22 Aug, 23

Decentralised Blockchain Governance: Mental Models to Capture the Failure of Current Approaches and a Proposed, Frictionless Framework

decentralised blockchain governance
Nathan Lenga

Innovation Lead

Since Bitcoin’s genesis block, minted on the 3rd of January, 2009, many innovations have emerged from blockchain technology. One such innovation was community-driven governance through voting mechanisms. Most tokens are created with varying degrees of utility; more commonly, this utility relates to governing the underlying protocol. Despite the importance of this innovation, development beyond tokens providing holders with governance power has been minimal. 

This report will initially examine the importance and evident failure of the ubiquitous governance model currently deployed by most protocols. The purpose of this governance report is to propose an alternative, yet more effective structure for voting and managing projects. In doing so, a plethora of edge cases will be considered and discussed. The two primary categories of edge cases that must be accounted for in an effective governance mechanism are game theory and mental models. Both are deeply addressed throughout the piece. Generically, these mechanisms can be defined as a framework of responses focused on reconciling uncertainty, dependence and opportunism in governance (Urban, 2019).

For the final section of this report, a model that factors in all concepts discussed throughout the piece will be explained. This theoretical model is reliant on various external developments in the space, but fundamentally can advance the wider crypto space by achieving the initial purpose of the governance innovation – giving users power.

1. Governance

The potential benefits offered by on-chain, transparent governance through governance tokens and Non-Fungible Tokens (NFTs) are some of the most significant to come out of the blockchain revolution. Giving users the ability to directly vote on changes to the protocols they use offers individuals the power to enact changes that positively impact them in the long term. Accordingly, individuals have begun preaching that the power dynamic between founders and stakeholders has become inverted –  but has it, really?

Unlike thriving organisms which evolve and adapt to survive external innovation, governance tokens and models within the crypto space have remained comparatively static. With blockchain sparking a Cambrian explosion of decentralised finance (DeFi) protocols, investors began seeing the profitability of procuring a substantial portion of voting power. This correspondingly minimised the influence that the everyday user of platforms had to create different power structures as they failed to match the buying power of these crypto whales. Therein lies the problem. 

1.1. The Importance of On-Chain Governance

Before delving into why most DeFi projects are currently lacking an equitable, just governance model, it is crucial to understand the disruptive nature of users having control over the trajectory of the platforms they interact with. The transparency of the blockchain enables anyone to read on-chain data regarding who voted and the influence of their vote. For the first time, individuals had a method to vote in a trustless fashion. 

Moreover, another revolutionary feature of voting through a blockchain with governance tokens is that everyone with skin in the game can participate in deciding whether to change or protect the protocol. This is hugely different to the Web2 model. Irrespective of how long we spend on Facebook or LinkedIn, without owning an absurd amount of shares in the company, we will not be able to have a direct impact on the company. With 5 billion people around the world using the internet for a daily average of just under 7 hours, we are already living in a digital network that is immersed in social media. And despite this, we are at the whims of others to control how we live and experience our digital lives. 

Purchasing any portion of a governance token and subsequently voting on proposals for change is a novel experience for users who are migrating from Web2 to Web3. Having skin in the game, governance token holders can utilise platforms like Snapshot and Paladin to generate groundswell for a certain issue that pertains to them. Evidently, this natural progression towards involving participants in ascertaining what improvements and changes to make to protocols is crucial for the growth of on-chain democracy.

1.2. The State of On-Chain Governance

Currently, governing cryptocurrency protocols and organisations are solely facilitated through purchasable, transferable tokens. This was the initially-adopted model and has remained relatively unchanged since. Accordingly, this is a prime example of The Lindy effect as most cease questioning the lack of innovation around these tokens due to their expected correlation between the future life expectancy of a working concept and its current age. Just because something works, does not mean it is impervious to improvements. 

The idea that the “early bird gets the worm” is highly relevant in the crypto space, however, not anyone can simply arrive early. Venture capitalist firms and institutional investors play a crucial role in acting as an impetus behind innovation via the provision of liquidity, support, expertise, experience and more. For this reason, many startup projects look exclusively to these groups to assist them. As a reward, these entities receive tokens or are given the early opportunity to purchase the token prior to its launch on exchanges; notably, at a fraction of the price. These tokens ordinarily provide holders with governance power. Notably, this is the general approach for projects given that they are constructed such that governance value accrues in tokens in order to raise funds. Hence, the early investors obtain most of the upside and voting power. 

Having received or purchased vast amounts of governance tokens, these investors can vote and establish governance proposals that best suit their private interests – typically their bottom line. Therein lies the root of the deleterious weeds sprouting in the on-chain governance sector; tokens are insufficient in facilitating decentralisation and providing power to the day-to-day users. Consequently, relying on the banal platitude that applications will become decentralised through the passage of time is unfounded.

