Understanding blockchain governance is crucial if you wish to invest in cryptocurrency or take part in a chain-based project. Blockchain technology is evolving at a rapid pace. It attracts users from all over the world and rakes in billions of dollars in investments every year. To ensure the fair participation of all users and the […]
Understanding blockchain governance is crucial if you wish to invest in cryptocurrency or take part in a chain-based project.
Blockchain technology is evolving at a rapid pace. It attracts users from all over the world and rakes in billions of dollars in investments every year. To ensure the fair participation of all users and the transparent distribution of resources a set of rules is necessary.
The way rules appear on the chain and how much power users have in changing them constitute blockchain governance.
In this guide, we dissect blockchain governance and discover its mechanisms through crypto examples and associations with real-life political systems. We take a closer look at off-chain governance and find out whether on-chain governance is feasible in the long run. In the end, you should have a clear understanding of who calls the shots on blockchain roadmaps and their success.
What is governance?
Before we dive into the blockchain governance definition, we should take a second to remember what governance is.
If you don’t remember the definition of governance from your school days, have no worries! We got your back with a simple explanation. Governance depends on three elements:
Think of any 1st world country in the world or any state that functions on a democratic system. The people living there are participants in a system (society) that offers them rights, protection, and opportunities to thrive.
For the system to work and the participants to benefit from all these advantages, a set of strict rules is put into place. In our case, these rules make the constitution and all the civil and criminal laws that derive from it.
While all the participants are expected to follow the rules entirely, there is the possibility that some may not do it out of ill intention or negligence. So, the presence of rulers is crucial to ensure the system’s functioning. In our example, the rulers are the politicians in command and the instruments that they use to enforce the correct application of the rules, such as the police and the courts of law.
The system works towards reaching a mutual goal for all those involved, and its completion is achievable as long as all three elements collaborate and engage in as little corruption as possible.
The example of a state democracy is an easy way to understand what blockchain governance is. However, governance is everywhere around us. It is the fundamental mechanism behind the well-functioning of a company, a social media network, a book club, and even a family.
Types of governance
Governance has been a mechanism for social symbiosis and control ever since humans gathered in tribes, which was one of the first instances of social networking. History has recorded several forms of governance that ranged from tyrannical and totalitarian to exceptionally libertarian.
To better understand blockchain governance, we will focus on two types of standard governance that best apply to blockchain technology:
- Representative Democracy
- Direct Democracy
Let’s break them down!
- Representative Democracy
This is one of the most common forms of state governance in the world. It works by having the participants vote to delegate some of their members as their representative, and implicitly rulers. This select number of people then produces and votes on rules that should improve the functioning of the system.
The Pros of representative democracy include:
- Participants don’t have to worry about voting on every new rule that comes into discussion
- The implementation of new rules works faster and more efficiently
- It’s cost-effective and brings balance to the system
- Participants are encouraged to participate by having their say on who should become a ruler
The Cons of representative democracy are:
- Some rulers may act in favor of personal interests rather than for the good of the system
- The election process is susceptible to fraud
- The rulers can deceive the participants in exchange for their votes
- It provides more benefits for the majority groups within the system and harms minorities
- Direct Democracy
In a direct democracy, participants vote individually for the rules that govern the well-functioning of the system. All of them are rulers. Imagine a country without a parliament where you, as a citizen would have to express your opinion on every decision that has to be made nationwide.
The Pros of direct democracy are:
- Every vote weighs heavily in the final count
- It offers more transparency by eliminating potentially corrupt rulers
- Participants have more control over the rules
- The government is more accountable and easier to replace than in a representative democracy
The Cons of direct democracy include:
- Reaching consensus on a rule is slower and more expensive
- Not every participant is keen on voting
- Participants may vote under an emotional influence or out of self-interest rather than logical reasoning
- The larger the system gets the more difficult it is to maintain the governance efficient
What is Blockchain Governance?
Now that we have a better understanding of what governance is it should be easier to get a better grasp of blockchain governance and how it works.
A blockchain is a network of computers that collaborate to obtain mutual benefits and attain a particular goal. Similar to a social system, a blockchain needs a set of rules to function and to ensure that all the participants have equal rights and opportunities. For those rules to come into effect a form of governance is imperative.
However, contrary to a social network, a blockchain is by nature a decentralized system where users come and go. One of the fundamental conditions of its success is its scalability or its potential to evolve and increase in size while adapting to both internal and external factors of change.
The scalability of blockchain results from its ability to attract new users, which usually is in the form of incentives. Without incentives, the computers that contribute to the network’s existence leave, and the blockchain crumbles and its purpose diminishes.
Blockchains also require consensus through a set of coordination methods that ensure the equally beneficial participation of all the peers on the network. This condition is generally met through smart contracts and validated transactions.
