Tezos is a Proof of Stake (PoS) blockchain where, unlike the case of Proof of Work-reliant Bitcoin, transactions are validated on the network by a process humorously known as “baking.”
Typically, for a blockchain which relies on a PoS algorithm, the process of block validation is called “staking”. However, Tezos is a project which originated in France, a country famous for its baked goods. Consequently, the Tezos coins are grouped into “rolls” for the staking rights selection process, and that’s why the term “baking” became a natural fit.
Is Baking the New Mining?
In the early years of Bitcoin, it was possible to configure software on a reasonably-powered desktop computer to participate in mining on the network. It was a way to actually earn new bitcoins without any serious investment in computer hardware. The year of 2014 was fairly pivotal for Bitcoin mining as the difficulty of math calculations to validate new blocks began to significantly increase, meaning that smaller mining operations would have to begin investing in equipment. Those that did not keep up ended up falling by the wayside, as larger and more sophisticated mining operations captured the market.
If the goal of cryptocurrency is to be a decentralized ledger, owned by no single individual or group of individuals, then the ability for more and more unique participants to help secure and enable the network is essential in order to retain objectivity. The result of increased Bitcoin mining difficulty and mining consolidation has produced, in some instances, lopsided control of the Bitcoin network. It also shut out individuals and hobbyists along the way.
According to Jonas Lamis, Founder of Tezos Community, the largest public Tezos delegation service, the “rewards generated from baking are the first ‘killer app’ for Tezos,” and nearly 80% of “all the activated Tezos [coins] are currently generating rewards through baking and delegation.”
Baking is like mining without killing the planet.
The result, Lamis says, is that most coin holders prefer to hold and bake for the long-term rather than trade, which may be a causative factor in driving down Tezos crypto exchange volume.
With Tezos and a handful of other third-generation cryptocurrencies based on various Proof of Stake consensus algorithms, the ability for small groups and individuals to once again secure the network and earn income passively in the process may ignite the next wide-scale boom in crypto as a high yield investment.
How Much Can I Really Earn?
So far, with a successful beta period launched on June 30, and a subsequent production launch on September 17, Tezos has been producing real, spendable baking rewards for months now. Several factors go into the actual return from an investment in Tezos and baking your coins, but there are calculators and simple equations that will give you fairly accurate figures.
The broadest way to quantify baking rewards can be defined as your number of coins being baked multiplied by the number of bakes per cycle which equals the number of coins you’ll earn as a reward. Each “bake” per cycle consists of validating a single block which, under the current protocol, happens once every 60 seconds in the Tezos algorithm.
The reward amount is fixed, but the variable is the number of blocks you’ll be assigned baking rights for in a given cycle. Furthermore, rewards are also earned based on the volume of transactions since Tezos has “gas” to help prioritize transactions and compensate bakers beyond the baseline of rewards for producing a block.
The minimum annual return on baking rewards can never drop below approximately 5.5% which is the number that assumes there is 100% network participation in baking. Since the number of coins participating in baking can vary greatly, and the number currently stands at around 80% baking participation, the actual rate right now is a little higher, somewhere closer to 9.5% annual return.
Baking is an optional part of Tezos, and coin holders do not have to bake their coins. However, opting not to do so means that the inflation rate of the network eventually makes your coins less valuable.
Baking Option #1: Baking Your Own Roll(s)
If you have at least 10,000 Tezos coins, the amount needed to constitute a roll, you have the ability to solo bake and keep 100% of the baking rewards for yourself. The average Tezos ICO contribution resulted in 2,300 coins, so for most Tezos holders, this option is not viable. The minimum threshold will probably be reduced in the future once time and effort can be put into optimizing the software to allow for smaller roll sizes and more bakers.
“I would definitely recommend solo baking over delegation,” says Shazaf Burki, Founder and CEO of MyTezosBaker.com, a delegation service rating and information website. “Solo Baking is good for the Tezos protocol as it increases the overall decentralization of the system,” he added.