Conversely, projects like Gitcoin acknowledge the faults in the generic governance models used in the cryptocurrency space. To surmount these barriers, Gitcoin utilises quadratic funding to democratically fund public goods and determine the importance of a project (or idea) in the confines of a community. Unlike ordinary voting whereby a single vote equates to a single unit of influence, quadratic voting results in influence being determined by the number of addresses who cast the same vote. Gitcoin has donated over US$ 70 million to open source software through the use of quadratic voting mechanism; the platform provides additional funding for projects that receive more donations from community members, rendering its approach democratic.

1.3. A Prophecy or Already a Reality

Unfortunately, the failure of DeFi protocols’ voting models to pave the way for democracy and participatory governance is not theoretical. The unequal battle between early, institutional investors and smaller users has played out numerous times, with the former invariably emerging victorious. 

An example of this is Uniswap. The dominant decentralised exchange (DEX), which has an annualised trading volume of $461.2 billion USD, is actively used by an average of 33k users per day. Despite this, out of 323.8k token holders, just 10 wallets, excluding Uniswap-related wallets, hold over 13% of the token supply. Further, a single wallet which popular analytics tool, Nansen, labels a “Token Millionaire”, holds $132.5 million USD worth of UNI, equating to just under 2.5% of the total token supply. 

These numbers are reflected in the outcomes of Uniswap governance proposals. For instance, the recent proposal to create a Uniswap Foundation akin to that of the Ethereum Foundation passed with 100% of pledged tokens voting yes. Although 35 million UNI was pledged across 1,860 votes, the on-chain data depicted the absence of adequately decentralised governance amongst all participants. Only 5 unique wallets contributed 23 million UNI, equating to 65.7% of all voted tokens.

What’s Next

On-chain governance has fallen victim to the juggernaut known as the Pareto principle; the observation that 80% of consequences arise from 20% of the causes. Such an unequal relationship between inputs and outputs gives rise to the Matthew principle, whereby the rich grow richer and the poor become poorer. Irrespective of the importance of optimising, improving and building effective governance mechanisms, the existing model is the only framework to be adopted. Nonetheless, to improve on-chain voting systems, deeper consideration and accommodation for game theory is required.

2. Game Theory

Initially conceptualised by John von Neumann and Oskar Morgenstern in the Theory of Games and Economic Behaviours, game theory is the study of interactive, dependent strategic decisions within competitive games amongst rational agents. This field of thought has applications in the fields of war, business, psychology, and blockchain. Given its effectiveness in providing functionality to blockchains, applying the tenets of this investigation model to a governance mechanism can further facilitate consideration for edge cases.

By understanding how rational participants of a DAO will approach governance, the proposed system can reflect the needs and interests of its members. Similarly, game theory can be utilised to safeguard the longevity of the governance framework as opposed to consistently updating its fundamentals. The majority of governance stacks, such as that of Polkadot and Cosmos, have fallen victim to this concept due to foundational flaws in how participants interact. 

2.1. How Blockchains use Game Theory

Blockchains use game theory mechanics to promote honest activity on behalf of participants, ergo keeping the network bulletproof. This is primarily achieved through incentives and disincentives.

The Proof of Work (PoW) consensus model, popularised by Bitcoin, champions honesty in creating blocks of transactions through a disincentive. Using the paradigm of the Bitcoin Network, miners have an exorbitant amount of power to select and create transactions as they choose. In order to discourage these individuals from undermining the validity of the blockchain to selfishly benefit themselves, transactions are only valid if they are part of the longest chain. As such, other miners on the system must build off the initial miners’ block for them to receive rewards. Accordingly, if a miner mints a false block, no subsequent miner will continue adding to their initial block. Clearly, the magic of game theory is protecting Bitcoin as it would be nonsensical for a miner to satisfy the current average cost of $19.4k USD worth of computing power needed to mint the false block. This is the punishment model of Bitcoin and other PoW blockchains.

Likewise, Proof of Stake (PoS) relies heavily on game theory to disincentive and prevent harmful activity in the proposal of blocks. Blockchains using this consensus mechanism, such as Ethereum, require an amount of the native token, ETH, to participate in validating the network. Ethereum requires 32 ETH to set up a validator node. If a validator proposes an incorrect block to elevate their wealth and the blockchain discovers the falsehood, the entity can have its entire stake slashed; that is, removed. Therefore, validators are deterred from doing the wrong thing as they are more likely to lose their staked tokens than they are to earn a meagre addition to the issuance reward when creating false blocks.

Evidently, the principle of incentives within game theory should be applied to governance to erect a system whereby participants are financially or socially driven to benefit the underlying DAO with informed and thoughtful votes.

2.2. Coordination Failure and The Nash Equilibria

To optimise the effectiveness of a governance mechanism, coordination between a diverse set of participants must be championed. Through the lens of game theory, we can comprehend the foundational trends of how rational members vote on DAO proposals. The essence of this behavioural perspective is that in situations whereby communication between the parties is limited, each party will attempt to maximise their own benefit. Thus, coordination failure is a paradox in the decision-making process, resulting in individuals acting in their self-interests, consequently not arriving at the optimal outcome. It is clear to see how these would arise in governing a DAO. The analogy to understand how this works is the prisoner’s dilemma.

