Governance in Decentralized Systems

Web3 is an industry, created, and introduced to solve the core problem of Web2 - censorship. It manifests as a derivative of certain elements in the traditional financial and technological system.

When communication was a hassle in Africa, town criers were responsible for disseminating the information to the community, before the evolution of phones and mobile gadgets to enhance communication.

The act of storing/saving money is also important, humans kept their money either buried or hidden under their pillows, but with the introduction of the banking system, humans could create banks where storing and saving money was easy. Storing/saving money as well as communication is important but technology brings advancements to these vital pillars of human society which have been observed and improved on over time.

In a traditional banking system, there are certain criteria bank users must meet before accessing certain services such as having a high credit score before borrowing money. And due to monetary policies as well, commercial banks still answer to central banks to supplement their own needs which clearly shows that a higher governing body has been put in place to make the entire financial banking policy run as a system.

These rules are maintained and enforced because humans are involved and before a system can be run properly understanding human behavior is necessary.

Why are governing systems necessary?

While entities often aim to improve human lives, it's important to remember that human behavior can be unpredictable and difficult to measure. Therefore, rules must be established to guide how systems operate. Before setting these rules, a governing body must be appointed to define the guidelines that all entities must follow.

Take a newly developed city with new buildings, street lights, roads and so forth. When new residents come in, the community lead or the state will present a set of instructions that residents must follow. A simple one can be: certain items go in the waste bin and others in the recycling bin.

Naturally, there’s no guarantee that the residents will do as they’re told. Since humans can’t always be trusted, rules exist to keep them in check and ensure that society (the system) operates as it should. In our example, these rules ensure that residents know what’s acceptable and what isn’t. The residents understand that they are part of a social contract and that there are consequences for going against the terms of the contract.

If a governing system is established in Web3 doesn’t that make it centralized?

The internet has evolved through three phases: Web1, Web2, and Web3. Web1 marked the early days of the internet, with limited adoption. Web2 brought widespread adoption, but also introduced issues like data monetization, which put users at risk due to the selling of personal data and other downsides of centralization. Web3 is now emerging to counter these centralization challenges, focusing on decentralized systems and enhancing asset security through blockchain technology, a core concept in this phase.

When designing a blockchain, the consensus mechanism is a critical factor. It determines how the network is secured, how validators verify transactions, and the agreed-upon method for confirming a transaction's validity.

Every blockchain runs a specific consensus mechanism such as Proof of Stake, Proof of Burn, Proof of Play, Byzantine Fault tolerant (BFTs), etc.

The uniqueness of every blockchain varies and can lie in its consensus mechanism. It is part of what makes Ethereum different from Bitcoin, Berachain different from EOS, and a list of others you might want to compare. Before a consensus is agreed upon, a body has to vote, this voting introduces the decision-making process on who qualifies to take part in the process and who doesn’t.

Compared to the traditional system where a committee or a board of governors makes the rules, a participant may be able to be part of the decision process and in the long run not really be part of the process (more of this will be explained in this article).

Aside from determining the consensus, there are other cases where decision-making has to go through a governance system. Every blockchain has a unique governance mechanism and hence not all blockchain answers to a higher blockchain, unlike in the traditional banking system where commercial banks answer to central banks.

Irrespective of the uniqueness of every blockchain’s method of governance, there are two general principles every protocol must maintain:

1. Algorithmic Governance
2. Social Governance.

Algorithmic Governance

In government institutions, there are codes everyone must follow. Hence the saying: “The code is the law”. This also applies to blockchains, where protocols have workflows and specific patterns for achieving consensus. There are penalties for not following the consensus rules.

This code is unlike in a community where a “code of conduct” is enforced. In blockchain systems, a different type of code is introduced known as “Smart Contracts”. These are human-readable codes but are pre-defined codes written to enable certain actions when conditions are met.

Unlike community codes, these codes function as social contracts that require a third party to oversee and ensure compliance. If one side violates the rules, the third party acts as a witness and imposes penalties.

In blockchains, smart contracts act as overseers and automate processes. For example, if a node becomes faulty, a penalty like slashing rewards can be automatically applied without human intervention or the need to update the code manually. At this stage, the system becomes self-executing.

