With the advent of blockchains, several systems of on and off-chain governance have been developed. They are designed to manage and implement changes to the blockchain. Because of their on the net nature, the majority of cryptos are moving their governance on-chain. We will discuss how developers can propose changes and updates with this type of governance which the nodes can vote to accept or reject the proposed changes, and we will go over the positives and drawbacks of these new systems of governance.
A blockchain is a network of nodes that contain a distributed ledger which is essentially a shared database. The blockchain’s transactions are recorded and publicly shared between all the nodes. Any transaction will need to be added to a new block of the chain before it is fully verified. The blockchain’s consensus mechanism needs to be followed for this to happen. With the Proof of Work (PoW) consensus mechanism, used by Bitcoin and other cryptos, the nodes are miners, and they verify the data making sure that it’s correct and the transaction’s parameters have been met.
Once the fastest miner’s verification is complete, the results are provided to the network and reviewed for consensus to be reached, and the new block gets added to the chain. The fastest miner will receive some compensation, usually newly “mined” cryptocurrency.
While some blockchains will have a combination of offline and online governance for code modifications, “on-chain” governance works only online. The changes to the code are through proposed code updates. Developers submit proposals for blockchain improvements, and usually, a core group of developers, which may include the proposers, will coordinate consensus between stakeholders.
The three main stakeholders:
Node operators– Stakeholders that validate transactions, for PoW these are the miners.
Developers– Programmers that are responsible for the blockchain’s core algorithms
Users/participants– Holders of the cryptocurrency (investors)
Stakeholders have an economic incentive to participate. The nodes can earn a cut of the total transaction fees for voting; developers have alternate funding mechanisms, and investors want to improve the value of the cryptocurrency through improvements.
Stakeholders can accept or decline proposed changes. Not all nodes or participants have equal voting power; nodes with more coins in their possession will have more power. If the proposed change is accepted, it is added to the blockchain and baselined. There are some instances where implementation includes a rollback before the baseline if the proposed change was unsuccessful.
As we stated, the implementation of governance will vary between blockchains. The Tezos network uses a self-amending ledger. When proposed changes are implemented, they are rolled out to a test version, and if successful, they are finalized onto the production version, not successful, and they will be rolled back with the production version unchanged.
DFinity has a hardcoded constitution that triggers passive actions such as an increase in the reward size and active measures such as quarantining network parts for the implementation of updates.
Bitcoin and Ethereum’s governance systems are informal, designed with a decentralized ethos of Satoshi Nakamura and Vitalik Buterin.
Critics claim that on-chain governance is centralized to miners and developers with the following forks as examples:
Ethereum- The split of the Ethereum blockchain into Ethereum (ETH) and Ethereum Classic (ETC) was a result of “The DAO” hack where $50 million in ETH was stolen. The solution was a hard fork to protect the network and return the stolen funds. The hard fork changed the protocol and invalidated previously validated blocks. The hard fork required agreement between nodes and developers to change the protocol and was not agreed upon by all participants producing arguments and criticism. The ETH hard fork was debated, and critics argued that the “code was law.” Others claimed that the fork was a valid and positive method to prevent malicious attacks allowing the system to deal with the problem and restore funds.
Bitcoin– Bitcoin had its own hard fork in 2017, resulting in two different chains moving forward, the original Bitcoin (BTC) and Bitcoin Cash (BCH.) The Bitcoin community was developing ways to improve Bitcoin’s network scalability, increasing its capability of simultaneous transaction processing. When new transactions to be added to the network, there is a limit to how many can be processed at the same time, Bitcoin for example can only process a single megabyte of transactions at once; this limitation led to delays in the completion of high-volume transactions.
The 2017 fork relates to a proposal to increase the Bitcoin blockchain’s average block size but was rejected by the crypto’s core development team. Even though high transaction fees resulted in Bitcoin’s use as a daily transaction medium being unsustainable, this change was rejected. The single constituency that benefitted from the high transaction fees were the miners. The result was that a renegade developer group and some miners chose to create their own cryptocurrency that allowed for variable block sizes. The Bitcoin vs. Bitcoin Cash hard fork was complete, allowing the processing limit to increase from one to eight megabytes.
From the beginnings of the blockchain space, with its informal systems of governance, on-chain governance has emerged. On-chain claims it can solve the centralization of Bitcoin problems, incorporating all of the blockchain network nodes into governance’s decision-making process (more democratic).
At its core, blockchain technology provides an inclusive technology approach where all participants can potentially share in blockchain’s benefits. As the various projects of the community attempt to increase their scalability to process more transactions, competing with legacy electronic payment systems, like Visa and SWIFT, updates and upgrades will undoubtedly continue. They are competing against established monetary systems that want to see them fall by the wayside; the Boston Fed has tested a digital dollar that they claim can process 1.7 million transactions per second.