In this ‘game’, two prisoners who co-committed a crime, prisoner A and prisoner B, are in separate rooms, hence unable to communicate. They are each told that if they both remain silent, both will receive a 2 year sentence. On the other hand, if both betray each other, they receive a 5 year sentence. However, if one prisoner remains silent and the other betrays, the former is vindicated whilst the latter punished with an 8 year sentence. Clearly, the optimal decision for both prisoners is to remain silent, yet how does one know the other will not inform against them? Hence, it is logical for the prisoners to choose the ideal option for them at the expense of the optimal outcome for both. 

Source: AI-generated image from DreamStudio

Responding to this paradoxical dilemma, John Nash released Equilibrium points in n-person games. This paper revolutionised game theory; the central breakthrough being that an equilibrium exists within most non-cooperative games – the Nash Equilibrium. This outcome is where neither players are willing to alter their strategy due to a lack of communication. Governance models should leverage this concept by striving to create proposals wherein the optimal option is uniform with the Nash Equilibrium. Effective voting and advantageous impacts from the DAO will arise from members’ being in accordance with each other, resulting in the specific Nash Equilibria not succumbing to the threat of solely benefiting voters individually.

However, unlike the prisoner’s dilemma where payoff eclipses moral considerations, in other coordination problems, these aspects carry no meaning. In these situations, the only meaningful data point in these games is the incentive for every person to arrive at their destination. Hence, coordination games fail when a minority of the group has a destination different from the majority. This might manifest itself in leveraging education, data and reports to ensure that all members of DAOs have comparable destinations based on the long-term motivations of the organisation. As such, this must be a consideration in an effective governance model. 

2.3. Schelling Points

Another consideration to overcoming coordination failure is the presence of Schelling points. Also known as focal points, the concept of Schelling points is the game theory mechanism that symbolises how individuals cooperate without communication. An awareness of Schelling points in specific areas, including governance, can assist DAOs in effectively encouraging voters to unite without having previously interacted with one another.

This phenomenon has been tested and proven numerous times, beginning with Thomas Schelling’s own experiment, detailed in The Story of Conflict, whereby he placed a number of his students at different spots around New York and instructed them to find each other. In this coordination game, despite the lack of communication, the majority of the students were waiting under the clock in Grand Central Station at 12 noon. This occurred because the location and time were both focal points. Likewise, when a crypto-native is presented with a list of numbers, one being 21 million, in the absence of communication, most would select 21 million as it is the maximum number of BTC to be mined – a focal point.

The crucial takeaway is the pseudo-inevitability that individuals will strive to harmonise their “intentions and expectations with others if each knows that the other is trying to do the same” (Thomas Schelling, 1981). DAO members will act according to this framework. However, to increase the likelihood of participants independently reaching focal points regarding governance proposals, DAOs must leverage recurring features amongst its members; for example, their knowledge of crypto fundamentals, decentralised finance and the purpose of the underlying protocol. In this way, an effective governance model should emerge whereby geographically and ideologically distinct individuals can collaborate.

2.4. Bounded Rationality

To regularly reach advantageous equilibriums in governance votes and Schelling points, the game theoretical implications of bounded rationality must be accounted for. The concept originated from Herbert A. Simon’s contention in Models of Man that humans are only partly rational, leaving their remaining actions to be irrational. When individuals vote on choices presented to them, they make decisions under limited rationality due to a range of factors, resulting in their decision being satisfactory, but never optimal.

Bounded rationality is multifaceted in its nature; understanding these unique factors can assist individuals in making the best decisions instead of satisfactory ones. One aspect is cognitive limitations. This refers to our ability to process and comprehend information in an optimal fashion. Being cognitively limited, humans are bound by rationality, given we cannot consider all available data points in decision-making. A productive governance mechanism would combat this through a committee model whereby individuals with expertise prepare reports to be disseminated throughout the DAO.

Additionally, information imperfection further diminishes our ability to be perfectly logical. As the previous Secretary of Defence, Donald Rumsfeld, explained, “there are known unknowns… but there are also unknown unknowns”. In this context, our rationality is curtailed by what we know we lack an understanding of as well as information we are yet to discover we are not aware of. An optimised mechanism for governance would accept that resolving the issue of unknown unknowns is arduous. Instead, it would focus on mitigating their impact on voting by leveraging analogies and mental models that encapsulate concepts, with the inclusion of their edge cases.

Time constraints are the final impediment under bounded rationality which prevent humans from perfecting their decision-making. These restrictions solicit pressure on our thought process, propelling us to take shortcuts to efficiently reach decisions. This limitation restricts our ability to process all the information presented to us and analyse that situation; two requirements to reach optimal decisions. To ease these pressures, the members governing the DAO should release research on proposals significantly earlier than the vote.

