Suppose you’ve invested 20% of your net worth in one protocol. You study the project and have done as much diligence as one could do, being a retail investor. But the governance systems themselves don't work as well as they could. The protocol is controlled by "bad actors" who are focused on things like rent-seeking.
Then (and through no fault of your own) your investment is at risk.
Decentralized governance, referred to as "DeGov" is important to understand and even more important to get right, given how much financial calamity we’ve faced in the industry.
With the advent of Web3 we have seen a mixture of interactions in DeGov systems by both corporate and retail alike, unlike anything we’ve seen before.
Governance has a place in almost everything and anything: NFTs, GameFi and DAOs are just a few well known examples.
And protocols have been able to innovate and iterate governance at a speed that before was not possible in the entirety of human history.
To give one analogy: the Romans had the same republic governance system in place for approximately 500 years.
But iterating governance at a high speed means that we need to take the time to evaluate, analyze and assess our progress.
This comes with challenges that need to be dealt with.
The greater awareness you - as a retail investor have, the more you can conduct first principle thinking and your own analysis.
The Tragedy of The Commons
It’s an issue that we currently face. Small token holders have an insignificant influence on the outcome of the project and so they have little incentive to not be lazy and actually vote. This is in comparison to a big token holder.
But for those who aren’t aware of what voting in proposals looks like, this is roughly the process:
Let’s look at Uniswap as an example. The native token is “UNI”:
“UNI is a tradable asset and functions like most other standard ERC20 tokens, except it has a deeper power as a voting mechanism. In order for UNI to be used as a vote, the owner must first go through the delegation process. Delegating UNI binds the voting power of your tokens to an address so it may be used to vote. This address could be yourself, or a trusted party who you believe will vote in the best interest of Uniswap Governance.” Source
But the problem arises with how much UNI you hold. If you’re a large holder then you are more wary of the power you pass over with your tokens to delegated parties.
If you are a small holder, you only suffer a smaller proportion of the cost of bad governance decisions - but you gain the full benefit of the dividend from governance rights auction. (h/t Vitalik Buterin - add link).
Understanding how to solve the Tragedy of the Commons is the next important step we are looking to solve.
In the current industry we follow something like the Athenian democracy.
This direct, rather than representative: any adult male citizen over the age of 20 could take part, and it was a duty to do so. The officials of the democracy were in part elected by the Assembly and in large part chosen by lottery in a process called sortition.
Comparatively, we are seeing an aggregate movement towards representative democracy, also known as indirect democracy - a type of democracy where elected persons represent a group of people.
This is the way forward, given that most of the industry currently leans on direct democracy.
Let’s take Ethereum as an example.
Ethereum voters could delegate responsibility to a set of “empowered experts” and it’s their role to make the decisions on behalf of the masses.
In the same way that Sony shareholders don’t make the direct decisions on what products to produce. They aren't in charge of what Playstation/console is next in line. They instead delegate this to a workforce, with expertise that they hold accountable (periodically) in their shareholder meetings..
This leads us to the a16z accountability flywheel:
As a result of better representation, compensation and delegation - there is a stronger incentive for “experts to perform” in their given roles.
The big part of representative democracy is making it useful to individuals in different niche. As an example: gamers elect those with the most experience to help improve the game design, but retain control to remove them at any point.
Transparency on chain means their actions are viewable but not necessarily understandable.
And holding a set of people accountable on chain means that there is a smaller scope for voters to vote on - each vote thus becomes significantly more important.
On chain governance is really only relevant to the application layer.
The majority of issues are on the application layer. With blockchain based layers, they are forkable and so can move. But governance on application based layers is more of a pressing issue. The application layer controls external assets and you can’t fork the control of the assets - you'll end up losing them.
That’s why the narrative of focus has been on correcting and improving governance in DeFi systems.
But what exactly are the main problems with token voting in these DeFi systems?
It doesn’t represent all parties within a community
Conflicts of interest inevitably arise
Protocols, like communities are made up of a set of diverse individuals who have different values, visions and goals. This can be anything from active contributors in a protocol to non-token holders who make useful contributions and suggestions. Token voting gives power only to a single party - token holders. And often this means that a large number of price speculators are left in control of the protocol.
In more cases than not, this leads to a misalignment in incentives and greater focus on the price of a project than its utility.
Delegation is the concept that will be used as a solution over the next few years, and it is why I place emphasis on representative democracy to be used more in gaming and DeFi.
The great benefit is that we can iterate these systems at light speed. If something doesn’t work and the system fails - we can at least fail fast.
And the conclusions may not be that one governance model fits for all token holders. We may end up with an X set of varying frameworks that are adopted by protocols depending on their objectives and the spectrum of contributors.
I think of the areas to explore - individual accountability will be the single most important.
Voting fails to an extent because not everyone votes, and there is currently only community accountability. A terrible decision isn’t blamed on the individuals who’s actions led to the decision.
In particular, we currently follow a model where influencers are believed based on their previous actions and social status. Whilst they may have been right previously, it is important to not discount the fact that given the embedded greed of human nature; their intentions may and can in time prove to be selfish.
If a terrible decision happens, then those who supported it should have their reputation on that specific protocol tarnished.
Perhaps the technology to do this isn’t there yet, but I’m sure there is someone out there working on these exact problems.
Whilst it may prove efficient to negatively reinforce actors, positive reinforcement is beneficial too. Perhaps some sort of retroactive reward like an airdrop may prove useful, or as mentioned before - a reputation based points system.
Let me present to you an analogy:
In a school group project:
If someone messes their part up - you don’t kick them out nor do you penalize them. The rules don’t allow that. But there is consensus about the persons reputation, so decisions and thoughts from that person are taken with a grain of salt.
Although their contributions are neither stalled nor prevented.
Final Thoughts
Vitalik is a strong proponent of moving away from “coin voting” being the only legitimate form of governance.
“Coin voting is attractive because it feels credibly neutral: anyone can go and get some units of the governance token on Uniswap. In practice, however, coin voting may well only appear secure today because of the imperfections in its neutrality (namely large portions of the supply staying in the hands of a tightly-coordinated clique of insiders).” - Vitalik
I agree - although I would prioritize education first.
The more pressing issue for me and many others is the lack of education which acts as a strong barrier to entry. Few people are able to read and understand on chain transactions, especially not least the retail investor.
The solution is to have greater on chain education and this will benefit all of DeGov.
Actions on chain will become transparent to the masses, and no longer just the few.
To build up such educational knowledge, I’m certain that actors/influencers will need to align. After all with adoption inbound, it is better to have have the tools in place to educate - rather than a post factum.
Endnote
If you’re looking to build/working on governance in some area, whether that would be in regards to Web3 and crypto, or even non-native crypto communities then do reach out. I would be happy to talk to you!