Blockchain Governance: A Primer – Technology

This is the first in a series of blog posts on blockchain
governance. This blog explains what blockchain governance is and
lays the groundwork for deeper study.

Let’s begin with an example to understand the need for
governance structures for blockchain solutions. Suppose an
electricity transmission company supplies electricity to your house
in New Delhi, India. You know that this company procures
electricity from a power generator; arrives at its cost; manages
how electricity is supplied to your residence; decides what to do
if a power grid fails; decides where to supply the electricity in
times of overload; and will handle repair work, amongst other
things.

Now consider a situation where you can produce your own
electricity using rooftop solar panels, and even supply excess
energy to your neighbors. All the information about power
production, storage and transfer is recorded securely on a
blockchain. You have one technological support provider who puts
this solution in place and maintains it (suppose, for a fee). In
such a situation, you are all power producers and ideally should
all have a say in how this set up is maintained. Some of the
questions you will seek to answer include how the price of
electricity is calculated; how electricity is channelled in times
when demand is greater than supply; who can view the information on
the blockchain; who can decide on software upgrades; who will be
legally liable if a law is broken, amongst other things. These are
the questions which the discourse of blockchain governance seeks to
answer. The above example is based on Brooklyn located, LO3 Energy
which had to answer the same questions while operationalizing its
service1. LO3 finally create a
non-profit organisation to help local communities govern their
microgrids2. For more such
examples, do read Mary C. Lacity’s paper titled ‘Addressing
Key Challenges to Making Enterprise Blockchain Applications a
Reality’3.

Going forward, start-ups, companies and commercial consortia
will need to design governance structures which not only address
regulatory and legal requirements4
but also account for complexities arising from the decentralized
and participatory nature of blockchain solutions5. These considerations change for
every enterprise. In the example above we discussed how individuals
who do not have a vested interest in modelling the governance
structure a particular way to interact with one another. But what
if the participants were global logistics giants? How willing would
one player be to put its information on a blockchain developed and
maintained by its competitor? TradeLens,6 a joint development by IBM and
shipping giant AP Moller-Maersk found out. On the announcement, it
had some 90+ signed-up adherents, but within weeks TradeLens was
finding it difficult to onboard the required participants to reach
critical mass7. Experts and
observers commented that the reason for this was the suspicion of
non-Maersk carriers to participate in a Maersk owned and controlled
blockchain network.8 The Centre for
Supply Chain Studies in the US faced similar concerns while
exploring blockchain solutions to comply with the Drug Supply Chain
Security Act, 20139; a law which
mandated collecting information for all changes in ownership of
pharmaceuticals through the supply chain. The questions they faced
included10:

  1. Who decides ‘Who’ sees which data and under what
    circumstances?

  2. Will competitors learn too much about the participant’s
    volume and trading partners?

  3. How will intellectual property be protected?

  4. How will financing for blockchain development and ongoing
    operations take place?

Going a step further, distributed ledger technology allows
multiple firms to come together to innovate11, which requires credible
cross-firm governance structures. Such consortia would be
interested in ensuring that no single entity can unilaterally make
rule changes, code base upgrades, or alter records.12 They would also have to design
secure and credible decision making processes and norms13.

The above examples illustrate that the decentralized nature of
the blockchain landscape makes governance tricky, since it can no
longer be centralized like in traditional enterprises.14 Fortunately, this can be solved by
designing a ‘governance portfolio’15 tailored to the requirements of
each blockchain application.

This blog series will explore the considerations, restrictions,
and incentives which influence the choice of the governance
structure of a given blockchain solutions’ provider. We will
briefly touch upon popular governance models and end with an
indicative list of considerations for entities in the process of
developing their own blockchain governance models.

 “The only way we are going to get value for the
whole industry is to think differently about working together.
I’ve been calling blockchain a ‘team sport’ for a few
years now. We have to work with our competitors on things that
improve the entire industry, like safety, quality, and reducing
barriers to trade across borders.”

