On Chain VS. Off Chain Governance: The Ins And Outs

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To understand the importance of blockchain governance and the debate surrounding it, It is important to first define blockchain governance and it’s role in the entire blockchain ecosystem.

Blockchain governance in cryptocurrencies relates to decisions about two things: the rules of the protocol (the code) and the incentives the network is based on (the economics).

Blockchain protocols have significantly evolved since their inception, however, it is undeniable that they are still in their nascent stage and there is significant room for improvements before we arrive at their fullest potential. Every day several new innovative solutions in areas such as scalability, privacy etc emerge and are implemented into protocols. There have been implementations directed by core developers and the community that have been significantly successful and several have failed too. Adaptability is key. The most recent significant incident of a hard fork was that of the Monero (XMR) community forking to implement ASIC resistance into their protocol to avoid the centralization of mining. This demonstrates the fact that blockchain protocols need to be able to adapt and make improvements to sustain and survive in the long run. In an ecosystem like this, the importance of a governance system to administrate proposals, implementations, and other crucial decisions is drastic. With the decentralized nature of the entire landscape, governance is very tricky and critical as it needs to not be centralized and permissioned. Several major blockchain projects such as Tezos, Dfinity, Decred etc have introduced on-chain governance centered models where governance is an integral part of the protocol just like any other component. However, before diving into their proposed solutions it is important to understand and deconstruct the existing governance system and break down the benefits and tradeoffs.

The key to blockchain governance is to analyze the different classes of actors in a network, their individual incentives and the coordination of the actors to align their incentives and arrive at a conclusion.

Different classes of actors in a network:

  1. Miners: Miners are the backbone of the network and help the network sustain. Their incentives include block rewards and transaction fees. As a result, miners are likely to favor changes that would increase the value of their existing holdings, increase/maintain the block rewards and transaction fees.
  1. Developers: Developers play a vital role right from envisioning the protocol to maintaining the blockchain during its lifetime. They help shape the future implementations and direct the entire community. Their incentives include the potential increase in existing holdings and popularity in the community/industry over their contributions. Even though pre-mining of tokens and using them to fund development of the project has seen a significant increase in popularity over the years, there isn’t an incentive mechanism in place to incentivize people to contribute towards the development of the system in the long run. Private funding and crowdsourcing exist but there isn’t a robust rewarding mechanism in the protocol for people, who are not part of the initial team or foundation, to participate.
  1. Users: Users like other actors are incentivized to favor upgrades which would not only increase the price of their existing holdings but also improve the core functionality of the system.

While it is obvious that all the different participants have some common incentives, asymmetries in incentives do exist and cause a lot of governance issues. For example, Users and developers can push for upgrades which could drastically decrease the transaction fees to hurt the miners in a way that it is impossible for the network to sustain economically. Similarly, miners can push for upgrades which could drastically inflate the block rewards which in the long run might hurt the network. As established, It is important to study the asymmetries and arrive at a sustainable middle ground. Let us look at the way existing protocols such as Bitcoin and Ethereum are governed.

Bitcoin

Bitcoin has an off-chain governance approach. Bitcoin developers coordinate using a mailing list and they maintain Bitcoin improvements proposals (BIP) repo where anyone can contribute their ideas to further advance the system. There are several developer communities on IRC, slack channels etc where core developers coordinate and discuss various implementations. As mentioned before, their incentives include the potential increase in existing holdings and a sense of fame and respect from the community. They have access to private funding and contributions from people who want to fund the open source projects. However, there is no native reward mechanism in the bitcoin protocol which rewards development. A lack of such an incentivizing system has led to people accusing that the bitcoin core development is not as widespread as you’d hope to be and the direction of the system is being shaped by a relatively small group of developers.

As for the user community, bitcoin-talk forum has served as a hub for community discussions since the very inception of Bitcoin’s inceptions. Reddit communities (such as r/bitcoin, and r/CryptoCurrency) and websites like Twitter also serve as discussion platforms and can be utilized to gauge community opinions and reactions.

