Decentralizing the ‘Delegation Service’
How Bakepools form and operate (Bakepool Series — Part 2)
The Tezos network is decentralized (as a distributed network comprising hundreds of baking nodes) but Tezos baking ‘Delegation Services’ are not.
Bakepool is an open-source tool that enables bakers to form a new class of Baking Delegation Services — services that are self-organized scalable pools entities consisting of multiple bakers, with an equitable delegate distribution engine, and role-driven multi-sig.
Through the bakepools, the decentralized Tezos community will have a mechanism to prevent the mass-consolidation of the delegation landscape by institutional bakers. In fact, even institutional services will naturally prefer to delegate through bakepools instead of running an in-house baker. Institutions like Coinbase and Binance will prefer this for economic reasons, and not simply philosophical ones.
Status Quo problems for Bakers (sorry, but it’s true)
Most bakers face 2 enormous competitive hurdles in the coming 1–2 years:
- Point-of-Sale advantage of institutional bakers
(people just delegate their Tez to whatever’s closest/in-front of them — i.e. whatever wallet, exchange, or OTC they bought their Tez)
- Scaling/Capacity advantage of institutional bakers
We’ve already seen these threats by Binance and Coinbase. Coinbase is now the largest Tezos baker with the most capacity of any delegation service which, when full, comprises over 5% of all Tez in circulation. Not to mention, Coinbase owns other staking operations such as Staked.us which would increase its tank by another 20–25%.
The only way that the average-sized Tezos baker will be able to compete with the scaling advantage of these large institutional goliath bakers like Coinbase and Binance, is to first be able to scale to the capacity of those goliaths. Not as individuals, but as collectives. Recall how hominids in the cognitive revolution realized that banding as tribes to share resources, knowledge, and protection offered strategic advantages over ‘going it alone’.
Instead, of delegating to a baker, the delegator will be able to delegate to a bake-pool which passes the delegation load equitably to many different bakers within its collective.
Bakepool’s technology enables solo-bakers to self-organize into collective entities to match wits on a pound-for-pound level with the likes of large institutional bakers like Binance and Coinbase, by the measure of delegation capacity, as well as in other ‘intangible’ scaling factors like branding, marketing, customer service, and administrative duties.
There are many types of “Capacity” being pooled in a bakepool:
- Delegation capacity
- Bargaining power — (See Nash theory)
- Labor-hour capacity—Administrative duties
- Cognitive capacity — Stress; How much can one human baker handle?
- Branding capacity — Standing out in a noisy marketplace
Bakepools enable the scaling of all of these, but this article will focus on Delegation capacity since that’s what leads to the rest.
Starting a Bakepool
Each bakepool smart-contract starts with the originator of that contract who will serve as that bakepool’s Bakepool Captain (or just ‘Captain’).
- The Bakepool Captain (BPC; or just the ‘Captain’) originates the smart-contract and names the first participant in the bakepool (the first baker that will be joining that pool) and thereafter has the right to curate the list by whatever standards he or she desires. Over time decisions left solely to the Captain can become decentralized themselves and designated for a vote by Bakepool Partner Bakers.
- Partner Bakers (PB) are those bakers who join the bakepool, thereby contributing their unused delegate capacity as a resource to the bakepool, and become can collect a streamline flow of delegates. Captains have the authority to approve the entry of new PBs and remove them as well. Captains will also be able to defer authority on new additions or removals to all PBs at-large who would vote on those matters. PBs can opt to leave a bakepool at any time. Upon leaving a bakepool, the former PB baker can either return to operating solely as a solo-baker or by joining another bakepool.
Delegate Distribution through a bakepool
When a delegate delegates to a bakepool, either directly or through the default mechanism of an exchange, the delegate order is processed through an aggregator-delegator engine so that the order can be divvied equitably to all Bakepool Partners.
Of course, it will be unlikely that BPs have the exact same measure of capacity, and it is a quite likely occurrence that an equal distribution of delegates to all BPs would leave some BPs over-delegated, and others under-delegated.
Arithmetically, the delegation assignments follow a method derived from combinatorial auctions. The algorithm prioritizes attempting to maximize the number of BP participants and to minimize standard deviation. So long as a BP is not yet over-delegated the first disbursement of delegates from a new order will include their baker. The amount first distributed is the greatest common denominator (between all BPs in the bakepool with any degree of capacity).
Think of it like a game of Tetris, (as combinatorial matching is often analogized). Each vertical column is like a baker in a bakepool. The Tetris- pieces are like delegated Tez (XTZ). We’re trying to distribute the pieces as evenly as possible without going over- or under- for any column.
The baker’s activities should be minimal as though they were simply running their own baker and not accepting delegates. Logistical automation, such as those regarding payouts, will be integrated as well.
Advantages of Using Bakepools
Bakepools benefit everyone in the ecosystem from bakers to custody-oriented services, to customers that delegate to 3rd party services, to the Tezos ecosystem as a whole.
