The Capital
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The Capital

What Tezos has to do with Baking

Forks are standard when a community supporting a specific blockchain can't agree on a way forward together. There have been several famous cases in which one blockchain project forked and resulted in 2 different communities, such as Bitcoin Cash and Bitcoin.

While such hard-forks can lead to creating chains catering to different needs, the founders behind Tezos wanted to create a network that wouldn't need to go through hard-forks, as these can be very disruptive to a nascent community.

Tezos has been developed since 2014 in Switzerland by Arthur & Kathleen Breitmann and a core group of developers. The mission behind Tezos was to "establish a true digital commonwealth."

Commonwealth: Is a group that chose to engage and support each other due to shared interests and common goals.

Tezos made headlines in July 2017 when they raised 232 million in their uncapped ICO. This was the then-biggest ICO in crypto history. Unfortunately, the project was soon overshadowed by legal troubles that unfolded between the two organizations supporting Tezos.

Dynamic Ledger Solutions (DLS) and the Tezos Foundation, run by Johann Gevers, got into a dispute about using the ICO funds. This led to problems with the community and, consequently, a drop in the exchange rate for the Tezos token (ZTX). Eventually, the team resolved the dispute, and Gevers left his position at the Tezos foundation after receiving $400k in severance.

With delays, Tezos officially launched its blockchain network in September 2018. Tezos is developed in a modular style with a self-amending ledger, generic blockchain protocol, which is divided into three layers:

  • Network Protocol: gossip protocol, responsible for peer listening and broadcasting information between nodes
  • Transaction Protocol: pretty self-explanatory, executing transactions and implementing the accounting model
  • Consensus Protocol: defines the method of finding consensus and helps reach agreements

Gossip Protocols: Gossip is a quite common concept in peer-to-peer networks that enables different nodes to communicate. The way it works is that when a new node B joins the network it consults with node A that is already in the network and pre-configured. A tells B about C, D, E and B will then connect with those nodes. When B now broadcasts new messages, it’ll inform A, C, D, E. Once they receive the message they will broadcast it “gossip” to their other peers F, G, H. etc.

The last two protocols combined are the Blockchain protocol which can communicate with the Network protocol through the network shell.

One of the most remarkable features of Tezos, despite its architecture, is how on-chain government is realized. To mitigate forks, self-amendment is implemented that helps upgrade the technology without a need to go through a fork. Stakeholders — users holding tezos token (XTZ)- can vote on upgrades of the system, which allows a smooth evolution of the network. The process works in the following way:

  • The developer submits a proposal to fix a bug or make a specific change to the network, including a request for compensation. The compensation incentivizes developers to contribute.
  • The proposal goes through a testing phase in which the community can test the protocol and make suggestions for further improvements.
  • After the testing period, Tezos holders vote on the proposal's implementation.
  • When approved, a "hot swap" will occur that kicks off the new version of the protocol. This whole process is similar to soft forks, which tend to be minor upgrades to the entire network without political division.

Thanks to this mechanism, tezos protocol upgrades will only happen after consideration from the community while guaranteeing that most tokenholders back every change.

Liquid Democracy

Voting on Tezos is working with a liquid Proof-of-Stake based on a concept of liquid democracy. Liquid democracy is flexible and allows a transition between direct democracy (everyone voting by themselves) and representative democracy (votes delegated to someone else). Tokenholders can either vote directly on policies or delegate their voting responsibility to a delegate who will vote on their behave. Delegates themselves can further delegate their voting responsibilities which are called sensitivity.

If the token holder disagrees with their delegate votes, they can easily take back their vote. This system has the advantage that each individual is represented, and to win someone's trust, you don't need to invest millions. It also allows minority groups to be accurately represented while being scalable.

Liquid PoS & Baking

Validating transactions in Tezos is done based on the Proof-of-Stake algorithm, but with some differences. Firstly, the process of staking in Tezos is called Baking. Every token holder can use their tokens for Baking or delegate their validation rights to another holder. Note that this is a mere transfer of validation rights. The token holder will still be owning their tokens.

