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Cryptocurrency Governance and Challenges

Given that we are approaching the tenth anniversary of the original Satoshi white paper being published, it is probably appropriate for us to step back, zoom out, and ponder upon some topic that is foundational – What can modern nation-states learn from the prevalent governance architectures of blockchain systems?

Some would argue that blockchains are accelerating the process of deconstructing nation states, a process that multilateral trade started and rapid technology advances have been speeding up (at least until recently! We are now in peak social media, post truth times, and ‘Big Tech’ definitely is questioning its moral and ethical compass and its role in creating increasingly rigid, inward facing nation state ideologies, led more often than not by demagogues).

That digression aside, it is interesting to compare the governance models that exist in cryptocurrencies.

At least in theory, uncensorable and immutable digital monies, especially Bitcoin, allow users to wrest away control of their wealth from the inimical effects of poor institutional governance. In public blockchains “code is law,” but what provides assurances to stakeholders that code cannot be easily tampered with and amendments to the protocol are in the best interests of a majority of stakeholders (If not all of them)?

Just like nation states, public blockchains are inherently political and require checks and balances in place to protect the integrity of the network. From a governance perspective, first generation blockchains such as Bitcoin and Ethereum did not have a formal governance structure, almost by design. Key decisions regarding protocol upgrade are decided by a core group of members trusted by the community. This is definitely more decentralized than traditional political governance of our daily lives, but not every user in the ecosystem is allowed to participate in the decision-making process (directly or indirectly). The ever-present threat of a hard fork is an extremely powerful check against poor governance in this setup (as it is with nation-states when a region that feels wronged or neglected wants to break away). We have seen real-life examples of fundamental disagreements within communities which have led to blockchains being forked off (notably, Bitcoin Cash and Ethereum). This form of governance, that seems to be working reasonably well at the current moment, is ‘quasi-decentralized’ with strong penalties through hard forks for poor decision making.

Newer generation protocols, such as Cardano or Tezos for instance, place a significant emphasis on “on-chain governance”, by encoding a formal governance structure at the protocol level. On the face of it, this might appear to be a better governance structure as it inherently feels more democratic. Every tokenholder has a right to vote for/against proposals made by community members and the proposal will only be accepted if it gains a majority vote.

However, this process has its own set of challenges that we believe are very difficult to overcome. Firstly, it’s not purely democratic because the voting structure is “one coin one vote” and not “one person one vote,” which would make it rather plutocratic. A truly democratic voting structure is vulnerable to ‘Sybil attacks’ due to the pseudonymous nature of ownership in the public blockchain architecture; It is far easier to create a new identity on blockchain than to acquire an extra token in order to have one more vote. Secondly, an all-inclusive decision making process is very costly as it involves inputs from a significantly large group of members. Incurring significant decision making costs is still acceptable if the outcome is likely to be unanimous. This is highly unlikely, as numerous elections in even reasonably democratic nations have shown. Without unanimity, the cost of externalities is high (cost of suffering from decisions that are voted against your choice). The minority faction thus has a strong incentive to fork off the main protocol to reduce their cost of externalities. In addition, a majority of cryptocurrency funds are controlled by centralized exchanges which reserve the right to vote on behalf of their users. Voting by exchanges may be self-serving and may not align with the interests of users who own them. 

To sum up, the risk of a hard fork persists in both systems, whether it be the the meritocracy/technocracy of a few wise men in the off-chain governance setup or the democracy of the crowd in an on-chain architecture. However, given the high cost of running democratic elections in an on-chain governance framework with no perceptible result in improved outcomes, the off-chain governance architecture of Bitcoin and Ethereum might emerge as a winner.

In our opinion, technocracy/meritocracy might be the best (available) political system to govern blockchain protocols. There are intricate trade-offs in every blockchain between scalability, decentralization and consensus. These are highly nuanced and a majority of the blockchain stakeholders are not in a position to make an informed call regarding the true consequences of the trade-offs across the three legs of this trilemma.

Now, does this mean that we should have a discussion around giving up democracy for a slightly simpler system with similar results?

Meanwhile in Crypto Wonderland….

“NZ Invests in Crypto Startup” New Zealand’s innovation arm, Callaghan Innovation, has invested $330,000 into a cryptocurrency savings and trading platform. The investment comes as the platform rebrands from MyCryptoSaver to Vimba to reflect the expanded range of services the Auckland-based startup offers. According to Sam Blackmore, CEO of Vimba, the funds will be used to build “secure multi-signature crypto wallets” and expand the product offering.

“Ron Paul Criticizes Proposal Taxing Crypto” Federal Reserve critic and crypto proponent Ron Paul criticized the central bank, saying government-created currency could lead to what he calls a “Fed-created recession.”The libertarian-leaning economist, who served as a U.S. representative for more than a decade said that the only way to avoid a pending crisis is to abolish the “monetary madness,” which includes the taxing of Bitcoin and other cryptocurrencies.

“GS Talking to Clients on Crypto” Goldman Sachs has been onboarding a small number of clients to actively trade bitcoin non-deliverable forward contracts. Apparently, the firm’s clients aren’t necessarily looking for new products but are calling senior bankers and traders for direction on where the space is going and to learn how they can break into the market. GS is also exploring ways to provide cryptocurrency custody solutions for customers.

“Shariah-Compliant Crypto Exchange” The first Islamic crypto exchange (FICE) by Adab Solutions is slated to open in 2019. The exchange will be operating according to shariah law principles. Islamic financial experts under its Shariah Advisory Board will analyze and confirm if each cryptocurrency listed on FICE is “halal.” ADAB Solutions is expecting to achieve USD 146 million in daily trading and USD 4.4 billion monthly turnover by 2020.

“Petro Launched”Venezuela’s controversial state-owned cryptocurrency Petro is now available for purchase for fiat and crypto, Venezuelan Economy Department announced on Twitter. Petro can now be purchased directly from the country’s treasury via the coin’s official website or from six crypto exchanges authorized by the government.

Crypto Twitter Pick

What We’re Reading
 / Listening To

Planting Bitcoin Soil (¾) by Dan Held

The Ultimate Bitcoin Argument featuring Murad Mahmudov

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