~ Dale Chrystie, Blockchain Strategist at
FedEx, Chair of BiTA Standards Council.16

On-Chain and Off-Chain governance

Broadly, blockchain governance may be divided into on-chain and
off-chain governance.

In on-chain governance, the rules of governance are implemented
at a protocol level.17 The whole
governance mechanism and interaction among participants is
regulated by lines of code which are written before the launch of
the network and any amendment or change in the existing codebase
requires the approval of network participants (improvement
protocols).18

Essentially, the code mimics a constitution (in that it defines
what is possible and what is not) as well as a judiciary (in that
it rejects certain acts by participants for being contrary to the
code). Further, when embedded in code, rules become immutable and
bring predictability to governance functions that are otherwise
susceptible to social and political vagaries. However, this also
has downsides.19 Once all
participants are informed about the rules, bad actors may try to
manipulate the rules to their advantage20. A good example of this is the DAO
hack21. In April 2016, Slock.it
developed a DAO run investment fund run on self-executing smart
contracts22 on the Ethereum
protocol. Shortly after the project went live, a hacker exploited a
vulnerability in the algorithm to drain money from the fund23. The attacker then published an
open letter claiming that under the ‘code is law’
principle, he had acquired the ether legitimately as per the terms
of the smart contract. Furthermore, this opinion was mirrored by
many in the Ethereum community24,
which creates fertile ground for hackers to take this defence in
the future as well.

Several major blockchain projects such as EOS, Tezos, Dfinity,
and Decred have introduced on-chain governance centered models
where governance is an integral part of the protocol.25

In off-chain governance, these rules, procedures and social
norms are not embedded in the code of the protocol but are
implemented in the physical world, like traditional governance.
Since it resides outside the network infrastructure, it is
vulnerable to more traditional threats, such as corruption,
collusion, human errors, amongst other things. On the positive
side, this framework allows more flexibility and agility to adapt
to the changing requirements of the network.26

Therefore, off-chain governance more closely resembles
traditional governing structures. Established cryptocurrencies such
as Bitcoin and Ethereum use this model of governance through a
balance of power between core developers, miners, users, and
business entities as part of the community. Bitcoin’s
sustainability thus far can largely be attributed to its
recognition of the need for a slow evolution that is composed of
gradually implementing improvements.27

The choice of on chain or off chain governance influences the
level of centralization in decision making as well. On chain
governance allows every proposal to be independently voted upon by
every participant on the network, which is more aligned to the
decentralized nature of blockchain technology. However, user
participation has persisted as a challenge in such set ups.28 Creating the right economic
incentives and aligning these incentives with the overall objective
of the network is a complex task.29 If a majority of users do not
vote, then the protocol ends up being controlled by a small number
of participants, often negating the point of decentralization.
Further, if network participants collude it could also lead to
anti-competitive practices which is detrimental to the overall
blockchain network. For instance, recently EOS block producers
colluded with each other and mutually decided to vote for each
other in a bid to gain more income from block producing EOS.30

Off chain governance can also lead to greater centralization of
power. This is because it usually allows only a few network
participants to partake in governance functions. Many argue that
this is against the ethos of distributed ledger technology.31

Fortunately, governance models can include a mix of on chain and
off chain governance. Functions which require expedited decision
making can be done off chain.32
These include decisions on software upgrades and decisions on legal
liability and compliance. Some consortia, including the Hyperledger
Project, use steering committees, which are a credible means of off
chain governance and can be replicated for other blockchain
applications.33 Other rules which
are more fundamental to the survival and growth of the blockchain
can be embedded into code to make sure that they are observed in
all situations. This can include decisions such as when a hard
fork34 in the network is
necessary.

Conclusion

Within the limits set by the code (and the law, of course),
organizations have considerable flexibility to decide the mix of on
chain and off chain governance. Unfortunately, there cannot be a
one size fits all approach in this regard. This is because
organizations differ in their size, products, missions and
technical expertise and wherewithal of their participants. For a
deeper understanding of on chain and off chain governance, we
recommend Primavera de Filippi and Greg Mcmullen’s treatise,
Governance of blockchain systems: Governance of and by Distributed
Infrastructure published by the Blockchain Research Institute and
COALA in 2018.35

In the next blog in this series, we will explain the physical,
architectural and legislative constraints which influence an
entity’s choice of blockchain governance models.