In conclusion, blockchain governance is the ability of a blockchain to generate incentives for the participants while ensuring that consensus is always achievable between them.
Who decides blockchain governance?
Blockchain works in theory, but it needs real-life entities to put it in practice as well. Responsible for this task are four groups of elements that are essential for the blockchain’s existence:
- Core Developers
- Node Operators
- Token Holders
- The Blockchain Team
Let’s break them down and see what each of them represents!
- Core Developers
This group is responsible for ensuring that the blockchain’s core code works in its preset parameters. They have the power to make small, local modifications to the code without changing it for the entire network.
- Node Operators
This group is responsible for implementing the changes that the core developers make to the code. They have an entire copy of the blockchain ledger on their computers, and they decide whether they update it with the developers’ new features or not.
- Token Holders
This group forms the majority of participants to the blockchain. They hold the digital assets or tokens that the network uses to validate transactions and smart contracts. Similar to how citizens of different states have a varying range of rights and responsibilities, so do token holders on different blockchains.
- The Blockchain Team
This group’s role varies from one blockchain to another. In some cases, it can be a company that runs a blockchain as a large scale project, as it is the case of Ripple.
The Blockchain Team can also be a non-profit organization or a community of developers and investors. They may have control over the marketing structure and the mission to attract new participants to the blockchain.
Types of Blockchain Governance
Blockchain is still a relatively new technology that can develop to embody and employ several forms of governance. However, to maintain our focus on the present state of peer-to-peer, trustless networks, we will refer to the two most common types of blockchain governance:
- Off-Chain Governance
- On-Chain Governance
Both forms of blockchain governance derive from the traditional, real-life types of governance we have discussed above. Let’s take a closer look at each of them to discover how governance works on real blockchain examples!
- Off-Chain Governance
Most blockchain-based projects use off-chain governance to ensure the well-functioning of the network. Two of the most popular examples include Bitcoin and Ethereum. In both cases, the respective communities try to maintain equilibrium between incentives, methods of coordination, and the businesses that use the blockchains.
In off-chain governed blockchains, only a few participants make all the decisions. While they represent a minority, they are generally the users with the most power, influence, and knowledge on the network. So, while the blockchain is a decentralized web, the ability to govern it is centralized in the hands of a few participants.
Nevertheless, off-chain governance does not imply tyrannical constraints for the users who can otherwise deliberately leave the blockchain if they lack incentives. They may easily exercise this right in the event of a hard fork.
A hard fork takes place when the network cannot achieve consensus over a new set of rules, so some users choose to diverge into a new blockchain while the others remain on the previous, “classic” one.
The consensus is a big theme of off-chain governed blockchains where core developers, large miners, and wealthy entities have a strong grip over the decisional power.
Another topic that creates dissent among off-chain governed blockchains is the incentives problem. All the actors in the community, including miners, traders, developers, and investors have tangential goals, but not identical.
As a result, they have to engage in push-and-pull collaborations to move their projects forward. One case of disagreement over incentives led to the first hard fork on the Bitcoin blockchain, which spurred Bitcoin Cash.
Generally, off-chain governance has three distinct approaches:
- Benevolent Dictator for Life
The utopist association of two contrasting terms, “benevolent” and “dictator” define the simplest approach to off-chain governance. In this case, the creator of the blockchain or network is the only participant who can approve or veto a change that would affect the entire community.
An example of this form of governance is Facebook’s creator and CEO, Mark Zuckerberg who enjoys exclusive privileges in deciding the future of the social media behemoth.
- Core Development Team
In this case, a team of the most active developers has the final say on the changes that should shape the future of the network. This type of off-chain governance best suits open-source projects where users can suggest or demand new features and the core development team decides their implementation.
- Open Governance
This form of governance is similar to representative democracy. It allows the participants to pick a team of rulers from among the most skilled developers and investors. Open-source projects like Corda and Hyperledger employ this off-chain governance model with successful results.
- On-Chain Governance
The most recent form of governance regarding blockchains is the one that differs the most from real-life governance models. On-chain governance enables a network to function based on rules that are stored on the blockchain as smart contracts. The participants can use built-in methods of coordination to modify the rules according to their needs, but without changing the regulations on which the blockchain works.
On-chain governance benefits:
- Minimal risk of chain fragmentation through hard forks
- Access to an in-built voting system for all participants
- Direct democracy and equal voting rights
- A high level of transparency and trust
- Optimal decentralization through smart contracts
On-chain governance aims to increase democracy and give participants more control and power to take decisions in a bid to avoid extreme events such as hard forks in the blockchain. In this regard, users have access to an in-built voting mechanism that lets them choose in which direction the blockchain should move next. The majority of the votes help the participants achieve consensus easily and it decides the next stage of the roadmap.
