Tezos (XTZ) Tokenomics: A Deep Dive into Its Economic Model

Tezos (XTZ) is often highlighted for its innovative on-chain governance and self-amending protocol, but its underlying tokenomics plays a pivotal role in shaping how the network operates. In this article, we explore the tokenomics of XTZ and what makes it distinctive within the broader cryptocurrency landscape.

Total Supply and Circulating Supply

Tezos does not have a hard cap on its total supply, setting it apart from other cryptocurrencies such as Bitcoin, which has a fixed maximum supply. As a result, inflation dynamics must be carefully considered. New XTZ tokens are consistently introduced into circulation through a process known as baking, Tezos' consensus mechanism. The continual creation of new tokens could dilute the value per token unless demand keeps pace with inflation, raising important questions about long-term value preservation for XTZ holders.

The circulating supply is not static and depends on several factors, including new token issuance through baking and the participation rate of users in the network’s governance and staking activities. The balance between circulating supply and demand for staking can have important short-to-medium term implications for liquidity on secondary markets.

Staking and Baking

Tezos uses a unique consensus mechanism called Liquid Proof-of-Stake (LPoS). Users can “bake” XTZ (similar to staking in other PoS networks), requiring a minimum of 8,000 XTZ for an individual to become a baker, though smaller stakeholders can delegate their tokens to professional bakers. Bakers are responsible for validating transactions, securing the network, and proposing changes to the network’s governance.

Rewards for baking include a combination of new token issuance and transaction fees. However, participants face dilution risks if they do not stake or delegate their tokens. This design incentivizes broad participation in staking activities within the network and helps maintain high decentralization levels. The staking rewards and inflation rates, however, are not entirely static and fluctuate with baking activity and governance decisions.

Token Distribution

Unlike some other projects that heavily concentrate tokens among founding teams or early investors, Tezos has aimed for a wider distribution. However, token ownership is still concentrated, with a notable percentage of XTZ held by large institutional holders and bakers. This concentration could, at times, pose governance risks, especially when the largest participants have disproportionate voting power on the platform’s future upgrades.

Inflation Mechanism

New XTZ tokens are created via inflation, as part of the block rewards distributed to bakers participating in the network’s validation process. The inflation rate, while ongoing, is subject to adjustments from network-wide governance proposals. This dynamic enables the community to self-regulate the token flow and balance staking incentives against dilution risks.