It is also important to understand the community’s dynamics with protocol upgrades. Bitcoin has seen several soft forks and hard forks in the past. There have been prolonged headed discussions in the community by users and developers over implementations and upgrades. Issues such as seg-wit and block size limit have lasted for a long while and also given rise to several forks, Bitcoin cash being the most popular fork. Upgrades such as pay-to-script, segwit were included as soft forks and the community is known for it’s aversion to hard forks. Hard forks tend to disrupt the network and require all the miners to upgrade their clients which causes chain splits and other confusions.

Ethereum

Ethereum has a governance system very similar to Bitcoin. The development of Ethereum is funded and governed by the Ethereum foundation based out of Switzerland. The development is funded by the money raised during the ICO in 2014 and the pre-mined Ether owned by the foundation. Ethereum has EIP’s to drive new ideas and they also broadcast their core developer discussions on YouTube where they go through several proposals and discuss them in detail. It is also important to note that the Ethereum community has successfully withstood several hard forks and is known for their openness and flexibility to protocol upgrades. One of the reasons for that would be simply the fact that Ethereum was born out of failed attempts to upgrade and implement full-scale smart contracts on the bitcoin blockchain due to the rigidness of the community.

Even though the off-chain governance model has been in place for quite a while now and has served as a means to improve and upgrade the existing protocols, proponents of on-chain governance models claim that the lack of incentives for development would leave the process being controlled by a small group of core developers. And due to inherent human nature, having a centralized group of people shapes the development process makes the community vulnerable to bribery and other influence vectors.

Let us look at the proposed and existing on chain governance protocols and ideas to weigh in on both sides of the argument.

Tezos

Tezos is a decentralized smart contract platform like Ethereum but with a built-in governance model and formal mathematical verification of smart contracts. They raised 230M$ in ether and bitcoin during their ICO in July 2017. The money raised is now worth about 600M$, as of writing this article. They have faced their fair share of troubles with the SEC and have continuous delays to launch their main net (which is estimated to be arrived by Q3 2018). As for their governance model:

  • Tezos takes a fundamentally different approach by creating governance rules for stakeholders to approve of protocol upgrades that are then automatically deployed on the network. When a developer proposes a protocol upgrade, they can attach an invoice to be paid out to their address upon approval and inclusion of their upgrade. This approach provides a strong incentive for participation in the Tezos core development and further decentralizes the maintenance of the network. It compensates developers with tokens that have immediate value rather than forcing them to seek corporate sponsorships, foundation salaries, or work for Internet fame alone.

Anyone can propose improvements to the protocol and once approved the changes go live on a test network and eventually upon further approval make their way to the main network. On final implementation, the participant is paid in newly minted tezzies for their contribution to the network. This is a significant move towards building a rewarding mechanism to maintain the development of the protocol.

DFINITY

DFINITY is an “intelligent decentralized cloud”. They aim to be a next-generation Ethereum-like platform and reaching to the next level by replacing “Code is Law” with “AI is law”. As for governance, DFINITY follows a model similar to Tezos but also allows direct changes to the ledger itself given there is a consensus among the coin holders. Although it seems to go against the inherent “immutability” nature of blockchains, proponents have claimed that past events such as TheDao fork would’ve been smoothly resolved given there was a system like this in place. Supporters of such a system have hailed it because of its ability to smoothly remove any illegal content engraved into the ledger by bad actors. While others have called it a double-edged sword because there are several questions such as “What content should be categorized as illegal given there are several jurisdictions?”, “What about hate speech and who draws the line?” etc.

Decred

Decred is a hybrid PoW/PoS cryptocurrency which embraces autonomous onchain governance models. Decred, unlike Tezos and DFINITY, has a fully functional main network. Decred has its own constitution and like other onchain models it allows stakeholders to make protocol upgrades and invalidate blocks given, there is a consensus.

