Not every Tezos holder will own the minimum of one roll (8,000 ꜩ) or have the technical knowledge or expertise to become a baker. Delegating is a process that lets Tezos token holders delegate their right to produce a block to a baker, who can do so on their behalf. Delegates manage their tokens through a private key called the manager key. The owner of a manager key can specify a public delegate key. The entity delegated to has the right to take part in PoS and governance on behalf of the token holder.
Delegating lowers the barriers of entry to participate in staking for the average user. While bakers receive higher rewards for staking, they also pay for hosting, maintaining node infrastructure and risk having their funds seized for poor performance.
Tezos Staking Rewards
Staking rewards incentivize participation in the blockchain’s consensus mechanism. It also offsets the impact of inflation on users’ funds. As token holders receive assets in reward for staking, their holdings increase in line with network inflation, as more assets are added to the overall circulating supply.
Rewards issued for staking vary given the level of network participation. As more people participate, the rewards will be lower. As participation decreases, the reward will be higher. If all Tezos token holders bake with their tokens, the baking rewards would be near 5.51% per year. In reality, the rewards for token holders who delegate are less than that of baking directly, as delegates share rewards. The portion of rewards kept by baker is known as a ‘fee’, which ranges from 5% and 20%.
What makes a good validator?
Good bakers are those who perform well consistently, put up a healthy security deposit and contribute to the health of the network. Here is an outline of the key considerations for what makes a good validator:
- Financial Considerations: Selecting a validator requires considering what amount of funds they will receive for performing their services as commission.
- Capacity: Bakers have a capacity of how many coins they can accept. A baker is ‘over-delegated’ when the delegated coins go beyond the limit of what they have set.
- Reliability: Baker reliability is key, meaning they have a proven track record of paying out reliably and consistently.
- Security: Security means having a secure setup and that they have not acted maliciously in the past (i.e. double baking).
- Tezos Staking Risks
Delegating funds is risk-free, as the tokens are never locked or frozen. This is because a token owner simply delegates their right for a baker to mint blocks on their behalf, rather than sending the funds themselves. For delegators, it is important to be vigilant about bakers not paying rewards. This is because rewards are not automatically distributed by the protocol itself, rather by the bakers. However, such behaviour is quickly identified by the community and delegators can easily switch to a better baker which doesn’t misbehave.
If a baker behaves dishonestly, the protocol can punish that actor by seizing their security deposit. Such security deposits are in place to prevent Nothing-at-Stake attacks on a PoS blockchain, ensuring participants have “skin in the game”. Security deposits for baking are 512ꜩ, and 64ꜩ for endorsing. These deposits are locked up for 5 cycles, roughly 14 days. These deposits are slashed in the case of double baking / endorsing.
The network is alerted of bad behaviour with accusations. These can be made by a baker if they discover two endorsements have been made for the same slot, or if a delegate has created two blocks for the same height. An accusation forfeits the safety deposit and reward of the delegator or endorser at that point in the cycle.
Becoming a baker requires both knowledge and specific hardware. The full list of requirements is outlined here.