The downfall, as it stands right now, is that solo bakers must possess some level of proficiency in command line tools and network administration. There is no production-ready foolproof “point and click” solution to begin solo baking on Tezos, yet.
For now, there are various guides that can help in setting up the necessary software, but if you don’t have the time and/or you fear doing something wrong, your best bet is to delegate your coins to a service and earn rewards without having to lift a finger or run an install script.
Baking Option #2: Delegating Your Tezos Coins
If you’re not ready to spin up your own bakery and take on the responsibility of ongoing maintenance, then the next best option is to delegate your Tezos coins to a baking service. For you, as the coin holder, there is almost no downside to delegation since you always maintain full control over your coins and never have to give up any information such as private keys or perform any transfers.
Delegating your Tezos coins, which will earn you rewards without any further involvement on your part, is as simple as using one of the many Tezos wallets to set the delegate on your account.
When asked about the finding a reliable delegation service, Lamis said there is no risk to delegation since all Tezos coins remain in your own wallet. The only possible scenario, under the current implementation of the Tezos protocol, is that a delegation service could renege on their promise to actually credit your account with the rewards earned from baking.
As far as returns from a delegation service, the actual amount you receive is typically around 90% of the reward you would normally receive if you were solo baking. The extra 10% (sometimes as high as 15%, depending on the service) is kept by the service as an operating fee.
For example, here is a chart from MyTezosBaker.com, assuming you delegated 5,000 XTZ tokens to one of the top 6 services listed:
Image courtesy MyTezosBaker.com using XTZ price of $1.34 USD
“During its first year, Tezos holders who stake their XTZ expect they will receive between 5% and 10% return on their holdings,” according to Lamis. This value will change over time, and could eventually be subject to changes which arise as protocol alterations resulting from the onchain governance voting mechanism inherent in Tezos.
Even Crypto Exchanges are Baking Tezos
Aside from dedicated delegation services, even some crypto exchanges are getting in on the baking action and providing the service as a bonus for customers who keep their XTZ tokens in their exchange wallet.
The crypto exchange Gate.io announced in September that customers could earn around 10.5% return on Tezos coins which the exchange would use for baking on the network. According to release, “Gate.io will delegate most of the Tezos (XTZ) deposits for baking and return all baking rewards to XTZ holders. In this case, traders only need to simply deposit XTZ and get rewards regularly.”
Your average savings account yields a paltry 2% if you’re lucky. Imagine parking your Tezos coins and earning a 10% return. Obviously, the actual return amount in USD will vary based on the value of Tezos, but as is the case with all cryptocurrency, the price is always subject to change.
“We are going to see more people getting involved with baking,” said Burki, including exchanges, organizations, and individuals. “Big players have already started to jump in after realizing that the amount of rewards generated are not insignificant.”
The Future of Baking/Staking
When asked about what the future may bring for Tezos baking, and for Proof of Stake cryptocurrencies in general, both Lamis and Burki were very optimistic heading into 2019.
“New businesses will be built around staking,” said Burki, adding, “2017 was the year of ICOs, 2018 was the year of stable coins and 2019 will be the year of staking.”
Burki also said that while his website currently lists 84 delegation services, he expects that number to grow to as many as 400 services over the next 12 months.
Aside from the delegation services themselves, there are already over 450 Tezos accounts which are baking, according to Lamis. This number includes public delegation services, private delegation services, individual solo bakers, and other entities like the Tezos Foundation, which operates several baking servers.
“I suspect that a rising XTZ price will significantly change the market dynamics, both in the number of participants and in their fee structures,” said Lamis.
Tezos has an advantage right now as being one of the first major cryptocurrencies, which already includes features like smart contracts to go live with a Proof of Stake consensus mechanism built on staking. As 2019 approaches, this is a technology to watch closely.
Disclaimer: Always do your own research on delegation services. Return amounts listed here are subject to change at any time and at the discretion of the delegation service operators.