Better for Bakers
Finally, for most would-be bakers (and returning former bakers who previously quit the game because it wasn’t worth it) accepting baking delegations can become the passive-income machine that it was always dreamed to be. As a baker within a bakepool, you will no longer have to worry about marketing or administrative aspects running your own Tezos delegation service just to attract delegators. The captain will do all of that for you for their fair share of the rewards. Smaller bakers can join bakepools and collectively scale compete against institutional baking services — even in the face of Coinbase and Binance. Bakers will have a streamlined inflow of delegated Tez to fill your capacities as best as possible.
Better for Delegators (i.e. the customers)
If you are delegating your XTZ baking — by baking to a bakepool get the benefit of delegating your Tez to a distributed pool instead of relying on a central point of failure or success. If something happens to a baker in that pool or even a few bakers, the bakepool can still go on without you having to worry. Also, because economies of scale in this instance removes the cost and labor burdens for the individual bakers, fees can come down too. That is, bakers will accept less for payments if they only have to work a fraction of the time.
Better for Institutional services (e.g. Coinbase, Binance, AirGap)
Instead of running their own in-house bakers (which are a central point of failure) besides being costly to maintain, institutional services such as custodians, wallets, and exchanges, will do well by outsourcing to a bakepool or a several bakepools. (Outsourcing to bakepools will help nullify the ‘Point-of-Sale advantage’ hurdle that bakers are facing referred to earlier in this article.)
Why? On a strictly economic basis, 2 main reasons:
- Scaling — Even mighty-mighty Coinbase has been struggling with over-delegation, having gone over-capacity multiple times. Bakepools though, by nature of being distributed networks that can add on more bakers at any time (and with them, their capacities) are always more scalable than in-house bakers, and can help Coinbase!
- Cost Savings — These entities, by outsourcing to bakepools, get the benefit of reduced labor and overhead, as well as a lowered risk of damage for actuarial risk. This translates to a better bottom line.
Custody-oriented services can especially appreciate the risk management advantages bakepools bring to the table. Decentralization in this manner lowers the risk of failure (eliminates their own central point of failure), which will bring down their insurance premiums. Insurance, (along with compliance and reputability) are one of the main values offered by these goliaths custodians like Coinbase Custody.
Coinbase, for example, has been very fair and sensitive to the needs of the Tezos ecosystem. They do not want to be responsible for internal governance matters of the Tezos ecosystem, yet they nonetheless hold a lot of voting power. They’ve been doing the right thing from Day 1 — abstaining from voting, but as they’ve grown to facilitate delegation of over 5% of Tez in circulation (which could foreseeably grow to 10% or more) and as other institutions follow suit, it will become untenable for the majority of voting power in staked Tez to lay dormant. As more exchanges have begun to announce in-house baking services, the voting power that will come with their comparable scale can become quite a worry for the ecosystem.
Outsourcing to bakepools nullifies this risk and in fact, turns it into a positive. That bears repeating.
Outsourcing to bakepools nullifies this risk, and in fact, turns it into a positive.
Each bakepool Captain will decide how he or she will handle voting rights and this will be publicly disclosed to bakers and delegators as they do their research. How a bakepool chooses to orient its voting will even become a competitive trait of bakepools. It will be fascinating to watch. Here are some hypothetical examples:
- One bakepool could pass voting rights on to Partner Bakers because that’s what their constituency of Partner Bakers desires
- Another bakepool could be aligned with a particular governance ideology with regard to voting decisions and the Captain will vote for the entire pool as a representative of those interests
- Yet another bakepool could be completely agnostic and maintain voting rights for the delegators themselves. In fact, they could attract delegators on that basis alone.
So who makes money and how? Captains, respectively, must compete to make their bakepool attractive to all sides, and likewise, must do so by configuring their bakepool’s distribution table in a competitive manner. There are several layers of fee distribution that the Captain must configure for their bakepool:
- Fees to the Bakers
- Fees to the Bakepool Captain (which itself can be decentralized to many owners instead of just to one individual),
- Fees to the Affiliate service (such as a custodial service or exchange that outsources to a bakepool)
- The remainder, of course, goes to the end-owner of the XTZ
Right now, the median delegation service fee is 10%. You can see an index of fee rates at https://mytezosbaker.com/.
A sample example model of distribution would be:
- 5% to Bakers
- 5% to the Bakepool
- 5% to the Affiliate (exchanges, custodians)
Bakers, remember, you will not have the costs of time and stress of running an independent delegation service. Your Captain will handle all your marketing for you and the algorithm will make sure you get your capacity filled. If you feel your Captain isn’t delivering enough value with regard to the fee distribution table configuration, you can and should leave the bakepool and find a better bakepool. That’s the beauty of free-market competition.
In the final article of this series, I will detail how the decentralized ecosystem will blossom; on how bakepools will compete with one another, and how bakepools will evolve into multi-faceted services that would begin to flourish a lush diversity throughout the Tezos ecosystem. I will also discuss how the governance of a bakepool itself will evolve into different tiers of authority and how the democracy-quotient of each bakepool will become a key tenant of competition for bakers by bakepool captains.
Join the conversation:
Official Website — https://bakepool.org
Also, join our channel on the Tezos Baking Slack.
A thread is also open on Tezos Agora