Even though the new governance model seems pathbreaking and incredibly useful, several people have been skeptical about the merit and need of such a system. There are several major critiques of such a system put forward by people such as Vitalik Buterin. The most common argument is that having an onchain governance model would take the participation of governance away from miners (and subsequently users). In an off chain, governance model node operators have to update their client manually to align with the new chain. This enables miners to make a conscious choice to participate in a chain they want to. However in an onchain governance model protocol upgrades are automatic and doesn’t need any manual interference. While it is still possible for miners to reject the change and form their own chain, such a task would require tremendous coordination and work. The idea is that pivoting and changing should be harder because that way only changes worth the effort would see the light of day, pushing away unnecessary upgrades. Several people against such a system argue that this might lead to reactionary upgrades and it is important to embody the “it is important to kill bad legislation than passing good ones” philosophy. Miners in an off-chain model serve as an important check to balance the power when it comes to making changes to software. Onchain governance might remove such checks and balances.

One other qualm would be how onchain governance might be how it might resemble plutocracy. Protocol upgrades are decided by “1 token = 1 vote” mechanism and this leads to people with a significant share of the total supply have more vote power than the rest of the network. This is definitely not unheard of. As of Sept 12th, 2017, 4.11% of the bitcoin address hold 96.53% of total supply. Even during TheDao fork, a single voter had a significant share of power.

It is also important to note the low participation rate during the vote. TheDao had less than 5% voter turnout. Even protocols such as Lisk and Ark where voting is a crucial part of the protocol (due to DPoS) never see >50% of voter turnout. A crucial argument is that the coin holders and actual users of the network are not necessarily same and have different incentives which are not completely aligned. For example, users would like the network to be cheaper to use, while coin holders would want it to be otherwise given their vested interest in the token. However, it can be argued that it isn’t in the holder’s best interest to act in a way that would drive away users. The non-alignment of the incentives combined with the ability to push changes automatically definitely makes people skeptical. Another complaint is the fact that it is very much possible to bribe users to vote against their best interest. While it seems obvious that users wouldn’t want to vote for protocol upgrades that are not in their best interest claims of bribery already exist and warrant attention. Protocols such as EOS, Lisk, Ark have a Delegated proof of stake where certain nodes have significant power to validate blocks and the rewards are significantly higher compared to PoW or PoS. These nodes are elected by stakeholders by voting. Even though there are witnesses to prevent any bad actors acting maliciously, the significant rewards, in newly minted tokens (~5% in newly inflated tokens annually in EOS with moves to reduce it to ~1%), for the Delegates has increased the competition. Miners are likely to bribe the voters to elect them as delegates in exchange for some of the newly inflated tokens. Skeptics claim that this kind of system might lead to mining cartels to being formed and there will be subsequent actions such as this in any system with stakeholder voting.

However, these problems could just be the fact that the blockchain space is still in its infancy and a more mature ecosystem onchain governance might sustain without having to worry if the rewards outweigh the risks. Futarchy, Quadratic voting, Liquid democracy, Reputation-based voting are other variants of voting which take a slightly different route than “1 token = 1 vote” but can still be integrated into an onchain governance model. Another interesting observation is the fact that in PoS (a consensus algorithm towards which several platforms including Ethereum are moving towards) there is going to be a significant paradigm shift when it comes to alignment of incentives. Because in PoS the distinction between miners and coinhodlers becomes thin meaning that miners in PoS are likely to have the same incentives as end users. There wouldn’t be different classes leading to miner activated fork vs user activated fork leading to a system where users and miners (who have significant “stake” in the system) will have a better coordinating mechanism. 

Vitalik Buterin argues that an off chain governance system which takes several factors (such as the initial roadmap, consensus among development team, coin holder voting, user voting with some kind of Sybil resistant polling system, established norms) rather than simply an onchain voting mechanism would be a better route when it comes to blockchain governance. However Naval Ravikant tweets that “Most coins wouldn’t exist if Bitcoin and Ethereum had incentives for future development built into the core protocol.” Regardless on chain governance is a exciting prospect for blockchains and it is only a matter of experimentation and time which would lead us to perfecting blockchain governance. Irrespective of the benefits and tradeoffs, both governance models should be studied and implemented extensively.