DEFINITION of On-Chain Governance

On-chain governance is a system for managing and implementing changes to cryptocurrency blockchains. In this type of governance, rules for instituting changes are encoded into the blockchain protocol. Developers propose changes through code updates and each node votes on whether to accept or reject the proposed change. 

BREAKING DOWN On-Chain Governance

Current governance systems in bitcoin and ethereum are informal. They were designed using a decentralized ethos, first promulgated by Satoshi Nakamoto in his original paper. Improvement proposals to make changes to the blockchain are submitted by developers and a core group, consisting mostly of developers, is responsible for coordinating and achieving consensus between stakeholders. The stakeholders in this case are miners (who operate nodes), developers (who are responsible for core blockchain algorithms) and users (who use and invest in various coins). 

Critics of the system claim that this form of informal governance is, in fact, centralized among miners and developers.

They point to two prominent forks in the cryptocurrency ecosystem as proof. The first one is a split of the original ethereum blockchain into ethereum classic and ethereum in 2016. That split occurred despite another soft-fork proposal which would have been easier to implement but would have resulted in a loss for investors affected by a hack in the cryptocurrency’s blockchain. According to news reports, a majority of the ethereum community was in favor of a soft fork, but its core group of developers was swayed by investor opinion and implemented a hard fork. Some claim that this is a contravention of the widely-held “Code is Law” principle in which the governing parameters for a software are laid down in the original code. 

The second example provided as proof that current governance systems are broken are the series of events that led to the emergence of bitcoin cash in 2017. During that fork, a proposal to increase the average block size in bitcoin’s blockchain was rejected by the cryptocurrency’s core development team. They rejected the change, despite the fact that high transaction fees made bitcoin’s use as a medium for daily transactions unsustainable. The only constituency that benefited from high transaction fees were miners. In the end, a renegade group of developers and miners moved away to create their own cryptocurrency with variable block size. 

On-chain governance emerged as an alternative to informal systems of governance. It claims to solve the problems of centralization of bitcoin by incorporating all nodes within a blockchain network into the decision-making process. Stakeholders in the process are provided economic incentives to participate in the process. For example, each node can earn a cut of overall transaction fees for voting, while developers are rewarded through alternate funding mechanisms. Each node’s vote is proportional to the amount of cryptocurrency it holds. Thus, the greater the numbers of cryptocurrency held by a node, the more votes it has.  

How Does On-Chain Governance Work?    

Unlike informal governance systems, which use a combination of offline coordination and online code modifications to effect changes, on-chain governance systems solely work online. Changes to a blockchain are proposed through code updates. Subsequently, nodes can vote to accept or decline the change. Not all nodes have equal voting power. Nodes with greater holdings of coins have more votes as compared to nodes that have a relatively lesser number of holdings.

If the change is accepted, it is included in the blockchain and baselined. In some instances of on-chain governance implementation, the updated code may be rolled back to its version before a baseline, if the proposed change is unsuccessful. 

Implementation of on-chain governance differs between various blockchains. For example, Tezos, a cryptocurrency, uses a form of self-amending ledger. Proposed changes are implemented to the coin’s blockchain and rolled out onto a test version of the chain. If the planned changes are successful, they are finalized to a production version of the blockchain. If not, they are rolled back. DFinity, a startup that is using blockchain to build the world’s biggest virtual computer, unveiled a plan to adopt a hardcoded constitution on its network. The constitution triggers passive and active actions. An example of the former might be an increase in reward size for blocks while the latter might involve quarantining certain parts of the network for updates or roll backs.  

Advantages of On-Chain Governance

According to its proponents, the advantages of on-chain governance are as follows: 

  • It is a decentralized form of governance

Changes to a blockchain are not routed through a core development community, which evaluates its merits and demerits. Instead, each node is allowed to vote on the proposed change and can read about or discuss its benefits and drawbacks. It is decentralized because it relies on the community for collective decision-making.  

  • Quicker turnaround times for changes 

Consensus regarding proposed changes is achieved in relatively less time among stakeholders. Informal governance systems require time and effort between stakeholders in order to achieve consensus. For example, the bitcoin cash fork and ethereum classic fork took months to build up and implement. What’s more, off-chain maneuvering can result in messy situations wherein certain nodes can agree to disagree and not run the proposed changes. Algorithmic voting mechanisms are relatively faster because test results for their implementation can be seen via a code update. Running the code change on a test net, as in the case of Tezos, also enables stakeholders to see the effects of that change in practice. 

  • Possibility of a hard fork is reduced significantly

Because each proposed change requires consensus from all nodes, this means that the possibility of a hard fork is reduced significantly. Through the use of rewards, on-chain governance proposes economic incentives for nodes to participate in the voting process. The informal governance process does not provide economic incentives to end users, who utilize cryptocurrencies for daily transactions or invest in them for long periods. Instead economic incentives rest with miners and developers. Once voting is concluded, all node operators are required to follow the decision.   

Disadvantages of On-Chain Governance 

Based on initial experiments conducted with on-chain protocols, the disadvantages of this type of governance are as follows: 

  • Low-voter turnout

As with real-world elections, low voter turnout may become a problem for on-chain governance. The recent DAO Carbonvote, which recorded participation rates of 4.5%, is proof of this problem. Low-voter turnout is also undemocratic because it could result in a single node with significant holdings manipulating overall future direction of the protocol.

  • Users with greater stakes can manipulate votes 

Nodes with more coins get more votes. Again, this means that users with more stakes can take control of the voting process and steer future development in their desired direction. More importantly, it skews the dynamic away from miners and developers towards users and investors, who may be simply interested in maximizing future profits as opposed to developing the protocol towards innovative use cases.