Tezos Baking Economics — Guide
You’ve likely reached this guide from the Tezos Baking Economics model here:
This guide aims to explain some of the assumptions and caveats relating to the above set of projections modeling the operations and financials of baking in Tezos.
For anyone unfamiliar with the details of Tezos, here’s a good guide from the Tezos Foundation: https://tezos.gitlab.io/master/whitedoc/proof_of_stake.html
Caveats and Explanations of Model
Profit vs XTZ Price Relationship
- Definition: The tab of Annual Profit/Rev vs Price was created to help quickly establish an understanding of how profitable it will be to operate a Tezos node based on XTZ held in relationship to the XTZ price. In the assumptions tab, you will find the re-occuring costs (hardware setup, cloud ops, and marketing/community).
- Significance: Use this chart to assess the potential one-year profitability of operating a Tezos node based on the projected price of XTZ (if the earned XTZ were exchanged for fiat currency at the labeled XTZ price). See the profit vs price tab in the model linked above to dig in further.
Tezos Total Supply
- Definition: The total amount of XTZ supply is currently projected to grow at 5.5% year over year. In other words, the current annual inflation of XTZ is 5.5%. This annual inflation is currently set to decrease over time if reward amounts and other factors stay constant as the annual total new rewards generated as a percent of overall XTZ supply will decrease year over year.
- Significance: The total Tezos supply is assumed by the model to be 763,306,930. The increase in Tezos Supply isn’t currently modeled as there is no authoritative source yet on the current supply to verify correctness. However, the net new Tezos supply should always be the total rewards generated minus the total XTZ burned (due to certain malicious baker activities as punishment) during a period. Given the large current supply and the relatively small number of total new rewards generated since Tezos launch, the impact of not modeling the supply growth is small. However, the impact will grow as the total supply deviates further from 763,306,930.
Average Time Between Blocks
- Definition: The average amount of time to generate a new block in the Tezos blockchain is aimed by the Tezos foundation to be 60 seconds.
- Significance: Data captured by the actual daily performance of Tezos since June 30, 2018 seems to suggest that blocks are on average created every 64 seconds. Since each Tezos cycle contains 4096 blocks, the difference in performance times have a non-trivial impact on number of days required to complete a Tezos cycle.
- Definition: Since Tezos operates by Proof of Stake, XTZ holders are expected to stake their XTZ. The Total Network Staking Percentage is the amount of XTZ participating in baking and endorsement either via direct participation or delegation. The staking percentage has a real impact on both bond requirements (defined below) and rewards being generated from baking and endorsing. A lower staking percentage means there are fewer XTZ participating in baking and endorsement thus increasing the probability that XTZ that are being staked to be selected for baking and/or endorsing more frequently. Although this means more rewards for the bakers and/or endorsers, this also means a higher bond requirement given the increased participation.
- Significance: It is generally assumed that with wider adoption given increased PR, the stability of the Tezos infrastructure, and more accessible XTZ marketplaces, that the staking percentage will increase. Given the infancy of Tezos, it is challenging to model the growth of staking percentage. We’ve assumed a plateau in staking percentage of around 55% for now but this is easily changed in the model.
- Definition: To discourage bad actors and ensure correctness of new blocks being generated, every time a baker participates in baking or endorsement, she is required to put up a bond (i.e. security deposit) for 5 cycles. For baking, 512 XTZ is required for the bond whereas 64 XTZ is required for endorsing. Assuming no harmful activities have occurred during baking and/or endorsing, the baker gets her bond back at the end of 5 cycles after the bake or endorsement. The baker cannot bake or endorse if she doesn’t have the required bond amount.
- Significance: The current model approximates the bond requirement per cycle by assuming that the total bond of the network is 8.24% of the total XTZ supply. In other words, given that only the active bakers are contributing to the bond, although the number of XTZ in the total bond is the same, the bond required per active baker as a percent of the baker’s total XTZ is higher than 8.24%. For more details, the calculations are reflected in the spreadsheet.
- Definition: Holders of XTZ can delegate their XTZ to bakers if the holders don’t want to bake themselves either due to the risks associated with bonding or the complexities of setting up a baking operation. Delegators should be aware that a baker should only take as much delegation as the baker can bond. The current model assumes that the baker operates with a full delegation.
- Significance: To participate in the growth of XTZ, holders of XTZ should choose a credible baker.
Baker Selection Criteria
- Definition: Bakers and endorsers are randomly selected 7 cycles prior to actual baking or endorsing. A snapshot of the number of XTZ rolls (i.e. groups of 10,000 XTZ) owned by each baker (and thus delegate) is taken every 256 blocks, or roughly every 4 hours. This equates to 16 snapshots per cycle. One snapshot is then randomly selected for choosing the bakers and endorsers that will operate 7 cycles later.
- Significance: The current model assumes no selection bias (and therefore a completely random) selection of bakers and endorsers. The model then assumes a probability for the baker being selected for baking and endorsing based on the number of XTZ rolls held as a percentage of total XTZ rolls staked. Rewards are then derived from the number of assumed bakes and endorsements.
- Definition: The price of XTZ as with any cryptocurrency, fluctuates. For the latest XTZ price, checkout: https://coinmarketcap.com/currencies/tezos/
- Significance: There is a default USD XTZ price included in the model for monetary calculations (e.g. revenue and profit). However, this can easily be modified to other currencies and amounts. The rest of the numbers in the spreadsheet should automatically update once the XTZ price is updated in the Summary tab.
Period of Projections
- Definition: The model projects for 12 months. However, the number of months in the 12 Month Model tab is dependent on the cycle length which is in turn dependent on the average time between blocks. The Dates row in the 12 Month Model tab will dynamically change according to the Average Time Between Blocks input in the Summary tab.
- Significance: The current model assumes that baking starts near October 1, 2018, and ends near October 1, 2019. However, this is adjustable — just ensure that the relevant One Year Summary in the Summary tab is modified accordingly.
Feedback and suggestions for changes/corrections welcome.
Thanks to Andy, Matt, and Lorien for review and feedback about the above article. If you’d like to learn more about the Figment Networks Baker and our unique approach, please email at email@example.com