Tezos — Economic effect of a supply crunch

*Disclaimer: The following article is not investment advice. Do your own research. I am merely making observations based on data collected.

As you may know, Coinbase Custody started supporting staking rewards around 5.4% for institutional investors which hold Tezos and now offers the same to retail.

This dividend incentive has a network effect that is compounded by the staking requirements of Tezos and the burden upon exchanges to maintain enough staking capacity.

This means for exchanges to provide users a simple path to staking they must acquire their own Tezos to stake 1/8th of user holdings or they run the risk of falling into a deficit against user staking rewards if they are under capacity.

Let’s look at the numbers:

• Total supply: 694m with annual inflation of 5%
• ~80% of supply staked
• ~140m XTZ that is available on the open market

How much of that available supply will be eaten up as exchanges hedge to avoid being in a deficit against user payouts.

Coinbase Custody
Holding: 5.2m xtz
Staking Reward: 5.4%
Staking Balance: 48.9m
Staking Capacity: 44.8m *

Coinbase is over subscribed and must acquire roughly 400k more xtz to match reward payouts they will owe institutional customers. This is only the institutional side. I do not have data on their retail side.

Kraken
Holding: 25.4m xtz
Staking Reward: 6%
Staking Balance: 25.4m
Staking Capacity: 215.8m

This appears to be retail, not institutional account. They are much further ahead of the curve to cover user payouts with capacity to 215m in a bull run if their user base goes 10x they are less likely to be under water.

Binance
Holding: 2.8m xtz
Staking Reward: 6%
Staking Balance: 21.5m
Staking Capacity: 24.1m

Binance stake is surprisingly small considering they have much higher volume in other assets. Possibly because they are outside of the US and this dynamic could shift when/if Binance.us offers Tezos staking.

Gemini

No announcements but seems its founders are fans.

Now what happens to the 140m available when Bitfinex, Gemini, etc. start competing to provide user rewards and avoid being in a payout deficit?

I’m not getting deep into other aspects of Tezos in this article but at a high level want to point out why the retail side should be consistent and scaling dynamics.

Community

Another interesting component of the Tezos blockchain itself is less risk of a community split like we’ve seen with Bitcoin with Bitcoin Cash and Ethereum with Ethereum Classic. Since network upgrades are voted upon by stake holders it is less likely we will see political disputes over simple upgrades.

We have all seen plenty of this where upgrades become political within a community, Most recently ProgPoW (although it was sorted out eventually). A fork is a network risk to the loss of investors, advocates, and developer talent. Once you see the impact of poor governance, you realize how important an effective governance model is.

Scalability

Tezos is currently around 40 tps. They are looking at using Tendermint as an upgrade which would put them at 1k tps. That’s fantastic but not ready for primetime if any of their STO activities are planning to be settled on-chain.

A combo like Tendermint with a batch processing solution like Stark could be quite effective. I’d also suggest if they are reading this take a look at Hedera’s consensus service as leaderless BFT is considerably faster and more scalable. Then you have sharding which does not ‘make the network faster’ but segments the load to shards so the overall network has more throughput.

They also have a layer 2 solution in the works similar to Plasma. Like Plasma, I’d expect it would take years before that would be ready for prime time.

Conclusion

I’m not speculating on what the value will be of Tezos in the short or long term. I do not really know. It will be interesting to watch. The biggest thing I think they’ve solved is governance. The network effect of a staking reward that institutional investors can get exposure to can be a catalyst to groups like Grayscale and others who want to provide exposure to a dividend like return for their customers. This creates a new backoffice dynamic that they can’t just hold a reserve like they do with bitcoin where each GBTC represents a fraction of Bitcoin. They have to actively stake which both powers the network, drives demand and locks up supply.