Hope to see you next time!

(This blog was authored by Ratul Roshan, Associate at Ikigai
Law with inputs from Ishan Pandey, a fourth-year student at
Institute of Law, Nirma University, Gujarat while his internship
with us, and Anirudh Rastogi, founder and managing partner at
Ikigai Law)

Footnotes

1. M. C. Lacity, Addressing
Key Challenges to Making Enterprise Blockchain Applications a
Reality
, September 2018, MIS Quarterly Executive, Kelley
School of Business, Indiana University.

2. M. C. Lacity, Addressing
Key Challenges to Making Enterprise Blockchain Applications a
Reality
, September 2018, MIS Quarterly Executive, Kelley
School of Business, Indiana University.

3. M. C. Lacity, Addressing
Key Challenges to Making Enterprise Blockchain Applications a
Reality
, September 2018, MIS Quarterly Executive, Kelley
School of Business, Indiana University.

4. T.Alex, On Chain Vs.Off
Chain Governance: The ins and outs
, Coin Journal, dated 25
April 2018, available at https://coinjournal.net/on-chain-vs-off-chain-governance-the-ins-and-outs/.

5. M. Lacity, Z. Steelman, P.
Cronan, Blockchain Governance Models: Insights for
Enterprises,
University of Arkansas, dated 2019.

6 TradeLens, available
at https://www.tradelens.com/.

7 C. Brett,
Blockchain Frontline: 2018 recap and what to watch for in
2019
, Creative Intellect Consulting Limited, dated 22 January
2019, available at
https://www.creativeintellectuk.com/blockchain-frontline-2018-recap-and-what-to-watch-for-in-2019/.

8 Coindesk quoted
Marvin Erdly, head of TradeLens at IBM Blockchain, acknowledging:
I won’t mince words here – we do need to get the
other carriers on the platform. Without that network, we don’t
have a product. That is the reality of the
situation.

9. J. Denton et al, The Drug
Supply Chain Security Act and Blockchain: A White Paper for
Stakeholders in the Pharmaceutical Supply Chain,
Center for
Supply Chain Studies, dated 21 June 2018, available athttps://static1.squarespace.com/static/563240cae4b056714fc21c26/t/5b3103ae575d1f67042a9324/1529938866020/C4SCS

+White+Paper_+DSCSA+and+Blockchain+Study_FINAL2.pdf

10. M. C. Lacity, Addressing
Key Challenges to Making Enterprise Blockchain Applications a
Reality
, September 2018, MIS Quarterly Executive, Kelley
School of Business, Indiana University.

11 This observation
was made by M. Lacity, Z. Steelman, P. Cronan in their paper titled
Blockchain Governance Models: Insights for Enterprises,
University of Arkansas, dated 2019.

12 M. Lacity, Z.
Steelman, P. Cronan, Blockchain Governance Models: Insights for
Enterprises,
University of Arkansas, dated 2019.

13 V. Zamfir,
Blockchain Governance 101, Good Audience, dated
30September 2018,

available at https://blog.goodaudience.com/blockchain-governance-101-eea5201d7992.

14 T. Alex, On
Chain Vs.Off Chain Governance: The ins and outs
, Coin Journal,
dated 25 April 2018, available at https://coinjournal.net/on-chain-vs-off-chain-governance-the-ins-and-outs/.

15. The term ‘governance
portfolio’ is taken from M.C. Lacity, Z. Steelman, and P.
Cronan who are part of the Blockchain Center of Excellence at the
University of Arkansas. They use this term in their paper titled
Blockchain Governance Models: Insights for
Enterprises
‘.

16. M. C. Lacity, Addressing
Key Challenges to Making Enterprise Blockchain Applications a
Reality
, September 2018, MIS Quarterly Executive, Kelley
School of Business, Indiana University.

