Why is Blockchain Governance Important? - Bitfinex blog
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Why is Blockchain Governance Important?

Blockchain governance systems can be broadly categorised into several models, each possessing distinct characteristics, advantages, and drawbacks. Understanding the nuances of these varied governance structures can yield crucial insights into the enduring stability, flexibility, and overall success of many diverse blockchain projects.

A Look at Decentralised Decision Making

Blockchain governance is a cornerstone element for the long-term viability, adaptability, and integrity of blockchain networks. Governance systems serve as the rules and procedures that guide the development and operation of these networks. Aside from guiding the development goals, and aligning incentives on-chain, governance mechanisms often play a large role in defining the community behind the project. 

The governance policy often reflects community values like decentralisation, privacy, social justice, technical excellence; even commitment to a particular meme, or other such community values. They often act as a social contract among participants, thereby setting the cultural tone of the network.

Governance systems’ primary role is to define how changes to the protocol, like upgrades or feature additions, are decided and implemented. As technology evolves, networks need to adapt; effective governance systems ensure that these changes occur smoothly and with minimal disruption.

Web3 blockchains often take a more flexible and experimental approach to governance compared to the conservative ethos of Bitcoin. Web3 projects, many of which are built on Ethereum or similar platforms, frequently employ on-chain governance mechanisms that allow token holders to vote directly on proposals. These systems can include advanced features like liquid democracy, DAOs (Decentralised Autonomous Organizations), and even quadratic voting, which aim to make decision-making more inclusive and dynamic.

In contrast, Bitcoin’s governance model is intentionally slow-moving and resistant to change, valuing stability and security above all else. Decisions are made off-chain through a community-driven set of developers and miners. This conservatism is seen as a feature, not a bug, preserving Bitcoin’s core principles and its role as a digital store of value.

Additionally, Web3 governance often tackles a wider range of issues, including protocol upgrades, community initiatives, and even venture funding through treasury management. These activities go beyond the scope of Bitcoin governance, which primarily focuses on network security and protocol stability. The diverging attitudes reflect the differing ambitions of the two ecosystems: Bitcoin aims to be a decentralised and censorship-resistant digital gold, while Web3 aims to create a fully decentralised internet of value and services.

What are the Primary Types of Blockchain Governance Systems?

On-Chain Governance

In on-chain governance systems, changes to the protocol are decided and implemented through transactions or other operations that occur directly on the blockchain. Token holders usually vote on proposed changes, and if a proposal gets enough support, it is automatically implemented. 

These governance activities often come in the form of transactions or smart contracts, thereby leveraging the blockchain’s core technology to ensure transparency and trust in the decision-making process. Typically, token holders—the stakeholders in a blockchain network—have the power to vote on these changes, often in proportion to the number of tokens they hold.

The advantage of on-chain governance is its transparent and automated nature, which allows for quick decision-making and implementation. However, it is not without its drawbacks. Token-based voting systems can sometimes lead to plutocratic outcomes, where those with the most tokens—and therefore the most voting power—can dominate decision-making. Moreover, the irreversible nature of blockchain technology means that poorly considered or contentious changes can have lasting, potentially detrimental effects on the network.

Several prominent blockchains utilise on-chain governance mechanisms to facilitate decision-making within their ecosystems. Tezos is a notable example, using a self-amending ledger that allows token holders to vote on protocol upgrades and changes. Polkadot also employs on-chain governance, giving its DOT token holders the ability to propose and vote on network alterations. 

Similarly, Decred uses a hybrid model that incorporates both proof-of-stake and proof-of-work elements, allowing stakeholders to participate in governance decisions directly on-chain. Cosmos is another example where the holders of its native ATOM token can vote on proposals to update the network.

Off-Chain Governance

In off-chain governance, decisions are made outside of the blockchain through forums, developer meetings, and other mechanisms. Implementing a decision generally involves manual code changes. For example, Bitcoin’s governance operates primarily through an off-chain mechanism, reliant on a decentralised group of contributors, miners, node operators, and users.

In off-chain governance models, the process of decision-making occurs externally to the blockchain itself, often facilitated through various community engagement platforms.  These settings serve as the deliberative arenas where stakeholders discuss, debate, and eventually arrive at a consensus on proposed changes or features for the blockchain protocol.

Once a decision has been made, it’s generally up to the blockchain’s developers to manually alter the codebase to reflect the agreed-upon changes. This often involves a series of steps, starting with the coding of the changes, followed by peer review, testing in a sandbox or testnet environment, and finally, deployment to the mainnet. 

The process can be slower and may require more administrative overhead than on-chain methods. Another important aspect to consider is that off-chain governance models may be more susceptible to centralisation pressures. Key figures in the development community or major stakeholders could potentially exert disproportionate influence over the decision-making process.