In terms of incentives, the power to make decisions and influence the blockchain is a reward itself. However, as many of the users lack the necessary technical knowledge to make progressive changes, the blockchain may suffer from selfish, poorly-conceived resolutions.
One of the most obvious advantages that on-chain governance has over off-chain governance models is the high degree of transparency. In this case, the voting process is available for monitoring to all users, and the path from the rule proposal to rule admission is clear. On off-chain governed blockchains, the participants merely attend the decision-making process, which is usually led by one or just a few of the other users.
On-chain governance offers the highest possible level of decentralization, which goes in line with one of the fundamental principles of blockchain technology: a decentralized network. This performance is possible thanks to the existence of smart contracts that hold the rules of blockchain operations and the instruments that allow their modification.
The Downsides of On-Chain Governance
While some may argue that on-chain governance is better than off-chain governance, this type of blockchain governance does not enjoy impeccable functioning. There are certain downsides to employing it that derive mostly from the risks of real-life direct democracies, such as:
Nowadays, except for a couple of tiny Swiss cantons, there is not a single country that uses direct democracy as a political system. One of the earliest examples of its existence dates back to ancient Greece, and most specifically to the city of Athens. The reason why this policy worked almost 2,500 years ago is that it only involved around 30,000 people at that time.
Blockchains are by definition networks that aim for scalability. A blockchain is more powerful and rewarding with every new user that it incorporates. However, as it increases in size, on-chain governance becomes very difficult to implement efficiently.
At one point, most users would rather have someone represent their interests than having to deal with any issues that surface on the blockchain. From then on, off-chain governance may appear as a more feasible solution for many participants.
Lack of coherence
In theory, the proposal and implementation of new stages for the blockchain roadmap should be easy. There is a voting system that enables all users to have their say on any issue or potential change.
However, the chances of having an entire community of developers, node operators, investors, and casual users acting for the benefit of the group rather than for selfish goals are very slim. Divergent opinions can lead to a slow process of debating and voting even on the rules with the smallest impact.
Examples of Successful (so far) On-Chain Governance Implementation
On-chain governance is difficult to implement in the long-run. The odds of balancing scalability goals with network consistency are small, but still achievable as these projects have revealed:
Tezos is a blockchain project that likes to advertise the success of its on-chain governance model. The network functions on Proof-of-Stake smart contracts and allows its users to vote on any possible change to the chain, including major rewrites.
It sounds like a clear example of direct democracy so far, doesn’t it? Well, it’s not entirely so because while every participant gets a vote, not every vote weighs the same in the final count.
Tezos users receive incentives according to their investments. The more financial resources that they employ on the chain, the more incentives they receive and the heavier their votes will weigh. So, in the end, the ones that decide a new change in the Tezos roadmap are the richer participants.
Decred is an autonomous digital currency that employs a hybrid consensus system between Proof-of-Work and Proof-of-Stake. It is a self-ruling currency and aims for complete decentralization by offering equal voting rights to all its participants.
The platform users can always send their requests for new features or changes to the chain, which later go through a voting process similar to direct democratic systems. The only issue here is with the vote’s transparency since voting takes place outside the chain, and not directly on it.
EOS uses on-chain governance, but not in its fully direct democratic meaning. The platform gives access to the blockchain for users who buy EOS tokens. From then on, their participation is valid through the Delegated Proof-of-Stake consensus mechanism. They also receive voting rights, which they can freely exercise when changes are up for debate.
However, similar to how the Athenian Democracy did not allow women and slaves to vote more than two millennia ago, EOS does not give voting rights to its miners. So, while it embraces on-chain governance, EOS does not practice all-inclusive direct democracy.
The Bottom Line – Who really governs the blockchain?
Similar to real-life politics, blockchain has yet to find the ideal governance model that involves everyone equally in the decision-making process, and which also rewards all its participants with the same incentives.
The community is still divided between on-chain governance and off-chain governance alternatives. It will take time, innovation, debates, and plenty of trial-and-error attempts before the scale will tilt decisively in one direction or the other.
One thing that we can all agree on is that the users eventually call the shots on a blockchain’s trajectory.
Once the incentives on a blockchain lose their value the number of participants decreases. Fewer users result in smaller power of attraction for the project. The lack of power kills the chain’s hope for scalability, and all the work that developers and investors have put in it.
The strength is in the numbers, as the old saying goes. Revolutions are possible even on the chains that are under the strict control of benevolent dictators, as Ethereum’s Vitalik Buterin found out during the infamous DAO hard fork in 2016. So, until blockchain governance achieves an indisputable level of feasibility, the power of decision remains in the hands of the many!