Applying studies undertaken by Kasthurirathna and Piraveenan, it is likely that bounded rationality will have disadvantageous impacts on the topology of social networks within DAOs as they relate to governing the organisation. Nevertheless, the study accentuated that in specific systems, the drive towards rationality and understanding humanity’s limits can assist the community in arriving at rational Nash Equilibriums. As such, striving to overcome bounded rationality through debates, discussions and questions around governance proposals can significantly elevate the functionality of an on-chain voting model.

What’s Next?

Creating a battle-tested, effective model for governance, requires careful examination of the interplay between DAO members, with and without communication. Encouraging cooperation to reach mutually beneficial outcomes is at the core of erecting a voting mechanism that considers the principles of game theory. Notably, different forms of on-chain governance can arise from a focus on each aspect of game theory discussed; however, an optimal model will concurrently account for them all.

3. Mental Models

Creating a novel and effective governance mechanism needs consideration of various features of the world that are inherently arduous to comprehend. Mental models, which are organised and understandable representations of how some larger aspect functions facilitate the satisfaction of more edge cases. In this sense, mental models can provide a framework for making sense of some of the complex mysteries that have not historically been recognised by humanity.

In a similar fashion to how these representations can enable individuals to think clearly and enhance their perception of the world, a latticework of mental models can eliminate innate blind spots within governance apparatus. This part of the research piece investigates a plethora of mental models in light of designing an advantageous and just government model.

3.1. Mental Model 1: Trust

Cardinal to the idea of Bitcoin and subsequent blockchains is the tenet of trustlessness. However, the world around us has developed into what it is today because of trust. As such, trust is arguably required to continue improving societies and economies given these types of systems work the most efficiently. Some can conclude that the transparency of Bitcoin’s general, transparent ledger, facilitates trust in an open-source, public, permissionless blockchain. Hence, at a deeper, more nuanced level, blockchains do not eliminate trust. Instead, they prevent the congregation of faith within centralised entities, enabling individuals to trust a plethora of unique entities and hence a collective, yet distributed execution mechanism. 

Future governance proposals should take into account the mental model of trust in order to encourage the development of the underlying blockchain protocol without relying on trust between voters and a central authority. Though challenging, this can be achieved via recording governance on-chain with rolled-up transactions, immutably storing votes through decentralised data storage solutions, and many more concepts yet to be discovered.

3.2. Mental Model 2: Voting in Democratic Countries

Observing governance in the context of DAOs (Decentralised Autonomous Organisations) as comparable to countries that utilise democratic methods of voting, unveils layers of considerations for an on-chain voting model. Full democracies are nations whereby, among other things, civil liberties and political freedoms are respected, elections are free as well as fair and valid checks and balances on governments exist. The Economist Intelligence Unit’s 2021 Democracy Index report detailed that of 167 non-micro nations, 108, or about 65% are democratic. An empirical study that examined the relationship between democracy and innovation using the Popper hypothesis found that there is a strong, positive correlation between the variables.

As the dominant and effective model, analogising on-chain governance to that of democratic territories facilitates cutting-edge innovation for the underlying protocol and DAO itself. Under this mental model, an efficient governance mechanism would give every participant one single vote and simultaneously prevent the purchase of votes via accumulating mass amounts of governance tokens.

Furthermore, this comparison assumes that DAOs are most effective as a democracy. However, an opposing view levied against this is that the ‘D’ in DAO does not stand for democracy. Accordingly, it is crucial to ascertain whether a DAO and its subsidiary platforms are to be governed democratically or dictatorially when building productive and functional voting mechanisms.

3.3. Mental Model 3: Meritocracy and Comparative Advantage

A meritocracy is a system whereby individuals obtain success and elevate their standing based on their abilities, effort and output. Though a meritocracy, like all social structures, faces flaws, it provides significant benefits to society or the economy. This is a direct result of the model leveraging expertise to drive innovation as opposed to simply reusing banal ideas that have already been executed. An effective governance framework may adhere to this mental model when determining how to weigh specific participants’ votes.

The mental model of a meritocracy is closely intertwined with that of comparative advantage. Often attributed to David Ricardo’s On The Principles of Political Economy And Taxation, comparative advantage stipulates that roles should be delegated based on one’s ability to produce a good or service at a lower opportunity cost than another. This economic concept provides the answer as to why Tiger Woods should not mow his lawn, despite this action being displayed in the image below, as he has a comparative advantage in playing golf. Hypothetically, if Woods was to mow his lawn and earn $50 in 4 hours, the opportunity cost is the loss of the $100k offered for a television commercial or monetary prize for winning a golf tournament. 

