Tezos (XTZ): Superior Governance and Use Cases
Can blockchain tech be in sync with developers’ values? Read how Tezos’ (XTZ) innovative self-amending ledger reflects its principle of universal participation.
By Kathleen Breitman, Co-Founder, Tezos
Updated November 16, 2021 • 4 min read
Tezos is often referred to as the first “self-amending” blockchain, which routinely adapts and adopts new features natively and automatically via its unique on-chain governance mechanism. This protocol functionality allows the system to coordinate the selection of new updates through popular voting, integrate the new updates that are selected, and compensate the developers who proposed them.
Tezos’ Unique Inflation Funding Model
In the realm of blockchain and cryptocurrency, inflation refers specifically to the idea that the more coins there are in total, the less each individual coin is worth, following basic supply and demand economics.
Tezos has a powerful inflation-based funding model whereby newly created XTZ coins hold their value, so their economic worth provides a powerful incentive for strengthening the Tezos network in a number of ways.
Under the Tezos protocol upgrade mechanism, when developers and teams submit suggestions to update the network, they include an invoice requesting payment in XTZ in return for their work. If their proposal is approved by stakeholders and incorporated into the Tezos blockchain, the protocol mints the coins upon execution and sends them payment.
This functionality empowers the blockchain to effectively fund its own development, ensuring its long-term success and survival. Over time, the goal is for a wide variety of developers to work full-time on the Tezos public blockchain. But, as we just discussed, wouldn’t more coins dilute the value of all the existing coins out there? Tezos has a solution for that.
One of the founding principles of Tezos is universal participation, whereby anyone who holds even one XTZ can participate in the governance of the protocol and vote on proposed amendments by staking their coins on the network. New coins are minted at the end of upgrade cycles, and to prevent any dilution of staked coins, the protocol awards all staked amounts with a proportional share of the new coins. This structure means that for these holders, the inflation is non-dilutive. By analogy, imagine if the Federal Reserve of the United States put a portion of newly printed money into your bank account every time it increased the U.S. money supply. XTZ currency holders who stake their coins therefore tend to maintain their investment value, because they receive a representative portion of the new coins issued. This structure encourages all owners of XTZ to be active participants in the blockchain.
On-chain Stakeholder Governance
Tezos has a unique on-chain governance mechanism to oversee the protocol amendment process, which codifies the procedure for every cycle of changes. An on-chain action refers to a protocol or action executed on the main chain of the blockchain. The methodology for deciding and implementing upgrades to the Tezos blockchain is on-chain, and is directly incorporated in the code of the underlying protocol itself; the blockchain software automatically goes through every proposed upgrade and voting steps without a centralized director.
“Bakers,” who are usually also developers, can propose protocol upgrades. When the system has collected all the upgrade proposals, the registered bakers cast votes. When they do so, they are in fact voting on behalf of a larger group, and the weight of their votes are directly proportional to the number of coins the baker and their node might hold at that time. Non-baker coin holders — the majority of Tezos cryptocurrency owners — can move their coins to whichever baker is voting in line with their own preferences. This enables all XTZ coin holders to participate in the network’s development even if they do not bake themselves. This distribution of coins encourages a representative and democratic structure that avoids situations where a small percentage of currency holders are able to control updates to the protocol.
Given the coin inflation model mentioned earlier, all currency holders are incentivized to participate in the process. On top of this financial incentive, the final vote requires a minimum 81% of the current coin supply to be accounted for, further ensuring high rates of participation.
The Tezos system stands in contrast to Bitcoin and Ethereum, which do not have formal governance systems. Without formal governance, developers submit proposals to a core group, which then decides which updates to implement. This informal off-chain methodology and its related issues, like contentious hard forks, are part of what inspired the development of Tezos. For example, the non-formalized governance systems caused differences of opinion that led to blockchain splits for both Bitcoin and Ethereum (leading, for example, to the creation of Bitcoin Cash and Ethereum Classic).
Innovative Upgrade Procedures
There are four steps to the Tezos upgrade procedure:
Proposal: All users vote on which changes they think would be best to test out. The proposals with the most votes advance to the next round.
Exploration: All the users vote on the selected proposals from the first round. If a proposal meets a minimum threshold of votes, it moves to the testing round.
Testing: A separate testing blockchain is created to test the potential changes and ensure that they would be stable and safe to adopt permanently onto the Tezos blockchain. Those that satisfy this technical requirement move to the next round.
Promotion: All users vote on the successfully tested changes. The chosen changes are then uploaded through a “hot-swap” onto the Tezos blockchain. This process involves no interruptions to the operation of the network, and no splitting or forking occurs.
Tezos-Enabled Use Cases
Tezos was developed to enable smart contracts that can be formally verified using the mathematical structure of the functional programming languages underlying the Tezos blockchain network, as opposed to using the more traditional imperative programming languages found in the majority of other smart contract enabled blockchains. Mainly, Tezos projects focus on areas where the cost of failure is high. For example, high-value applications and where functional programming increases confidence in the viability of the chosen solutions.
This functional language underpinning Tezos smart contracts stimulates the development of decentralized applications (dApps) that also require an extraordinarily high degree of confidence in the accuracy and functionality of their smart contracts. Some of the dApps that fit well with Tezos are financial applications used to manage large quantities of assets and other high-stakes fields, such as autonomous driving, electric vehicle charging, real estate tokenization, and cloud-based software solutions.
Tezos is also built to support interactive end-user applications built directly on the infrastructure layer. One such application is a decentralized exchange (DEX), and a Tezos DEX called Dexter is already in development. Finally, strong network effects and an engaged community have enabled the cryptocurrency XTZ to function as a powerful store of value. In 2019–2020, its market capitalization increased to billions of U.S. dollars, placing XTZ in the top 50 cryptocurrencies by market cap.
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Kathleen Breitman is the co-founder of Coase, a software company that aspires to lower transaction costs. She previously co-founded Tezos, a blockchain-based smart contract platform with an on-chain governance mechanism to coordinate and push upgrades to its network. She has also worked at Accenture, Bridgewater Associates, and the Wall Street Journal.
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