Aside from Bitcoin, Ethereum also primarily relies on off-chain governance, with decisions usually made through a combination of Ethereum Improvement Proposals (EIPs), developer meetings, and community discussions. Litecoin, a fork of Bitcoin, similarly employs off-chain governance through developer and community consensus. Monero, known for its focus on privacy, also uses an off-chain model, with decisions made through community discussions and developer meetings. 

Liquid Democracy Governance

In a liquid democracy, the governance model is designed to offer a more flexible and dynamic approach to decision-making by allowing token holders two options: they can either vote directly on proposals affecting the blockchain, or they can delegate their voting power to a representative who will vote on their behalf. This delegation is not permanent and can be revoked or changed at any time, thus ensuring that token holders are not locked into their choices and can adapt to new information or shifting circumstances.

The idea behind this system is to merge the merits of both direct democracy, where every participant has an equal say, and representative democracy, where elected officials make decisions for the group. In a direct democracy, while participation is maximised, not every individual has the expertise or time to make well-informed decisions on complex matters. 

Liquid democracy aims to strike a balance by providing a flexible framework where participants can toggle between direct and representative modes of governance, depending on their level of expertise, interest, or trust in their chosen delegates. This creates a more nuanced and adaptable governance system that can better cater to the diverse needs and preferences of its stakeholders. Liquid democracy governance models are popular in Proof of Stake (PoS) blockchains, where validators can also act as staking pools and as delegates for other users during votes on governance proposals. 

Cardano is exploring the use of liquid democracy within its governance model through its Voltaire phase, aiming to create a more balanced and inclusive system for protocol improvements and funding proposals. This allows ADA token holders to either vote directly on governance issues or delegate their voting power to experts, thus providing a flexible framework for community engagement in decision-making

Aragon, is another project focused on creating decentralised organisations, offers a liquid democracy feature that allows token holders to either vote directly on governance proposals or delegate their votes to a trusted representative.

Quadratic Voting Governance

In Quadratic Voting (QV), a novel approach to democratic decision-making, participants are given a set number of voting credits, often referred to as “voice credits,” which they can allocate across various proposals or choices. Unlike traditional one-person-one-vote systems, QV allows individuals to express varying degrees of preference by assigning multiple credits to issues they care deeply about. 

However, the unique aspect of this system is that the cost of casting additional votes for a single proposal isn’t linear but increases quadratically. For instance, if the first vote for a proposal costs one credit, the second vote might cost four credits, the third nine credits, and so on. This quadratic cost curve serves as a built-in mechanism to deter the concentration of voting power and to discourage disproportionate influence by any single participant. It ensures that while participants can express strong preferences, they must do so at an escalating cost, making it expensive to dominate the decision-making process. 

This is particularly beneficial in blockchain governance systems where token-based voting could otherwise lead to plutocratic outcomes, as it compels participants to think carefully about their priorities. Quadratic Voting aims to democratise influence, enabling more balanced and fair representation of diverse opinions and interests within the community.

Gitcoin, a platform that funds open-source development, has effectively employed QV in its grant distribution system, allowing community members to allocate “voice credits” to projects they wish to support, but with a quadratic cost for additional votes. 

RadicalxChange, inspired by the work of economist Glen Weyl, has also been an advocate for QV and its adoption in blockchain governance. Some DAOs are also exploring the potential of incorporating QV to address issues of unequal voting power and to better capture the nuances of community preference.

Futarchy Governance

Futarchy is a governance model that leverages prediction markets to guide decision-making, particularly in complex systems like blockchain networks. In a Futarchy-based system, whenever a governance proposal is made, a prediction market is created for that specific proposal alongside any alternatives. 

Participants in the network can then place bets on what they believe will be the impact of each proposal, usually in terms of predefined metrics like token price, network usage, or other key performance indicators. Essentially, individuals are financially incentivised to accurately predict the outcome, thus arguably surfacing the “wisdom of the crowd” in a quantifiable manner. 

The proposal that garners the most confidence, as evidenced by the bets placed in the prediction market, is then automatically selected for implementation. This method is designed to filter out emotional or ill-informed decisions, focusing instead on what the collective intelligence of the network predicts will be the most beneficial outcome. By tying financial incentives to accurate forecasting, Futarchy aims to create a more data-driven, objective form of governance. 

However, it’s worth noting that this system assumes that market participants are rational and that the metrics chosen for prediction are accurate reflections of network health. Thus, the effectiveness of Futarchy as a governance model can depend on the quality of its implementation and the rationality of its participants.

The concept of Futarchy has intrigued the blockchain community, and several projects are either experimenting with or seriously considering its adoption as a governance mechanism. Gnosis, a platform specialising in prediction markets, has been at the forefront of integrating Futarchy into its governance model. Augur, another prediction market platform, has also shown interest in exploring Futarchy-based decision-making. DAOstack, a framework for decentralised organisations, has considered Futarchy as a potential governance module for its customizable DAOs.