Each blockchain follows a specific methodology, often driven by its virtual machine or transaction processing model. Smart contracts are designed with predefined workflows to establish algorithmic governance. Over time, however, new innovations may be required due to limitations in the existing design or other factors.

Builders and creatives may need to try out new things to increase user experience and that’s where social governance comes in.

Social Governance

This is specific to every protocol/network because objectives can change and the protocol may need to be updated.

Every network incorporates a social layer of governance to modify the chain's algorithmic governance. However, not all participants can initiate changes—only specific agents can propose or oppose modifications.

The relevance of social governance is much more practical and easily observed when analyzing similar implementations. Take for instance the concept of account abstraction when introduced into Ethereum and Bitcoin witnessed a hard fork to Bitcoin Cash.

In the case of account abstraction, Ethereum allows developers to submit requests for specific changes through response comments. Several Ethereum Improvement Proposals (EIPs) were introduced, including EIP-86, EIP-208, EIP-2938, and EIP-4337. Ultimately, EIP-4337 was approved for implementation. Unlike EIP-2938, which suggested changes at the protocol layer, EIP-4337 proposed the same concept without altering the protocol layer.

During these ideation phases, comments on GitHub issues were mostly used and this can be regarded forms of governance and not principles.

For the Bitcoin hard fork, block data storage has always been a limitation to Bitcoin’s composability alongside its non-turing contracts. At some point, a set of developers proposed a way to increase the block-size limit while others opposed that an increment could be done without protocol change (which requires all nodes to change/upgrade their software).

The first group which proposed an increment to the protocol change forked Bitcoin into Bitcoin Cash and the other group introduced SegWit. These proposals were made through Github issues and comments as well.

Some protocols may practice off-chain governance or on-chain governance. Off-chain governance relies on using social networks such as Reddit to discuss proposals or even GitHub comments to discuss changes that can be made to the protocol layer.

In many cases, developers are not incentivized for submitting proposals. To address this, on-chain governance is introduced, allowing proposals to be made and voted on directly within the blockchain's testnet. Upon successful implementation, the developer whose proposal is adopted receives a reward in the network's native token. Tezos and DFinity are examples of networks that utilize this type of governance, while Bitcoin, the most popular blockchain, operates with off-chain governance.

Due to incentives, on-chain governance is preferred to off-chain governance in practice. Blockchains that utilize on-chain governance give room to more rewards for users for their contributions to the network as agents.

Regardless of on-chain or off-chain governance, a more diplomatic approach has emerged through Decentralized Autonomous Organizations (DAOs) and governance forums. In this model, a quorum is established, requiring a specific threshold of agreement before any changes can be implemented.

Understanding DAOs

The term DAO comes from the initial term; DAC - Decentralized Autonomous Corporation which was a system of government in the traditional system introduced by individuals through buying of stocks, being shareholders, and entitled to profits in the organization.

The concept of Decentralized autonomous corporations was re-introduced as Decentralized Autonomous Organizations in Web3 by Vitalik Buterin. The initial objective of DAOs was to create a community where users can vote and make decisions but on a deeper level analyzing the denotations of the words: Decentralized, Autonomous, and Organizations.

These organizations start as a group chat could be telegram or Discord with a gated community token that users will need to own before being able to join and be part of the decision-making process. But taking a deeper look at the word “autonomous” it doesn’t give its own self-sufficiency as these organizations don’t run on their own but are just censorship-resistant and free.

These DAOs were introduced as a way to which governance can be made on certain communities or even blockchains but after the introduction of DAOs a misconception is laid between what a real DAO is and what a fake DAO is.

DAOs initially standing for Decentralized Autonomous Organizations logically cancels what we call DAOs currently. Currently, a set of persons can come up, create a telegram group, or even a discord chat, and set a gated pass for access into the "DAO". Certain criteria must be met before you can join. An example of this is DeveloperDAO where a fungible token serves as a gated pass other community DAOs make use of NFTs.

