The Beginner’s Guide to Blockchain Governance

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For millennia, kings and emperors ruled their subjects with supreme authority, centrally controlling the direction and policy-making of their country.

In what is now the United States, this system of rule prevailed until the 18th century, when the American Revolution successfully expelled their foreign rulers and introduced a dramatically new system of local democratic governance.

Two centuries later, we are in the midst of another such revolution.

With the creation of blockchain technology, radical, new systems of decentralized governance have been introduced. Although these systems have not yet impacted how our democracies make decisions, they are already impacting the ways business organizations make corporate decisions.

This is one of the most exciting and overlooked developments to emerge from blockchain to date. We’re seeing thousands of new projects exploring novel governance models that give greater power and access to stakeholders to be part of the decision-making process.

Of course, some of these attempts will be failures, but others will be tremendous successes. Through this process, blockchain will teach us a lot about which governance systems work, which don’t, and why.

To demonstrate how revolutionary these new systems of governance are, let’s first walk through traditional systems of governance and then highlight some of the new systems that have emerged through the introduction of blockchain technology.

Traditional Systems of Governance

Governance is not a new issue. There are countless books, studies and academic papers with theories on the best structures for business success. But until recently, anything beyond top-down governance was limited to theory.

In traditional systems of governance, when an entity is very small, it is usually governed by its owner/operator. The discretionary decisions of this single person are the governance system. Whatever he or she says, goes.

There are many advantages to this approach. The decision making process is fast, has consensus, and is made with the shareholders’ best interest in mind. That said, the quality of the decisions made depends entirely on the abilities of the sole decision maker.

In larger private companies, major decisions are usually made by the majority owner whereas day-to-day operational decisions are made by a professional CEO who is appointed by the majority of the owners.

This system of governance also works but is less efficient than the owner/operator model because there is information asymmetry between the owner and CEO. This means that it will take more time for the owner to make a decision and will only work if the CEO is willing to carry out his orders.

In publicly traded companies, governance systems get more complicated because there is no majority owner to make decisions. Typically, a fragmented group of shareholders elects a Board of Directors who in turn choose a single individual, the CEO, to make day-to-day decisions.

This system of governance is much less efficient than the two systems described above because there is an extra layer between the shareholders and the company’s CEO. The CEO answers to a Board of Directors who may only be involved in corporate affairs on a quarterly basis.

Because of the vast information asymmetry, CEOs of publicly traded companies have much more power than in other governance systems and accordingly often make decisions in their personal interests rather than those of the shareholders.

New Systems of Blockchain Governance

Thanks to blockchain technology, traditional top-down company structures are no longer the only option.

As a corporate lawyer with over 15 years of experience examining different corporate structures, the new forms of governance that are appearing today are nothing short of revolutionary.

Thus far, blockchain has begun to experiment with several types of governance structures but the majority attempt to utilize Unstructured Governance or Voting Systems.

Here we’ll walk through how each of these systems works, along with their pros and cons. Remember, this is not a definitive list. This is just the beginning of a grand experiment in governance. As the industry evolves, we will see countless more permutations of these systems and completely new innovations in this constantly evolving process.

Unstructured Governance

Let’s begin with Bitcoin.

For ideological reasons, Satoshi Nakamoto designed Bitcoin to be decentralized and without strong governance systems. There is no CEO or formal corporate structure in place because of the centralized decision making power that entails. Thus, decisions for Bitcoin are made by consensus of all the stakeholders.

When a project has a lack of formal governance, the decision-making process becomes extremely contentious and political.

Even without any official decision-making power, Satoshi unofficially led the bitcoin community and was able to garner consensus around him. This enabled Bitcoin’s unstructured approach to work for a time, but after his departure, the weaknesses in this system of governance quickly became apparent.

A prime example of this was when issues arose around Bitcoin’s block size limitation. Each of the various stakeholders—developers, miners, and coin holders—had conflicting preferences on the issue, and without decision-making protocol, consensus couldn’t be reached.

Ultimately, this led to a major divide. One faction broke off from Bitcoin to create Bitcoin Cash, taking roughly 10% of their miners, developers, and users with them. At the end of the day, the debate was “settled”, but at the cost of significantly fragmenting the Bitcoin community.

Bitcoin was able to survive the fragmentation due to being the world’s largest and most robust blockchain project. But it was in a unique position. Few other projects could have survived a division this acrimonious.

This is why it is so important for Crypto Law Insiders to understand their governance options and the risks and benefits associated with the structure they choose.

Voting Structures

Seeing the flaws in both traditional corporate structures and Bitcoin’s unstructured governance model and, many projects have tried to incorporate some form of stakeholder voting into their governance.

Dash was one of the first projects to add a formal proposal and voting system, allowing its Masternode operators to stake 1,000 Dash (worth approximately $1.5M at its peak) and vote on how treasury funds are spent. While Dash’s system gives stakeholders access to the decision-making process, with such a high buy-in there is a significant barrier to entry.

Other projects have tweaked Dash’s voting system and modified it to suit their own purposes.

Horizen (formerly ZenCash), for example, is building an on-chain liquid democracy voting protocol to allow all of its coin holders to vote on treasury fund proposals. Unlike Dash, Horizen aims to appeal to a broader voting base operating under the motto “One Coin, One Vote.”

While Horizen plans to use a Digital Autonomous Organization (DAO) to make funding proposal decisions, the core team implementing these decisions is still comprised of professionals.

While both Dash and Horizen try to incorporate some voting mechanisms into their governance, a few projects have decided to operate entirely as DAOs, where all decisions of the project are run through a series of predetermined smart contracts and/or voted on by token holders without any human involvement.

This purely democratized system is designed to completely take out any possibility of centralized decision-making from the process.

The most famous example of this governance structure is The DAO, which was set up as a crowdfunding tool for token holders to vote on how DAO funds were invested. Despite the initial hype around this ideological venture, The DAO suffered a crippling attack due to errors in its code.

Whether The DAO would have been better suited to manage the resulting crises if it had strong, centralized leadership is still being debated. Regardless, more and more projects are beginning to experiment with DAOs.

What does this mean for Crypto Law Insiders?

In order for Insiders to make intelligent choices when designing their own project or investing in third-party projects, it is essential to be informed on the different blockchain governance models being experimented with and the results of each.

Each experiment is a case study that gives us insight into which governance systems work, which don’t, and which is the best fit for your project’s objectives. Not just in theory, but in practice.

For some projects, it is possible that the ideal governance system will look very much like those described above. For other projects, newer and more innovative structures may be needed depending on the unique challenges and opportunities faced. We will continue to update our Insiders as blockchain governance evolves further.

Dean Steinbeck

Dean Steinbeck

Dean Steinbeck, Managing Director of Crypto Law Insider, is the leading authority on legal issues related to cryptocurrency and blockchain technologies.
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