Why is inflation even needed? It sounds like inflation is a good way to redistribute the transaction fees, but from the docs it appears that inflation is set to 1% yearly, which is probably more than the total transaction fees.
So what's the reasoning behind it? In Bitcoin, it's used to incentivize miners by creating new coins. What's the rationale in Stellar?
A deflationary currency like Bitcoin gives an incentive for hoarding. From an economic perspective, this isn't a good thing, as it decreases the liquidity of the asset and makes it less useful as a currency: nobody will want to spend their bitcoins if they expect their value to increase due to the limited supply alone.
Bitcoin's inflation rate is currently around 4% per year, so we don't feel these effects as much. But once all 21 million coins will have been mined, the only way to acquire Bitcoin will be to buy them from someone who already has them. Wallets will inevitably get lost over time, so the supply of useful Bitcoin is bound to decrease, adding to this effect.
Stellar is more focused on creating a currency that can serve as a medium of exchange i.e. solving the problem of fast and cheap money transfer, rather than an immutable store of value like Bitcoin is evolving to be.
As inflation is returned to current owners who subscribe to inflation pools, it does not decrease the value of their lumens. Also, it is a fixed and predictable value, so there is no risk in experiencing periods of hyperinflation. The biggest disadvantages inflation has for fiat currencies are thus avoided.
More philosophical than technical.
Why is inflation even needed?
The reasoning behind inflation lies inside its code. Think of it as a way to recycle the data in such a way to make the ecosystem flow better. Aside from transaction fees being a security feature, the real reasoning was to be like Bitcoin, without the flaws Bitcoin has:
1) Mining is completely centralized and seeing what happened to Bitcoin with Chinese miners patenting ASIC chips in order to mass produce mining operations shows just what kind of world you live in. The way SCP is, anyone can participate without being at the mercy of miners who run monopolies.
2) Mining is a waste of energy and the Stellar platform proves just how much better of a blockchain you can have by using a fraction of the energy Bitcoin is using.
The guide that explains the inflation mechanism shows that extra lumens are recycled in a sense, and redistributed in order to keep the system afloat without causing volatile changes. Why would they need to keep the system afloat? That leads to the next question:
What's the rationale in Stellar?
Stellar's intention is to be what Bitcoin was supposed to be: an open source community that cooperates with one another and to get away from the old financial institutions that barred many from entry. The Stellar Network solves just that and much more. Also the problem with Bitcoin is its energy cost with mining, and thus its incentive to continue has limitations. This is very crucial and Stellar has thought of a workaround by adding the Stellar Consensus Protocol, trusted nodes that verify transactions, and inflation. This way this ecosystem can stay afloat for a long time, at low-cost, while still giving incentives to be part of an amazing system:
"... a distributed, hybrid blockchain that is fully open-source. It is infrastructure that exists to facilitate cross-asset transfers of value, including payments."
On Stellar, inflation is calculated as 1% of the total supply plus the total fees charged on the network for transactions during the inflation period.
Every week when inflation distribution is made, the total amount distributed is calculated as such:
(1% of total supply / 52 weeks) + total fees during week
Then that amount is distributed proportionally to accounts with a balance higher than 0.05% of total supply OR accounts that have votes that account to more than 0.05% of the total supply.
That being said, the 1% inflation is probably in place to stage Lumens more as a monetary device (used in daily transactions) than as a store of value.
You might have already seen the Inflation page on Stellar's website but if not, it provides a good overview on how it works. Hope this helps!
The inflation mechanism was disabled (see CAP-0026) in protocol version 12, which was approved by validators on 10/28/19. After this date no further inflation payouts were made. Source
Quoting CAP-0026:
Inflation mechanism was originally planned as a simple way for users to support important ecosystem projects and keep the overall XLM supply slightly inflationary.