Source: AI-generated image from DreamStudio

In contrast to a fully democratic voting mechanism which would see each participant being eligible to cast a vote that is equal to all others, a governance paradigm under this mental model would weigh certain individuals’ votes based on their comparative advantage over others in the context of proposals for change. Despite a meritocracy encroaching on the requirements of democracy, such a system, wherein expertise gives additional voting power, expedites growth for the underlying DAO or protocol.

3.4. Mental Model 4: Bottlenecks

Another mental model that an effective governance model for DAOs must reconcile is bottlenecks. Although some historical bottlenecks are currently being remedied with artificial intelligence, development and innovation have frequently reached impasses because of this issue. One small, yet disproportionately impactful bottleneck in governance is efficiency in making necessary decisions. If every change must be voted on with a systematic procedure, the DAO will constantly fail to act proactively and aptly protect itself from foreseeable dangers. Herein lies the pivotal consideration when creating an effective governance model; how to ensure a fair and just voting process without exacerbating the impact of deleterious bottlenecks on the underlying protocol.

Despite the widespread plague of bottlenecks having detrimental impacts on humanity, within the paradigm of governance, they can offer benefits. Bottlenecks have the potential to catalyse reconsideration and experimental thinking as to whether alternative paths around the crux of the issue exist. This could see the DAO providing perpetual education on issues pertaining to its functionality and voters finding solutions to uniquely and fundamentally improve the organisation. In this way, what was previously a bug can become a positive feature.

3.5. Mental Model 5: Creative Destruction

In analysing the free market, Austrian economist, Joseph Schumpter, denoted capitalism to be the “perennial gate of creative destruction” (Capitalism, Socialism, and Democracy) whereby entrepreneurs will motivate themselves to outdo one another, correspondingly destroying old ideas and replacing them with new ones. This idea, currently known as creative destruction, became a centrepiece of comprehending the evolution of economies and specific sectors of societies.

With DAOs existing in the free market as opposed to within a vacuum, an effective governance mechanism must consider this mental model when driving innovation. This concept can be leveraged within governance by allowing some elements of the DAO to be efficiently changeable. 

Creative destruction can be damaging when DAOs innovate unnecessarily with new ideas rather than bettering existing ones. The governance model might differentiate between flexible and fundamental facets of the organisation. Consequently, the foundational features will be made more challenging to alter through a single voting event, protecting them from the detrimental implications of creative destruction.

3.6. Corporations

Similar to the uncertainty around whether DAOs are democratic in their nature, there remain heightened levels of discourse and discussions pertaining to whether DAOs should function akin to traditional corporations. Some have the opine that these organisations should be replete with executive bodies, leaders, CEOs and more; the ubiquitous hierarchical structure prevalent across most corporations. On the other hand, others, including Ethereum co-founder, Vitalik Buterin, contend that DAOs are not corporations in the context of governance and should inherit principles that are fundamental to political science to maximise their impact.

Currently, DAOs are inexorably drifting towards adopting the paradigm of corporate governance because the large majority of these entities are not transient. As such, like companies, DAOs seek to remain in operation. This is achieved through a meaningful concentration on the organisation’s bottom line. More DAOs have fortified their treasury with billions of dollars to survive in the long run; Uniswap’s treasury is valued at just under $2.8 billion and that of ENS at $1.3 billion. However, the most effective governance model emerges when an entity is focused on resolving one plight. This would see the DAO being inaugurated to lionise and champion a single task, dissolving the organisation if and when its goal has been realised. These types of entities will leverage a governance model that is established in contradistinction to the framework used by conglomerates striving to obtain and consequently retain their power through time.

What’s Next

Ultimately, although a number of these mental models are incongruent, they nonetheless provide a scope to understand key ideas existing within societies and economies. Taking note of these facets, as well as where they clash, can refine governance models by ensuring more scenarios, irrespective of their likelihood, are considered in the design. In the subsequent part, we will delve into the details of an effective governance mechanism for DAOs: Frictionless Governance. 

4. Frictionless Governance: A Proposed Blueprint

The final part of this research piece will propose an effective governance model, considering the features discussed in previous parts and the edge cases they represent. The mechanism for governing and voting recommended would require a paradigmatic shift away from the current framework. As previously noted, no single model is perfect; this concept makes sacrifices in some areas and correspondingly prioritises other facets.

Notably, this governance latticework does not currently exist; this paper is rather proposing the structure as a blueprint to improve how DAOs are managed in the long run. Taking inspiration from a multitude of aspects of the democratic governance model established by democracies, this model is analogised through the framework of a constitution and what it provides. 

4.1. Constitution and Statutes

According to the Australian Parliament, the constitution establishes the composition of the parliament, outlining how it works and its powers. It additionally distributes power between the federal and state parliaments, whilst protecting human rights. In 1901, the Australian colonies, now known as the states, came together to form a federation. This was achieved through the Australian Constitution which codified and enshrined the most foundational rights and freedoms for Australian citizens. The words of the constitution itself cannot easily be changed for this exact reason.

