork, although an account’s keys can be traded before that account is initiated by the owner. After launching in mid-September, Friendzy TVL peaked at $190,000 on September 26 but ended the quarter at $76,600.
• Hub3: Hub3 is another friend.tech spinoff, with some added features like group chats, discovery tools, and NFT whitelisting services. It launched on September 24, with activity picking up after quarter end

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DePIN

Solana is emerging as a central hub for DePIN (Decentralized Positioning, Identity, and Networking) applications, with notable participants like Helium, Hivemapper, Teleport, Render (planning a migration to Solana), and GenesysGo.

Key Q3 developments include:

1. Helium: In April 2023, Helium, a decentralized wireless network, transitioned to Solana. In mid-August, Helium Mobile introduced an exclusive $5 monthly unlimited phone plan for Miami residents, making use of the network.
2. Hivemapper: Hivemapper, focused on creating a decentralized global map, unveiled 'Hivemapper Bursts' at the end of August, offering extra HONEY rewards for mapping hotspot areas requested by customers. During Q3, Hivemapper mapped over 1 million unique road miles, accumulating a total of over 3.3 million miles.

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Payments

Payments on Solana are gaining prominence as an 'Only Possible on Solana' (OPOS) use-case, with significant achievements this quarter, particularly the integrations with Visa and Shopify.

In early September, Visa announced an extension of its USDC settlement pilot to include Solana, alongside Ethereum. The Visa Crypto team provided an in-depth analysis of Solana, emphasizing the platform's potential to facilitate mainstream payment processes. The reasons cited include Solana's cost-effective and predictable fees via local fee markets, parallel transaction processing, rapid transaction confirmation, a robust network with numerous nodes, and the availability of multiple validator clients.

Towards the end of August, Solana Pay seamlessly integrated with Shopify, enabling Shopify merchants to accept Solana's native USDC. Shopify, accounting for approximately 10% of the total U.S. e-commerce sector, now offers merchants a virtually fee-less alternative to the standard 1.5%-2.5% fees associated with credit card processing.

Other notable payment developments include:

• TipLink Gift Cards: TipLink allows users to send Solana tokens with a link. In mid-September, it added functionality for purchasing gift cards with crypto, serving as an offramp for users who receive crypto through a link.
• Beam: Offramp Beam went live in mid-August, supporting Solana along with several other networks. It then launched an SDK at the end of the month, allowing developers to easily integrate the solution into their application.
• CandyPay Mobile SDK: CandyPay allows applications to enable Solana tokens in checkouts. In mid-August it launched its mobile SDK.
• Meso SDK Early Access: Meso opened early access to its SDK, allowing developers to integrate its on-ramp product into their apps.
• Helio WooCommerce Partnership and Wallet: Multichain payments platform Helio partnered with WooCommerce in early September to power crypto payments on WordPress. A week later, it launched its own self-custody Solana wallet, which allows users to log in using their email or Web2 social accounts.

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Privacy

Privacy is an increasingly important aspect of Solana's ecosystem, with a growing array of protocols enhancing privacy. In addition to the fundamental zero-knowledge (ZK) upgrades in V1.16, Q3 brought significant developments which include:

• Light Protocol: Light Protocols is a zero-knowledge layer on Solana building Private Solana Programs (PSPs). Light Protocol takes a UTXO-based approach to privacy. It also uses private state compression so private transactions cost exactly the same as regular Solana transactions. In early August, it released the first reference implementation for PSPs.
• Elusiv: Elusiv is another privacy-enabling layer that takes a shared pool approach. Near the end of August, Elusiv launched private token swaps, using temporary keys to separate the link between a user’s public key and their transaction. Elusiv swaps use Jupiter liquidity.

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Development

Ecosystem development is furthered by the resources and infrastructure built by Solana Labs and independent companies like Helius and Ironforge.

