As stated in the Tezos position paper:
We aim to remedy the potential for atrophied evolution in the crypto-currency space by presenting Tezos, a generic and self-amending crypto-ledger. Tezos can instantiate any blockchain based protocol. Its seed protocol specifies a procedure for stakeholders to approve amendments to the protocol, including amendments to the amendment procedure itself.
The challenge that motivated the Tezos project – which is even more conspicuous today – is the difficulty for a decentralized system to safely evolve and incorporate innovation. Evolution and innovation in the blockchain ecosystem are a governance issue. Fork-based governance, the traditional approach, proposes that different visions be implemented as different instantiations of the ledger. This approach has been successful for open-source software projects, but in the case of cryptocurrencies, it tends to concentrate decision-making power in the hands of a small, visible group of participants. Worse, it can threaten to fracture the entire network.
Tezos aims to change this. It seeks to transcend the “governance by fork” paradigm so that the network may evolve and innovate without creating a new blockchain or disrupting the network effects that are formed over time – Tezos aims to accomplish this in a way that is fundamentally and broadly open and accountable.
The participants in this governance process – the “stakeholders” – are the holders of Tezos tokens, or “tez.” Presently, each Tezos token carries with it a vote on potential amendments to the protocol, which in turn can be proposed by any token holder. Tezos formalizes the process for deciding and implementing protocol upgrades directly within the protocol itself. In the first phase of its governance procedure, Tezos relies on a round of approval voting to select a potential protocol upgrade and then advance that proposed upgrade to a test network (“testnet”). After sufficient time on the testnet, token holders will vote again on whether to implement the given protocol upgrade.
Tezos’ technical progress is not dependent on or subservient to a series of hard-forks pre-planned by a centralized development team. And importantly, this model is only an initial implementation of the network’s governance process. The amendment process is part of the protocol, and thus can itself be amended. This allows better, more effective governance mechanisms for Tezos as they are discovered.
Stakeholders are also needed to perform the core Tezos process: the validation of blocks. The periodic recording of valid transactions in blocks, and the formation of a consensus around those blocks, is the method by which a valid ledger is constructed, verified, and stored across the network – perhaps the most fundamental innovation in distributed ledger technology. For blockchains generally, this process involves the selection of who will propose and validate a new block, combined with the incentives to keep that validator honest and to prevent the insertion of invalid transactions. In Bitcoin, the responsibility of creating a block is attributed by chance among those who choose to compete for the associated reward. The Bitcoin competition relies on computational resources and, accordingly, only a small percentage of the Bitcoin community participates in that competition.
The Tezos method of validation is different. Broadly speaking, rewards for securing the Tezos network are distributed according to the proof of one’s stake in the network. There are different ways to implement “proof of stake” based consensus, and Tezos is designed to favor decentralization. Everyone who owns tez is a stakeholder, and the responsibility of proposing blocks (and obtaining the reward) is open to every stakeholder. This process, called baking, involves the random assignment of validation rights among those token holders who have volunteered for the task and posted a security deposit to encourage their honesty.
Participation in baking is strongly incentivized. Bakers are rewarded with newly created tokens when they successfully include a new block, or when they serve as an examiner of others’ blocks (a function called “endorsing”). Token holders may bake themselves or delegate their tokens’ validation rights for that purpose to another baker. Those who elect not to participate in the validation process at all will see their proportionate representation in the network decline relative to their participating peers.
As a further incentive to bake (or to delegate one’s tokens to a baker), a reduction in the proportion of tokens committed to the baking process results in a corresponding increase in the tokens paid to bakers selected for validation. Rewards are paid in newly created tez. Presently, the pool of Tezos tokens is set to increase at the rate of 5.5% a year. This inflation is accomplished through the minting of new tokens to reward bakers. Accordingly, the rewards to bakers increase as participation decreases. If participation in validation drops, the incentive to participate increases proportionately. For instance, if only 50% of tokens are committed to baking, the annualized reward to bakers would reach 11% of the token pool.
A key feature of the Tezos protocol, designed to encourage community involvement, is the ability for developers proposing upgrades to the protocol to seek out a reward for their work, if the stakeholders decide to incorporate that upgrade. Promising upgrades – those that might improve the overall utility or security of the Tezos network by facilitating new technologies and applications – could command significant rewards in the form of newly minted tez. Critically, talented innovators do not need to rely on the permission of a centralized entity to contribute.
A developer need not already be a significant stakeholder in order to be incentivized to improve the network. Similarly, a developer need not rely on any other third party – including, for example, a venture capital firm or the Tezos Foundation – to reap a reward for their work.
These processes – approval of amendments, securing the network through validation, and rewarding innovation through the issuance of new tez – are open to all, well incentivized, and speak to the fundamentally decentralized and participatory architecture of the Tezos network.
Of course, there is a lot more to Tezos than its governance features. It is a base-layer protocol that was built from the ground up. It is written in OCaml, a functional programming language, which let Tezos adopt a very defensive programming style and opens the door to formal verification. Over time, this process – although arduous – can greatly improve the overall security of the network and the applications that run on it.