The central document of the DAO, its constitution, will be fundamental to the organisation going forward. It will contain the views, values, purpose and vision of the DAO. These ideas will be expressed in general, yet unambiguous terms, so as to cover as much area as possible, ergo ensuring future situations are covered by the constitution. 

Given the importance of the DAO’s constitution, its content will be determined in a series of votes that hold the community at its core. Though arduous and time-consuming, the members of the DAO will debate and vote on a number of issues, such as whether certain subDAOs should exist, their powers and responsibilities, the roadmap for the DAO, its purposes, member requirements and more.

Due to the crucial nature of the constitution to the DAO and how its governance model functions, a single, ordinary governance vote will be insufficient to change the document. Instead, a rigorous vote that prioritises collaboration, expertise and contributions will occur before any amendment to the constitution. On the other hand, not all rules and ‘laws’ within the DAO should be unchanging. Like parliamentary statutes, rules set by the DAO subsequent to the creation of the constitution can be changed by passing an amendment bill. This model will be recreated in this governance mechanism.

4.2. Separation of Powers

French philosopher, Charles de Montesquieu, concluded in his book L’Esprit des Lois (the Spirit of the Laws) that the most superior form of government is one founded on the separation of powers. He determined that keeping the legislative, executive and judicial powers independent would keep each other in check, preventing all the branches from obtaining an excessive amount of power. Though not a function pertaining to the voting process itself, incorporating the separation of powers into this governance model to facilitate decentralisation is crucial.

In the political system, the legislative branch is the parliament itself and has the role of initiating, debating and passing laws as well as amendments. The subDAOs, made up of individuals with expertise in the relevant area, will have the unique capacity to draft improvement proposals to the DAO, discuss its implications and finalise the organisation-wide distribution of its content. The executive branch of power is the cabinet; this entity is tasked with implementing and administering the laws passed by the parliament. Within this governance model, the DAOs developers would hold executive power to write the code based on changes to be integrated into the organisation. Finally, under the constitution, the judicial branch makes up the courts and judges who enforce the laws. The voters will hold the final power of making judgements about the law, determining whether or not to all

Each of these divisions – the subDAOs, developers and voters – remain entirely separate, utilising their specialised knowledge to provide checks and balances on the other powers. Accordingly, the developers would be able to optimise the codes that codify proposals passed by the voting division into the DAO. The voters would undertake and receive research on how the prepared proposal will impact them and their view of the DAO, before coming to a conclusion.

4.3. Committee System

As described within the mental models section of this piece, expertise is fundamental to progressing an organisation. This applies to parliaments, companies, societies and DAOs. The Australian parliament is replete with 64 committees, each filled with individuals with expert knowledge on the purpose of the specific committee. These groups of parliamentarians partake in thorough research and inquiries with their specialised understanding of the committee’s subject matter, before reporting back to the entire parliament.

Within this governance model, subDAOs will exist with distinguished members in the subgroup, investigating relevant threats, areas and opportunities for the wider DAO and subsequently writing improvement proposals for the voters to determine. Rather than placing every member of the DAO in a position to comprehend a new facet of the economy or organisation, the subDAO model leverages individuals’ comparative advantages in different fields to sufficiently inform voters. This will assist the overall DAO in overcoming holistic limitations on its rationality.

4.4. Decision Making

In order to provide a frictionless DAO, decision making must be efficient. Currently, most parliamentary systems are reactive when undertaking significant decisions; this is because those involved will comprehend the potential impacts and ascertain it is logical to proceed through stages of debate, discussions and negotiations. Undoubtedly, the initial proposal will face changes – omissions might be rectified, contradictions removed and ambiguities explained. These stages are crucial to effective governance as acting proactively to resolve problems that have not yet emerged can be dangerous. Importantly, however, only substantial decisions are made reactively in these governance models.

In contradistinction, the majority of existing DAOs vote on everything. Such an approach would eventuate in slow decisions being made for traditional systems; imagine the impacts of a week-long vote on whether more paper for the printer should be ordered or the colour of the paint to be used within a certain office. For this reason, certain areas that are detailed in the DAO’s constitution under the classification of residual powers and can be exercised by selected individuals without undertaking a vote. Although this introduces some centralisation into the Frictionless Governance model, the trusted authority performing these tasks will have been selected by a committee or a DAO-wide vote, that is, in a decentralised manner. Notably, the removal of meagre tasks will have positive direct and indirect impacts on the organisation as it can concentrate on resolving the main issues it initially set out to address.

4.5. Voting

The constitution and political system strives to give people power through the ability to vote. This is primarily achieved through the principle of a representative government; representatives in the parliament make laws and debate issues on behalf of the views and values of the nation. Notably, a representative government is only achieved when elections are held periodically, ensuring that if a parliamentarian fails to vote in accordance with the individuals they represent, those individuals can choose to vote for another delegate. In Australia, members of the federal House of Representatives face an election every 3 years. 