But in the real sense, most DAOs are only Organizations and Decentralized as there is a group of persons belonging to the same community and decentralized because no one gets to control the entire system. It is censorship-free but how about its state of being autonomous. This is where most DAOs are kicked out from the term DAO.

Governance in communities may differ in terms of the need for the inclusion of a DAO but in some cases, a protocol introduces only a governance forum to run governance after proposals has been made then voting is made.

Other examples of DAOs include FingerPrints and NounsDAO. In essence, these DAOs serve as a governance forum to make decisions on communities, within an organization, or a project in an ecosystem. It’s also crucial to understand that decision-making forums may have gated access or certain agents responsible for making decisions.

Voting and decision-making

Remember anything existing in the traditional world of finance can be replicated in the blockchain industry. In nation-state governance, tiers of government exist which include the legislative, executive, and judiciary have participants in the different arms where laws and concepts such as checks and balances apply which before laws are enacted or enforced, these participants who have a share in the decision-making process debate on the subject matter till a quorum is reached. Where the highest weight of either “yayy” or “nayy” goes to, then a law can be enacted. These set of persons in these different tiers are the participants representing the “people/nation”.

This is similar to the concept of DACs. The government can be said to be an organization representing the people but relating to the concept of governance in Web3/blockchains moral hazard has to be reduced as it is evident that in most cases the government tweaks power in their favor which breaks it from being decentralized. Governance in Web3 diffuses and spreads power to anyone - known as agents.

An agent/participant could be a validator, delegator, holder of a token, or developer. When a proposal, anyone set as a network participant has the authority to vote for the proposal. If this was restricted to just a set of persons, the tendency for a group to be formed within this set of defined persons can make the system centralized hence, proposals that aren’t in their favor will definitely reduce. Anyone can make a proposal in the public blockchain as a participant.

Let’s say a proposal is created on the governance forum just like in the case of Bitcoin that gas fees should be reduced. If blockchain governance is controlled solely by validators, this proposal will not be implemented. Validators would oppose it because they don't want their validation incentives to be reduced.

But due to the distribution of power, others such as mere holders will see this as an indication that high-frequency traders can move to the chain, volume increases, get the attention of crypto Twitter (CT) and hence pump their bags. It’ll depend on everyone who has access to vote that then pulls the vote before a quorum can be reached.

But being a network participant doesn’t guarantee you to be able to vote. Same way in political elections, a voter’s card will be required. A token is 99% of the time for you to be able to push a proposal. This could result from reducing bot participation in voting. The goal is to ensure the process is driven more by humans

Tokens set for making decisions can most times be the native token of the protocol and in other cases, a governance token is introduced.

This entirely depends on the protocol, some protocol introduces a governance token for the sole purpose of enabling its holders to carry out certain rights and authority these rights may differ but on general note, holders of governance tokens can vote in approval or disapproval of a proposal. A popular example of a governance token is $UNI. Holders of $UNI can propose changes to where protocol fees are distributed, protocol upgrades, and future token distribution.

There are different mechanisms introduced to how governance can be run on a platform or through a platform due to some risks and cons that are likely to be exposed in the process of governance.

In most cases, it could be that a certain number of people must most before a proposal must be implemented and not based on the “yes” vs ”no” number of voters, some mechanisms such as “quadratic funding” which mitigates the chances of whales centralizing power, and other mechanisms such as conviction voting where preference is given to members with longer presence in the protocol.

Other governance mechanisms include Quorum voting, commit-reveal voting, stake-weighted voting, liquid democracy, and 1 token 1 vote system. It’s an inexhaustible list.

Decision-making is practically subjective to every protocol based on the mechanism of how it was designed.

Final Thoughts

Given the subject matter of governance, for every other concept introduced into the blockchain industry, a replica of functionality is already in the traditional system but core objectives such as "decentralization” aren’t sacrificed hence, every methodology will vary when carrying out the same intent.

On the other hand, provided that the “code is the law” in blockchain systems, the relationship between algorithm governance and social governance is mutually beneficial as without the social level, execution by the smart contract cannot be made possible.

Finally, no governance mechanism remains the best as pros and cons applies to all of them. High scrutiny and low risks measures/chances are evaluated before implementation.