Overview of Tezos
Tezos launched in June 2018 as one of the world’s first major Proof of Stake networks. Today, Tezos has a vibrant ecosystem of network validators (bakers) and diverse public delegation services internationally.
Tezos is an open-source, community governed blockchain supporting complex smart contracts which enjoy censorship resistance, decentralization and user-control. Tezos maintains a form of on-chain governance which doesn’t require hard forks, meaning the protocol can upgrade gracefully over time. The Tezos consensus mechanism relies on Proof of Stake, in which nodes participate in reaching consensus on the state of the blockchain using user owned tokens as the resource for doing so. The Tezos consensus approach has been described as Liquid Proof of Stake, as stake can flow easily between bakers, requiring no lock-up or freeze to participate.
Tezos smart contracts are written in the language called Michelson, designed for security and formal verification first. Formal verification means that high-value, high-assurance decentralized applications (dApps) can be run on Tezos with confidence.
XTZ is the native token of the Tezos blockchain. Ownership of XTZ grants holders the right to participate in consensus and also governance decisions. XTZ is commonly referred to as ‘stake’ in the Tezos ecosystem. It is issued as a block reward for those that participate in consensus.
Tezos’s Proof of Stake Ecosystem
The Tezos consensus protocol called Emmy+ is a Nakamoto-style Proof of Stake (PoS) consensus algorithm. Proof of Stake removes the heavy environmental load required to maintain Proof of Work (PoW) blockchains such as Ethereum or Bitcoin, while also encouraging community participation in the consensus process.
Tezos block creation relies on a process called baking. Baking is the act of signing and publishing blocks to the Tezos blockchain. Baking achieves the same result in achieving consensus as Bitcoin’s mining, yet it relies on users’ stake rather than an external resource such as electricity. Bakers can create blocks if they have at least 8,000 ꜩ (the symbol for the native Tezos XTZ token), which is one roll. A roll represents a set of coins delegated to a given key. Bakers with more rolls have a higher percentage chance of producing the next block, as they represent a bigger stake in the system. Bakers have the opportunity to produce blocks during a cycle. A cycle consists of 4,096 blocks, lasting 2 days, 20 hours and 16 minutes. Roll snapshots are taken every 256 blocks, to determine the baking rights of every baker. This is 16 times per cycle. Bakers who perform their duties well are rewarded with block rewards, earning them the XTZ token.
The Tezos blockchain grants the right to mint a block by selecting a random roll in a randomly selected roll snapshot. The protocol generates a random seed for each cycle, which is used in the secure lottery to grant baking rights during a given cycle. It is possible that the same public key will appear multiple times in the list of keys selected to mint the blocks in a cycle. As time moves on, those selected in a list for block production are granted the opportunity to mint a block during their allocated slot. If one baker misses their opportunity, the next delegate can bake the block. The indexes of these slots are called priorities.
Participants in Tezos can also endorse blocks rather than baking. At every block, 32 random rolls are selected randomly to endorse a block. Endorsing a block is seen as a vote of confidence. They are included in the next block. The more endorsements a block contains, the healthier the chain. Similar to baking, endorsing is also rewarded with newly minted ꜩ.
How to get started with Tezos staking
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.
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.
Baker reliability is key, meaning they have a proven track record of paying out reliably and consistently.
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.