Although the parliamentary system functions wherein representatives can vote on laws and individuals on the representatives, the proposed governance model is more effective in giving people power. The members of the DAO will be given two options; to give their vote to a delegate who sufficiently represents their views or to regularly conduct their own investigations into the governance proposals before voting independently. Consequently, this model would be akin to a liquid democracy. This is the system that permits members to more directly vote and influence laws rather than entirely relying on politicians. Another pertinent feature of a liquid democracy that would be integrated into the governance model is the capacity for voters, who have chosen to delegate their vote to a representative, to remove the delegation of their vote at any given time.

Fundamental to the effectiveness of this governance model is its ability to prevent Sybil attacks. Without a protective measure against these attacks, DAO members would be able to vote on each improvement proposal numerous times; this is starkly different from the concept of one vote per voter in democratic countries. Accordingly, the DAO will leverage an on-chain proof of humanity token that represents their digital identity and can only be claimed once per person. Already, Gitcoin has released its digital passport to prevent sybil attacks in Gitcoin Grants and Proof of Humanity is building decentralised, online identities for a range of other purposes. Outside the context of crypto protocols, South Korea has announced that by 2024, its citizens will have access to blockchain-based digital, verifiable identities. Notably, the decentralised nature of these IDs ensures the government has no direct access to control or see the populace’s digital identities. This concept could be adapted and utilised in this governing structure.

To overcome cognitive limitations, voting under this governance model will not require members to evaluate complex problems themselves or articulate them when casting their vote. As previously mentioned, the subDAOs will have the obligation of creating research reports on improvement proposals that cover agreeing and contrarian positions towards the context. However, not all voters can be asked to understand every idea. Ralph Merkle recommended that members should be able to express their views, irrespective of how incoherent they are, and have them translated into specific policy choices. This will ensure all voters’ opinions and needs are accounted for in governance proposals, not only those who are highly informed and educated.

4.6. Incentives

An effective governance mechanism requires varying degrees of participation from members. It would be fanciful to assume that every individual in the DAO will invariably vote and involve themselves in debates when performing their role under the organisation’s separation of powers. To reconcile these incongruent features of the governance model, a variety of incentives will be used to encourage all forms of contribution.

A simple incentive model would see voters receive a number of tokens commensurate with the research effort they put into understanding the improvement proposal prior to voting. Under the assumption that DAOs operate like companies, in the sense that they generate revenue, a portion of inflows can be routed to an incentive treasury. Each time an improvement proposal, prepared by a subDAO, is put to the voters, tokens are distributed by the treasury at the conclusion of the vote. This sustainable incentive mechanism will result in high participation rates from members, ultimately benefiting the DAO’s ability to reflect its voters’ needs.

Yet, this framework fails to stimulate participation from expert members of subDAOs to draft proposals or contributions to the organisation that are external to voting. Retractive public goods funding provides another means to encourage individuals to actively participate in the DAO. This on-chain governance model will note and record any effort put into improving the organisation with the intention of periodically allocating treasury capital to reward them for their contributions. For instance, retroactive governance bonuses could be given to reflect detailed beneficial proposals, comprehensive reports, and debates one member was involved in. For a deeper explanation of retroactive funding in the context of regenerative finance, see our article here.

In addition to financial incentives, the Frictionless governance framework encourages members to participate by increasing their voting weight along a specific mathematical curve. Certain proposals will be targeted towards trustworthy and faithful members of the DAO; votes for these improvements will utilise this incentivised voting model. The polynomial curve is comparable to a graph of the law of diminishing returns; a member’s voting power gradually increases until an asymptote is reached, representing the maximum voting weight one can attain. At level, the growth in voting influence plateaus out. Notably, to prevent involvement from decreasing once the maximum is reached, members must continue voting and participating to preserve their weight. Further, the function to determine voting weight has a steeper slope when diminishing in comparison to building it up. This feature ensures long term involvement as members do not want to sacrifice voting power and lose their influence over the DAO’s future.

4.7. Double Majority Provision

This governance model ensures that the DAO’s underlying views, values and vision are evident within its constitution. However, it is likely that these will change, necessitating amendments to the constitution itself – these are known as referendums. This has occurred within the Australian parliamentary system; since the country’s federation in 1901, there have been a total of 8 successful referendums. The reason so few have passed is the severe difficulty in procuring sufficient votes from the people.

For a referendum to pass, the change must satisfy the double majority provision. The first provision is that a national majority of voters exist who vote ‘yes’ on the proposed amendment. The second provision of this requirement is that a majority of voters in a majority of states vote ‘yes’ on the referendum. Notably, the second provision, also known as the state provision, protects smaller states from losing influence over the constitution to the larger states. Evidently, the double majority requirement ensures that the constitution is safeguarded from unnecessary change unless there is a clear majority of support for the amendment. 

