Tezos Baking fees and its evolution
By: Phil Champagne
Tags: Hayek Lab, Tezos, Bitcoin, Delegation, Baking Fee

With the launch of Tezos betanet on June 30th, 2018, tezzie owners had to figure out either how to bake or with whom to bake. For the owners who started delegating or baking very early, they benefited from the early days of little competition for baking with quite higher returns. Somewhat similar to the first few months for Bitcoin where barely any other miners were involved and so the difficulty level was low and your node managed to win blocks often.

In order to bake, you are required to put some tezzies in a bond pool to service bond deposit requirements from the Tezos network where the tezzie are essentially frozen for a few cycles. It is a means for the network to penalize any bad players who try to bake or endorse fraudulent blocks, and it also require these tezzies to be available to the baking node, hence there is a higher risk. The network will eventually require 8.5% bond deposit ratio to the overall tezzies being put in the staking pool. The rest of the tezzies can have their private keys comfortably sitting in a hardware wallet for example and being delegated to a baking node holding the required bond pool amount.

One of the earliest observed problems was that very few bakers were available or more importantly how quickly these early bakers became over delegated, meaning they didn’t have enough tezzies in their bond pool for the amount of tezzies delegated to them. This will not be as much an issue in the beginning as the requirements for bond is slowly increasing up to 8.5% over the first 60 cycles, but it is nevertheless a problem. As part of the solution, some bakers decided to open up their bond pool for other contributors, in exchange for a portion of the fees charged to delegators — those safely staking while their keys might be safe in a hardware wallet.

As any free market environment would show, bring up a problem and it will bring solutions. More baking services have appeared, and all have offered a wide range of fees, some with an introductory rate of 0% fees to attract delegators. Considering the cost of running a baking node is quite lower than running a Bitcoin mining node, many are disagreeing with a 15% fee. As I mentioned in Chapter 2 of the Intro Book on Tezos (see Chapter 2 in the google doc https://goo.gl/hbxwXK), I believe decentralization will increase with the value of tezzies while with Bitcoin, small nodes must participate in a mining pool. Mining pools have in fact raised questions as to whether it may have lowered the decentralization aspect of Bitcoin. On the other hand, running a baking node is independent of pricing as it does not involved any kind of mining difficulty which for Bitcoin, is tied to the amount of computing power.

Right now, XTZ (the symbol for tezzies) has stayed around $1.30 for the past 2 weeks meaning a higher amount of tezzies is required for bakers to service their expenses and capital expenditure. This I hope is part of the reason some bakers are justifying running in a cloud service provided by Amazon Web Service or Google Cloud or any other major cloud service, but it surely does not provide decentralized infrastructure just as it can be argued that mining pools don’t either. Oh sure, there are different bakers running in the cloud, but when it comes to the hardware, they are tied to a narrowed infrastructure. We at Hayek Lab have chosen to directly go with our own hardware running in professional data centers. Sure this means 15% fees, which we surely hope to be able to bring down in the future, but it brings the next question: security and risk of bonding, and we have an interesting poll for you below.

Compensation for contributing to bond deposit

As stated earlier, delegating is a safe venture that can be done while keeping one’s private key safely in a hardware wallet such as nano-ledger. In addition, they can either be spent or moved to a different delegate any time the owner chooses to do so. Meanwhile, a bond pool investor has the following to deal with:

At any time, some or perhaps near all the tezzies are frozen in bond deposit. They cannot be spent or moved while in deposit.

These tezzies are at risk in the advent of a bug in the baking node’s software or the node has been compromised by an attack.

No baking can happen unless tezzies are put in bond deposit.

Rather than set at 8.5%, if the bond deposit ratio had been established at say just 1%, the fees would be quite lower as the network would not require as many tz in bond and therefore, there would be more competition for delegation. So the fees we see so far are tied to this requirement as well as the fixed costs of operation and of course the price of XTZ.

We intend to open up our service for bond pool investment earning 8% of the fees from delegated tezzies. The service will even allow for a combo approach where investors can provide the bond for themselves by say delegating 91.5% and contributing 8.5% into our bond pool, giving an effective fee rate of just over 6% at the current rate we are charging. And of course, we will constantly look at improving this rate to a lower value, but we preferred to lower them later rather than charging too low and having to surprise our delegators by having to raise them at a later date.

I’m posting a poll on twitter asking people what’s the lowest amount of fees they are willing to be paid in exchange for contributing in a bond pool, either run by yourself or a professional service.

Phil Champagne

Author http://BookOfSatoshi.com

VP Investor Relations, Hayek Lab, Inc.

https://www.hayeklab.com/