Blockchain Governance

What is blockchain governance?

Blockchain governance refers to the management and decision-making processes of cryptocurrency blockchains such as Bitcoin and Ethereum. Think of corporate governance, which is the factual and legal regulatory framework of firms to exercise good corporate management practice, and transfer this onto blockchain: you've got blockchain governance. Whatever the governance structure, matters at stake generally involve network access, funding allocation, block size, reward systems, voting and decision making.

Blockchain is a distributed ledger that facilitates the process of recording transactions and tracking digital assets, and physical ones, in the network. The distributed database is managed by multiple participants called nodes. The peer-to-peer network cuts out the middle man and allows for a highly secure way of recording transactions. Public blockchains, also called permissionless blockchains, are generally open-source. Immutability, transparency and security are key to the blockchain.

The importance of governance is well recognized in the field of IT (information technology) and many case studies have been conducted on the topic.

On-chain vs off-chain governance

There are two major forms of governance: on-chain and off-chain.

The decision-making mechanisms vary between on-chain and off-chain governance processes (Reijers et al., 2018 ). The major difference is that the first requires participants to have a token to vote. On-chain governance uses the Proof-of-Stake formula, while off-chain governance uses a Proof-of-Work formula.

While on-chain governance refers to decision-making that takes place directly on the blockchain, off-chain governance of blockchain technologies refers to decision-making that takes place outside of the blockchain, such as through community discussions and proposals.

In on-chain governance, rules for implemented changes are encoded into the blockchain protocol. Developers propose changes through code updates, and each node or participant votes on the proposed change. Participants include cryptocurrency exchanges, wallet software providers, miners, users, etc. The decentralized and permissionless nature of public blockchain systems means that stakeholders, including node operators and token holders, play a significant role in the governance and evolution of these networks. The possibility of a hard fork is reduced with on-chain governance, because each proposed change requires consensus from all nodes. Nodes are encouraged to participate in the voting process through economic incentives (for example cryptocurrency as a reward for block validation).

Typically, on-chain governance involves miners (who operate the nodes), developers (who are responsible for core algorithms), and users (who use and invest in crypto). Unfortunately, this system also means that users with greater stakes can manipulate votes, and as in the real world, low voter turnout may become a problem.

Questions around governance

A variety of governance models have been proposed for blockchain technology, including various consensus mechanisms. These models aim to ensure the security, scalability, and decentralization of the network while also providing incentives for participants. But whether existing rules and decision-making processes governing blockchain platforms should be changed from the inside (on-chain) or the outside (off-chain), and whether the system should provide for a mechanism to change the governance structure itself, are central questions to the debate between governance that includes humans and governance that can be automated through rules.

The Bitcoin and Ethereum governance systems are currently informal. They were designed with a decentralized ethos, first promulgated by Satoshi Nakamoto in the Bitcoin whitepaper. Critics, however, point to two prominent forks in the blockchain ecosystem to prove their point that this informal decentralized governance process is in fact centralized among miners and developers.

With this in mind, it is worth noting that all DAO projects are a mixture of off-chain and on-chain decision-making, echoing the idea that governance consists of more than coded procedures, both in the real world and with blockchains and digital currencies. Decentralized Autonomous Organizations (DAOs) are a key aspect of blockchain governance. These organizations operate on a blockchain-based platform and use smart contracts, consensus algorithms and other governance mechanisms to make decisions in a decentralized manner. The need for a central authority and third parties is removed. The DAO, created on the Ethereum blockchain, is a well known example of this type of governance. For De Filippi & Wright, the governance attached to these DAOs could be implemented as blockchain-based software systems through smart contracts.

On the Ethereum blockchain, EIP (Ethereum Improvement Proposal) Champions are expected to adapt to the circumstances of their proposal, as the community is so diverse and large that not one single metric can be used to gauge community consensus.

The future of blockchain governance

These questions of blockchain governance are not unprecedented, nor are they unique. Legal philosophy and theory have grappled with these issues for hundreds of years.

As the blockchain and crypto ecosystem grow and more and more startups emerge, it is safe to say the governance of blockchain technology will continue to rapidly evolve. Stakeholders must continue to closely consider the various factors that impact the decision-making processes of these systems, from the governance structures of individual blockchain networks to the use of blockchain in various industries and use cases, such as supply chain management, digital identity, smart contracts, voting, health records, and much more.

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