As alterations to the DAO’s constitution might be necessary, a new form of the double majority provision is required. The first provision, similar to that of the parliamentary system, will only necessitate that a majority of all voters support the improvement proposal. Under this provision, one member will receive a vote of equal weight to their peers. Moreover, the second provision will be known as the expertise requirement; voters will have their counted votes mathematically weighted against their peers based on their specialised knowledge of the proposals’ subject. This builds on the mental model of a meritocracy. The amendment to the DAO’s constitution will only be successful if it also procures a majority of support regarding the weighted votes. Such a model will ensure the DAO adequately balances the need to involve its members with the specialisation of its experts.

4.8. Summary of the Frictionless Governance Model

Ultimately, the proposed governance mechanism considers a number of edge cases to champion contributions from a DAO’s members so as to progress the organisation itself. The model provides individuals with voting power that is equivalent to their peers without jettisoning valuable expertise. Furthermore, like effective political systems, the DAO will face a plethora of checks and balances to ensure it remains decentralised wherein no single authority holds an exorbitant amount of influence over governance proposals.

No model will be perfect or without flaws, including the proposed structure. Nonetheless, working to improve one of the fundamental benefits of blockchain, on-chain voting and governance, is of substantial importance. Enhancements must continuously be made; hence, we encourage more individuals to think about effective means to vote and govern DAOs.

Conclusion

Governance is not an easy concept to improve or implement. Problems, edge cases and novel models can be discussed, but in order for any innovations to be actualised, a majority of support for change is necessary; something difficult to garner. However, through education on the importance of governing DAOs effectively to ensure they are not stripped of their decentralisation, more and more will grow aware of the need to innovate in this sector. 

Building the most effective model for governing crypto protocols is a paradoxical task. Novel mechanisms to retain power when voting will continue to emerge. More considerations will appear. This report endeavoured to consider a multitude of mental models for governance and the impact of game theory when designing the proposed model.

This report has hopefully accentuated the irrefutable importance of governance in the context of cryptocurrencies. Without intervention, governance would gradually mirror structures utilised by centralised authorities in direct contrast to the purpose of blockchain projects to democratise power and eliminate the need to trust one single entity.

About Zerocap

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FAQs

Q1: What is the importance of decentralized blockchain governance, and how has it evolved since Bitcoin’s inception?

A1: Decentralized blockchain governance has emerged as a significant innovation since Bitcoin’s creation in 2009. It introduced community-driven governance through voting mechanisms, allowing token holders to have a say in governing the underlying protocol. However, development beyond this initial innovation has been minimal, leading to evident failures in the current governance model. The article proposes an alternative structure that considers game theory, mental models, and other factors to create a more effective governance mechanism.

Q2: How does game theory apply to decentralized blockchain governance, and what are its implications?

A2: Game theory, initially conceptualized by John von Neumann and Oskar Morgenstern, is the study of interactive, dependent strategic decisions. In the context of decentralized blockchain governance, game theory can be used to understand how rational participants will approach governance. It helps in creating a system where participants are financially or socially driven to benefit the underlying DAO with informed votes. Concepts like coordination failure, Nash Equilibria, Schelling Points, and bounded rationality are explored to optimize the effectiveness of a governance mechanism.

Q3: What are mental models, and how do they contribute to the understanding of decentralized blockchain governance?

A3: Mental models are organized representations that help make sense of complex aspects of the world. In decentralized blockchain governance, mental models can provide a framework for understanding various features that are inherently difficult to comprehend. They can eliminate blind spots within governance apparatus and assist in designing an advantageous and just government model. The article explores mental models related to trust, voting in democratic countries, meritocracy, and comparative advantage, offering insights into their application in governance.

Q4: How does the article propose to overcome the challenges of the current decentralized blockchain governance model?

A4: The article proposes an alternative structure for decentralized blockchain governance that considers various factors, including game theory, mental models, trust, and democratic voting principles. It emphasizes the need for a system that encourages cooperation to reach mutually beneficial outcomes and leverages recurring features among DAO members. By understanding humanity’s limits and striving to overcome bounded rationality, the proposed model aims to elevate the functionality of on-chain voting and create a more effective governance mechanism.

Q5: What are the potential benefits of on-chain, transparent governance through governance tokens and Non-Fungible Tokens (NFTs)?

A5: On-chain, transparent governance through governance tokens and NFTs offers significant benefits by giving users the ability to directly vote on changes to the protocols they use. This empowers individuals to enact changes that positively impact them in the long term. The transparency of the blockchain enables anyone to see on-chain data regarding voting, allowing for a trustless voting method. Despite some challenges, this approach is seen as crucial for the growth of on-chain democracy and represents a novel experience for users migrating from Web2 to Web3.

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All material in this website is intended for illustrative purposes and general information only. It does not constitute financial advice nor does it take into account your investment objectives, financial situation or particular needs. You should consider the information in light of your objectives, financial situation and needs before making any decision about whether to acquire or dispose of any digital asset. Investments in digital assets can be risky and you may lose your investment. Past performance is no indication of future performance.

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