Notable releases in Q3 include:

• GameShift: Solana Labs released the GameShift API in mid-July, aiming to simplify Web3 game development.
• Helius Pyre: In mid-July, Helius launched Helius Pyre, an open-source platform that gamifies learning Solana development. Helius also released Test Drive, an open-source Postman-like tool for testing RPCs with documentation and examples.
• Solana Curriculum: freeCodeCamp released a free developer curriculum, walking developers through building 15 projects to help them get acquainted with building on Solana.
• Synthetic Assets Platform Implementation: Near the end of the quarter, Solana Labs released an open-source reference implementation of a synthetic assets platform.
• Other developments: The Graph integration, Ironforge’s Playground, four new Solana development courses, Ellipsis’ Verified Builds tool, and Magicblock’s gasless RPC API for gaming.

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Growth

Ecosystem is furthered by grants, hackathons, accelerators, and other initiatives put together by the Solana Foundation and independent organizations like Lamport DAO and Superteam.

Notable events in Q3 include:

• OPOS Hackathon: The Only Possible on Solana (OPOS) Hackathon was a community-run hackathon in August organized by Lamport DAO. Over 600 participants competed for $100,000 in prizes from 40 sponsors across 25 tracks. It was held in person, overlapping with mtndao’s hacker house. Top prize winners were Onda Protocol ($10,000, Compression track) and Ned Finance ($10,000, Jupiter track).
• Hyperdrive Hackathon: Solana Foundation’s online Hyperdrive Hackathon began in early September. Over 5,000 builders are competing for up to $1 million in prizes and seed funding across seven tracks up until October 15.
• Hacker Houses: The Solana 2023 Hacker Houses Tour, sponsored by Jump Crypto and Circle along with the Solana Foundation, provides a place for developers to build, find collaborators, and learn from community members. Hacker Houses were hosted this quarter in Berlin, Bengaluru, and Mumbai.
• PlayGG: The Solana Foundation hosted game festival PlayGG in mid-July. The event featured demos, livestreams, tournaments, and workshops highlighting several dozen Solana-based games.
• Even more events and initiatives included quest platform Layer3’s launch, Solana Summer Fest, sessions on how to host Solana developer workshops, demo day for accelerator Solana University, and the Monacode Hackathon.

Upcoming Q4 events include Solana’s annual Breakpoint conference, the Hong Kong Hacker House, Encode Club’s Solana accelerator, Berlin Demo Day, and more.

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Conclusions

In Q3, despite the challenging market conditions, Solana's ecosystem witnessed substantial growth and activity across DeFi, liquid staking, consumer, DePIN, and privacy protocols. Compressed NFTs (cNFTs) emerged as a prominent use case for state compression, with nearly 45 million cNFTs minted during the quarter, representing a remarkable 316% QoQ increase. DRiP, a free collectibles distributor, accounted for the majority of these mints. Solana's DeFi Total Value Locked (TVL) defied the market trend, surging by 32% QoQ to reach $368 million. This growth was predominantly driven by the introduction of points programs by DeFi and liquid staking protocols, with notable players including MarginFi, Jito, Cypher, and BlazeStake, among others.

Solana's underlying technology is gaining recognition and adoption from external entities, exemplified by Rune's proposal to explore a Solana fork for MakerDAO, the launch of the SVM-powered L2 platform Eclipse, and Visa's integration for payments on Solana. Additionally, Solana's tech saw enhancements in Q3, including the V1.16 upgrade, which reduced validator memory requirements, introduced features required for Confidential Transfers, and enhanced support for zk-proofs.

Finally, SOL's market capitalization expanded by 17% QoQ to reach $8.4 billion. This growth persisted despite concerns surrounding FTX's liquidation of over 57 million tokens, with an average unlock date in Q4 2025. However, the locked tokens could still be sold over the counter. In conclusion, Solana's network and ecosystem are poised to emerge from the bear market in a stronger position than they entered.

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Analyst's Disclosure: I/we hold a beneficial long position in the shares of SOL-USD and ETH-USD, either through direct stock ownership, options, or other derivatives.

I authored this article independently, reflecting my personal opinions, and I am not receiving any compensation for it. I do not have any business affiliation with any company mentioned in this article.

Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor.