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On-chain Governance, and how a currency funds itself


In order for an individual to better predict the future value of their crypto assets, it is important to understand how the protocol of each currency is maintained and improved.


 

Cryptocurrencies are not flawless programs; their scalability issues are very often raised during the most critical times. Since cryptocurrencies aim to achieve mass adoption, these issues will need to be resolved through protocol’s updates. The creation of a system of governance is then ultimately the outcome of this evolutionary nature.


Currently, the founding development team has the role of updating the protocol in the largest cryptocurrencies. Anyone can make proposals for improvements, but those will eventually have to be accepted by this central authority. This process can appear as a contradiction to the libertarian philosophy behind most decentralized projects, as their initial intent is to prevent the concentration of most of the power in only one person’s hands.


Additionally, the choices of certain development teams fail to represent and reflect the opinions of the network. This leads to the generation of discontent and hard forks. Bitcoin, for example, is considered to be relatively conservative as the development team does not enforce any core changes on the protocol. The main improvement has been the Lightning Network which was built on layer 2. As a result, countless forked versions of Bitcoin exist, each with its own vision.


A decentralized system of governance appears to be the natural solution to the current challenges, by allowing anyone to take part in the decision-making process for improving the protocol. When it comes to cryptocurrencies, such systems take the form of coin-based voting mechanisms. The amount of native currency or governance token staked by an individual represents the weight of each of its votes.

Tezos does just that. It is called a self-amending cryptocurrency, as it incorporates in its protocol the code for proposing and voting on suggested upgrades. In this arrangement, delegates called “bakers” oversee voting on the next update. One can delegate their voting power, in the form of Tezos’s currency (XTZ), to a baker, or stake enough XTZ to become a baker themselves.


To incentivize the different actors to participate in the political life of the network, Tezos inflates the currency by rewarding 5-6% return on investment for the coins stacked. Differently, Cardano applies a tax on transactions to maintain a treasury, which is used to fund the most upvoted update proposals.

Those implementations have clear economic advantages, as they allow the program to fund and incentivize its own development. Other dedicated development teams in the likes of Ethereum and Bitcoin rely on the classic donation model, which is the most predominant model amongst open source softwares.


However, this system is not free of criticism. Vitalik Buterin, the founder of Ethereum, who was in the past very enthusiastic concerning on-chain governance, admitted that he has changed his mind on the subject. In his perspective, defining voting power by the capital of an individual, is flawed, even in a delegated system. Individuals with the most resources always have the most voting power and can easily enjoy the monetary benefits of accessing delegate positions, thus increasing their influence even more. On top of that, voter participation remains low in most projects, and bribery remains a challenge.


In conclusion, governance is an exciting and crucial topic. The way a protocol is governed, maintained, or improved determines its future evolution. A future that will eventually tell us if this difference in philosophy translates into a contrast in performance.