Bakers receive block publishing rights based on the stake they own. To guarantee transactions' validity, every block is baked by a random baker and then notarized by another 32 random bakers. Once the block has sufficiently been validated, it is added to the blockchain, and the successful baker receives a block reward and the right to charge transaction fees for transactions in the block.

XTZ

The native token of Tezos is XTZ, also known as tezzie or Tez. Like most major cryptocurrencies, it's used mainly to run the blockchain, execute governance, and reward bakers that hold up the network.

Since launching in 2018, Tezos has experienced tremendous growth and survived the bear market triggered by the pandemic in early 2020. Tezos is currently trading at $3.93 with a marketcap of $3.37 Billion, which puts it at rank #49 in terms of market cap.

A few words on Decentralization

I actually first wrote this post when I was still working for an exchange. But we didn't end up using it because they didn't list Tezos before I left. Regardless, I thought it's worth putting it out there, but this time with a few critical words in the end after looking into how Tezos is faring when it comes to Decentralization.

Baking requirements & distribution

In PoS networks, it's always worthwhile checking who earns the most from them. Currently, 74% of the Tezos supply is baked (staked). That’s 680,919,583 Tezos. Bakers earn roughly 6.20 % yield on their locked tokens.

If you want to bake properly, you have to be ready to spend quite some money. 8,000 Tezos ($32,000) is the minimum balance needed to start as a solo baker. If you're like me and don't have a spare $32,000 of cash, you could delegate your Tezos to one of the many Staking providers such as Coinbase.

The total number of bakers is 462. Among the top 25 bakers, you might recognize a few names.

Top 25 Bakers by Staking Balance — Tezblock

In the next math exercise, I started adding up the staking balance of the top 10 staking addresses. The sum of the top 10 bakers' balance stands at roughly 335,346,000. Sounds like nearly half of the entire staked supply. Make of that what you will 😏

And suppose we were to go by the maxim that for true Decentralization to happen, anyone should be able to participate in validation. In that case, that's not possible for individual investors without going through middlemen like exchanges— which bears quite some irony.

Ownership

According to Messari, there are currently 1,827,602 Tezos wallet addresses — I am 2 of them btw because I bought some XTZ and then transferred to Umami wallet to get some cheap tezos NFTs. Anyway, that wasn't the point. The point is wallet addresses only say so much about genuine actual users, but they provide the best estimate we get.

So looking at the whale's list on tzstats, one will see a lot of exchanges. Unsurprisingly. To be able to put whatever balances they have into perspective, we need to know the circulating supply of Tezos:
868,745,249.

The top 10 addresses hold around 188,861,000 XTZ. As you can see, it's not separate entities, though. Various Coinbase addresses make up a significant portion of the holdings here.

Source

The top 20 addresses control roughly 31% of the circulating supply. Considering that these include various CEX addresses, one might see potential issues.

This is, of course, a result of the design of Tezos that makes it hard for ordinary people to bake unless they have $38,000 they can lock up in their baker node. When validation requirements are too high for average users to validate by themselves, you will end up with an element of centralization because those powerful enough to participate start offering it as a service. And in crypto, that's the exchanges. And maybe some VCs, but they usually just stake their own money.

I've probably said it quite a lot, but PoS networks with high initial stake requirements will end up having a bunch of centralized exchanges hold up their network. Is that ironic? Yes. Does it make a few people very rich? I mean, just look at CZ or SBF. Is it how blockchain was intended to be used? No.

For disclosure, as mentioned, I did buy some Tezos to buy some NFTs from Objkt from an artist I liked.

But I don't have a stake in it apart from the $100 I spent on Tezos-based NFTs. You can check out my random collection if you want here. I'll finish it with my latest purchase and the message I'd like to drive home. As long as you DYOR, and we keep educating: WAGMI.

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Naomi Oba

Naomi Oba

Writer in Crypto — passionate about financial education, blockchain, books, and food.