Governance in blockchains
How do you improve something that is distributed and decentralized
Governance is a crucial aspect of any well-functioning system, whether it be in politics, business, or the realm of crypto. Effective governance ensures that a system is able to effectively and efficiently achieve its goals and objectives, while also being accountable and transparent to those it serves.
In the political sphere, governance plays a vital role in maintaining the stability and integrity of a nation. It also ensures that government officials are held accountable for their actions and decisions, and that the government is transparent and open in its dealings. This, in turn, promotes public trust and confidence in the political system.
In the business world, effective governance is just as important. Good governance ensures that a company is able to operate in a fair and transparent manner, and that it is accountable to its shareholders and other stakeholders. It also helps to prevent unethical practices and encourages responsible decision-making, which can help to protect the long-term interests of the company. Good governance would have prevented the entire FTX fiasco.
Governance in crypto
The question then becomes, do blockchains and blockchain applications need governance? Everything happens in a transparent and trustless way and is fully accountable to everyone who wants to check the blockchain.
What do you need governance for, isn't that what the blockchain replaces? Well... yes, and no. Blockchains in its ultimate end-state could do without governance, nothing needs to change, the system works perfectly, all the needs are met and everything is transparent and open. Sadly, this is a utopian view and even Bitcoin still produces updates to its blockchain, in contrary to what many people believe.
The realm of crypto is no different. In order for the crypto industry to thrive and achieve mainstream adoption, it is essential that it has strong governance structures in place. To upgrade and or change a blockchain or an application on a blockchain (dApp), you need governance. It stands to reason with the hyper-changing fast-paced nature of crypto that good governance can greatly give you a leg up into making well informed and long-term good decisions over competing products and services.
Trade-offs between efficiency and decentralization
A public blockchain network may have higher governance risks because anyone can join and participate in decision making. A private blockchain network, on the other hand, has a more centralized governance structure, but may lack the same level of transparency and accountability. Overall, it is important for stakeholders to have a clear understanding of the rules and processes for making decisions within the network, and for those rules to be fair and transparent.
A compulsory requirement for a Blockchain project’s success is that it maintains decentralization. The project must also create governance that can deal with the complexity in decision making in order to reduce uncertainty, delays and costs when used by stakeholders over existing systems.
Off-chain and On-chain governance
There is a distinction between off-chain and on-chain governance in respect to blockchains. Off-chain governance relates to everything that happens away from the blockchains. Developer focused meetings, panel discussions, op-eds, twitter fights, conferences and everything in between where people discuss the way forward together. This is a useful way to exchange ideas and thought processes but has a danger of being hijacked by influential players that disproportionately try to sway a decision.
On-chain governance is more robust as the participants in the network vote with their money. In the case of Bitcoin miners, the capital is put to work to the blockchain regarded as the Bitcoin chain for example. If a significant portion of the network does not agree on the changes, the network may split into two separate networks, known as a hard fork. Hard forks allow users to choose which version of the network they want to use. Some examples of this type of governance include using voting procedures and allowing flexibility in operation through the use of hard forks.
In the case of Bitcoin, the rules and protocols governing the network were established when the network was first launched. There is some level of governance in place for making changes to the network, particularly at the technical level. This governance is influenced by the number of users participating in the network. Because there are so many stakeholders involved in Bitcoin, it is difficult to get consensus on changes to the network. This has resulted in various groups splitting off from the main Bitcoin blockchain to create their own versions of the blockchain.
This has happened in the past in both major networks. Bitcoin Gold, Bitcoin Cash and Bitcoin SV are a result of a disagreement on how to move the network forward. Similarly, Ethereum Classic is an example of an Ethereum network split caused by governance.
Understanding how a network moves forward, or how a dApp innovates, while still keeping its decentralized nature is essential when investing in both Layer-1 blockchains as well as everything that gets built on top. It's a good forward-looking indicator to estimate which blockchain or dApp will outcompete others, all else being equal.