Can anyone eli5 how the witnesses/validators are selected? Is it basically PoS, so that the large ICO Bitcoin addresses could basically run the network as they wish if they were so inclined?
They are selected by voting by users wallets, each user can change 1 of 12, and over time the bad one will be replaced with a good one. No its not built into protocol the selection of witnesses, its up to actual reputation and marketing in real world.
Right, but how is reputation and marketing in the real world determined algorithmically? If it's just number of votes, couldn't large ICO holders easily make the most txs and thus vote themselves as most reputable, especially when the coin is relatively small like now?
This is where the system is anchored to the real world. If someone feels that witness X should be replaced with witness Y for whatever reason, he can start a campaign and try to convince others to do the replacement (in the current version of the wallet, this can be done only manually in wallet settings). While some people have already switched to the new witness list and some are still on the old one, all users are able to add their transactions to the DAG because a difference of 1 witness is allowed. After the change has diffused throughout the network, a new change can be campaigned for and realized.
Obviously, no "votes" from anonymous users can be relied upon in a system with no barriers to entry. ICO holders don't get any more power automatically just from holding larger bags.
Can you explain more technically how the change of witness is diffused througout the network?
This part is the least technical, just more users accept the new witness list.
Which votes count, anybody making transactions? 1 vote per transaction?
As I said, there are no votes.
Btw, does the amount of witnesses, 12, impose limits on transactions/second in any way, or latency for finality?
Yes it does. If we had 1 witness (which would be roughly equivalent to checkpointing that is used in some cryptocurrencies), transactions would confirm faster. If more than 12, then slower. See the chapter about finality in the whitepaper, we reach finality when we see the majority of witnesses on certain positions on the DAG.