These required changes will need to be implemented to move blockchain ahead so that all can share it. On-chain governance should focus on increasing transparency and trust in a distributed ledger while these improvements are implemented. The blockchain community must ensure that any on-chain governance is not under the fiefdom control of a small group of developers/miners, that implement changes that are only in their best interest. This power structure could result in future disagreements and hard forks that will fragment and weaken the blockchain community when its fight against legacy systems requires solidarity.
On-Chain Governance Advantages
Blockchain’s on-chain governance proponents state several advantages to this hard-coded governance system:
Faster Turn-Around Times- There is significant effort required to achieve a consensus between stakeholders with an informal governance system. An on-chain governance system can reach an agreement between stakeholders regarding a proposed change using less time. The Ethereum and Bitcoin hard forks required months to build and implement. With an on-chain system, voting can have a defined period, and the moment a defined majority in one direction or the other is reached, voting can stop.
Off-chain dealmaking and disagreements can result in difficult situations where nodes can disagree, not running the proposed changes. With algorithmic mechanism voting, speed increases because implementations’ testing results can be viewed with a code update. The code change can be put on a test net, similar to Tezos’ method, enabling stakeholders to make data-backed decisions from the results.
Decentralized Governance– A blockchain’s changes are not routed through the core development community, evaluating its positives and negatives. Instead, each node can vote on the proposed change, independently reading about and discussing the positives and negatives. This decentralized process relies on the community to decide more democratically.
Hard Fork Options Are Significantly Reduced– All proposed changes require the consensus of all nodes, significantly reducing the possibility of a hard fork. Hard forks can be further reduced by the use of economic rewards for node participation in the voting process.
An informal process of governance provides no economic incentive to the end-users who are using cryptocurrencies for transactions and long-term investment. The only motivation is with miners and developers, yet all node operators must follow the decision of the few.
On-chain Governance Disadvantages
Being a new system, the on-chain governance kinks are still being worked out, and experience has identified the following issues:
Voter Turnout is Low- Similar to real-world elections, the more content people are with the system, the lower the voter turnout, and this can become a problem with on-chain governance. Aragon’s AGP-5 vote saw a voter turnout that was only 0.12% of the circulating supply, and even an Ethereum on-chain vote saw a meager 2.55% turnout illustrating proof of this problem. Such low voter turnout is undemocratic at best and means that a single node with enough holdings could manipulate the overall future of the project.
Vote Allocation is Based on Stake- Nodes with more coins have more power and can control the voting process steering future development to benefit themselves. This dynamic pulls power away from miners and developers, giving it to investors who may be interested in profit maximization rather than protocol use case improvements.
On-chain vs. Off-chain Governance Critiques
Blockchain governance questions are neither unique nor unprecedented. Similar issues of governance philosophy have been of contention for centuries, relevant to the on versus off-chain governance questions and issues.
The debate’s core relates to off-chain, human decision making, and on-chain rule-based decision making conducted with automated processes. The chicken or egg questions of whether changes to existing rules and methods should be made from the inside out (developers proposing) or the outside in (nodes and investors) and whether there should be a mechanism to change the current governance structure are contentious ones. These practical questions then lead to the theoretical, of whether existing code-based rules can or should supersede the exercise of human judgment and what ethical and political considerations this entails.
On-chain governance provides a legal order with a peaceful and legitimate resolution to disputes with no recourse to moral or political sources that justify its legitimacy. With crypto governance, competing stakeholder interests don’t require a “what would Satoshi do” arbitrator, nor are their arguments such as minors control fee decisions while investors are powerless to resist.
The critique is that such a positivist system can be captured by private interests and broken down during situations where exceptions are outside the governance norms, or in blockchain’s case, outside the code that runs the blockchain. Such a situation means that the system will have unsustainable contradictions; one group insists that holding inflation at bay but having a less liquid currency is required, while the opposition believes modification of blocks is needed to increase liquidity and increase the token supply.
Having an “above the rules” arbiter (a supreme court) to step in breaking the unresolved tie is a solution but is also the antithesis of the decentralized blockchain philosophy.
Blockchain governance is a new system, yet it deals with the same questions of governance that have been asked for centuries. While it is not perfect, at its core, the governance system seems to be democratic, and when moved to more on-chain decision-making, the possibility for problems is reduced. At the same time, the feeling of inclusiveness is increased. The blockchain community must understand that it will need to develop systems of governance, cost, and features, that make it the better choice over the current financial systems that want to see it fail.
Disclaimer: The author of this text, Jean Chalopin, is a global business leader with a background encompassing banking, biotech, and entertainment. Mr. Chalopin is Chairman of Deltec International Group, www.deltecbank.com.
The co-author of this text, Robin Trehan, has a Bachelor’s degree in Economics, a Master’s in International Business and Finance, and an MBA in Electronic Business. Mr. Trehan is a Senior VP at Deltec International Group, www.deltecbank.com.
The views, thoughts, and opinions expressed in this text are solely the views of the authors, and do not necessarily reflect those of Deltec International Group, its subsidiaries, and/or its employees.
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