17. T. Alex, On Chain Vs.Off
Chain Governance: The ins and outs
, Coin Journal, dated 25
April 2018, available at https://coinjournal.net/on-chain-vs-off-chain-governance-the-ins-and-outs/.

18. T. Alex, On Chain Vs.Off
Chain Governance: The ins and outs
, Coin Journal, dated 25
April 2018, available at https://coinjournal.net/on-chain-vs-off-chain-governance-the-ins-and-outs/.

19. M. Lacity, Z. Steelman, P.
Cronan, Blockchain Governance Models: Insights for
Enterprises,
University of Arkansas, dated 2019.

20. Z. Zheng, Blockchain
Governance
, Space Chain Foundation, available at https://spacechain.com/blockchain-governance/.

21. For the uninitiated, a DAO
is a code-based system that lives on the blockchain and operates
autonomously, only relying on individuals to perform tasks that the
code cannot do. As such, it is an algorithmically governed
organisation that responds both to automated code-based rules and
deliberate human input. See https://hal.archives-ouvertes.fr/hal-02046663/document.

22. W. Reijers et al, Now
the Code runs itself: On-chain and Off-chain governance of
blockchain technology,
HAL archives ouvertes.fr, dated 22
February 2019, available at https://hal.archives-ouvertes.fr/hal-02046663/document.

23. W. Reijers et al, Now
the Code runs itself: On-chain and Off-chain governance of
blockchain technology,
HAL archives ouvertes.fr, dated 22
February 2019, available at https://hal.archives-ouvertes.fr/hal-02046663/document.

24. See
https://pastebin.com/CcGUBgDG. Cited 30 July 2018. While the
authenticity of this letter is disputed, experts such as DuPont
(2017, p. 174) note that it nonetheless reflects the views of many
in the Ethereum community at the time.

25. Z. Zheng, Blockchain
Governance
, Space Chain Foundation, available at https://spacechain.com/blockchain-governance/.

26. M. Lacity, Z. Steelman, P.
Cronan, Blockchain Governance Models: Insights for
Enterprises,
University of Arkansas, dated 2019.

27. Z. Zheng, Blockchain
Governance
, Space Chain Foundation, available at https://spacechain.com/blockchain-governance/.

28. M. Lacity, Z. Steelman, P.
Cronan, Blockchain Governance Models: Insights for
Enterprises,
University of Arkansas, dated 2019.

29. R. Beck, Governance in the
blockchain economy: A framework and research agenda, Journal of the
Association for Information Systems, dated 09 June
2017.

30. A. Berman, EOS developer
acknowledges claims of “Collusion” and Mutual Voting
between nodes, Coin Telegraph, dated 02 October 2018, available at
https://cointelegraph.com/news/eos-developer-acknowledges-claims-of-collusion-and-mutual-voting-between-nodes.

31. T. Alex, On Chain Vs.Off
Chain Governance: The ins and outs
, Coin Journal, dated 25
April 2018, available at https://coinjournal.net/on-chain-vs-off-chain-governance-the-ins-and-outs/.

32. M. C. Lacity, Addressing
Key Challenges to Making Enterprise Blockchain Applications a
Reality
, September 2018, MIS Quarterly Executive, Kelley
School of Business, Indiana University.

33. M. C. Lacity, Addressing
Key Challenges to Making Enterprise Blockchain Applications a
Reality
, September 2018, MIS Quarterly Executive, Kelley
School of Business, Indiana University.

34. A hardfork is a radical
change to a network’s protocol that makes previously invalid
blocks and transactions valid, or vice-versa. A hard fork requires
all nodes or users to upgrade to the latest version of the protocol
software. J. Frankenfield, Hard Fork (Blockchain),
Investopedia, dated 25 November 2019, available at https://www.investopedia.com/terms/h/hard-fork.asp.

35. P. Filippi, G. Mcmullen.
Governance of blockchain systems: Governance of and by
Distributed Infrastructure
, Blockchain Research Institute and
COALA, dated 22 February 2018, available at https://hal.archives-ouvertes.fr/hal-02046787/document.

Originally published 25 January 2020

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