This article was first published on XTZ.news. I will be posting my articles there and with a few days delay, I will post here on Publish0x. For all Tezos news you can follow me here, or follow @XTZNews on twitter for more content.
The description you’re about to read is slightly simplified to keep it simple for people that are new to Tezos. If you’re thinking about setting up a node, please look into the matter more thoroughly.
For any decentralized blockchain to function, it needs multiple people to run specialized software on computers, which create blocks of information that form the blockchain. The computers that are set up for that purpose are called nodes. Whether Proof of Stake (PoS), or Proof of Work (PoW), the nodes run the network and make it secure, trustless and immutable. For PoW chains like Bitcoin and Ethereum, this is called “mining”. For Tezos, which is a PoS chain, this is called Staking, but is more commonly known as: “Baking”.
All decentralized blockchain protocols create rewards
The incentive for people to run a node, is the fact that you can earn rewards doing so. These rewards are payed in the form of coins (BTC, ETH, XTZ), and are created by the blockchain protocol. All blockchains run on this principle. Bitcoin, Ethereum, Tezos, they all create rewards on a daily basis to incentivize people to participate in the decentralized continuation of the blockchain. The big difference for users and holders of cryptocurrency is this: in PoW systems, the rewards go to the nodes with the most calculation power. In PoW, nodes do not need to hold any tokens. But in PoS, the rewards are distributed in ratio of the amount of tokens a node holds. Tezos made it even possible for all holders of XTZ to earn rewards in their PoS system. Holders of tokens that do not run a node, can also delegate their tokens to nodes and earn rewards in ratio to the amount of tokens they hold. (About 6% per year)
Tezos: earning staking rewards through baking, or delegating
As you now know, the Tezos PoS system is being run by bakers. A baker is someone that sets up the Tezos PoS software on his or her computer and runs the software 24/7 to compose and confirm the blocks of data that form the blockchain. To become a Tezos baker and start earning rewards, you need XTZ.
Bakers start earning rewards as soon as they are baking with 8,000 XTZ or more. Every 8,000 XTZ that is directed to a Bakers address, gives them 1 “Roll” of baking rights. The 8,000 XTZ can either be acquired and owned by the Baker, or it can be delegated to them.
Delegating means that someone who owns XTZ, but doesn’t want to run a node, can direct their XTZ towards a Baker of choice. This XTZ is not transfered, it stays on the Tezos address of the owner of the XTZ. It is simply “Pointed at” the Bakers Tezos address, through a smart contract. Delegating is simplified in Tezos wallets and very user friendly: it is done within seconds by the click of a button. Most wallets have video tutorials that show how to delegate. Important fact: if you delegate your XTZ, you can stop delegating at any time and your coins never leave your wallet.
The system has a few safety precautions, one of which is the fact that reward distribution is delayed. This means that you start earning XTZ right after you delegate, but the rewards are delayed for about 39 days. So only after that period you start receiving your rewards. This also means that after you stop delegating, you will still receive the delayed rewards for another 39 days.
Back to the necessary 8,000 XTZ to start baking. People can delegate XTZ to Bakers to reach the needed amount. But a baker can not complete a full 8,000 XTZ Roll without owning any XTZ. For every roll, they needs to put 800 XTZ at stake. This is also called a ‘bakers bond’. This 800 XTZ is fixated as bond for 13 baking rounds (13 cycles). Each baking round (each cycle) takes about 3 days.
So now we have it: a Baker who owns 800 XTZ, could start up a Baker, put that 800 XTZ up as bond, then wait for the rest of the 7,200 XTZ to be hopefully delegated to them and start baking. Or if they own 8,000 XTZ themselves, they can put up 800 XTZ as bond and start baking right away. Other options are anything inbetween where the Baker has some amount of XTZ between 800 and 8,000, and the rest is delegated to them.
So that’s the basics. 8,000 XTZ gives a baker a Roll of baking rights. From there, Bakers can also bake with more than 8,000 XTZ. But to add another roll of baking rights, they need to reach a multiple of 8,000 XTZ. And every time they reach another 8,000 XTZ (acquired by themselves or delegated to them), they need to make sure they have an extra 800 XTZ to put up as bond. (So they start with 8,000 XTZ, from which they puts 800 up as bond. Now as soon as they get another 8,000 XTZ delegated to them, they have to put up another 800 XTZ as bond to start baking with the second roll.)
You earn rewards over the XTZ you own
Rewards are earned over the XTZ that you own. So the Baker earns rewards over the XTZ they own. And the delegator earns rewards over the XTZ they own and delegates to the Baker. A baker can set a fee over the rewards as compensation for their work. Most Bakers charge somewhere between 5% – 15%.
So this is the Tezos LPoS system: anyone that owns XTZ, can easily participate and earn extra XTZ with the click of a few buttons. Yearly earnings are payed in XTZ, every cycle (so every 3 days). Yearly returns are a ~6% increase of your XTZ holdings. And every little bit of XTZ earned through staking is added to your address and starts earning right away. Compound interest.
DAO Baker: have your cake and eat it too
Now you know the tokenomics of Tezos LPoS. This means you’re ready to dive into DAO Baker. DAO Baker makes it possible to use your XTZ value and dive into DeFi without missing any of your XTZ staking rewards. DAO Baker accomplishes this, by tokenizing your XTZ. It creates an extra token: dXTZ, which is backed by your XTZ. This allows you to keep your XTZ in your wallet and continue to collect staking rewards, while using the dXTZ token to put value into DeFi applications like lending and supplying value to things like DEX liquidity pools and any other DeFi applications.
Additionally, Bakers will be able to tokenize their XTZ that is held as Bond. These tokens will be sold as equity shares.
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