What is a cryptocurrency governance system?

Qué-es-un-sistema-de-gobernanza-en-criptomonedas
7 min read

In the world of cryptocurrencies, one of the most important factors is the blockchain. Thanks to it, the structure of all blockchain-based projects we know is supported.

These projects require the work of thousands of people around the world to function. The work of these people consists of basic rules known as “Governance” or governance system.

Governance has the main objective of maintaining the functioning of a cryptocurrency or project where all users participate. In this article we will tell you all about how it works and its importance.

Origin of Governance

The first cryptocurrency projects did not have a governance system. An example of this is Bitcoin, the first cryptocurrency. In the case of Bitcoin, governance was governed by the decisions of Satoshi Nakamoto, as he was the sole developer.

After Satoshi’s demise new developers came to the project making Bitcoin governance more decentralized. After the arrival of Gavin Andressen, Bitcoin began to go through changes, among them the arrival of the Bitcoin Improvements Proposals or BIP. This was one of the most important contributions to decentralized governance in the blockchain.

The governance model was replicated in other projects, including Litecoin or the second largest cryptocurrency, Ethereum. However, other projects adopted different and new forms of governance. In the case of DASH and the first Decentralized Autonomous Organization (DAO), more open forms of governance were adopted. Each structure in the projects was adapted to the system used in the projects.

Qué-es-un-sistema-de-gobernanza-en-criptomonedas

How does governance work?

Governance in the blockchain is based on a set of rules by consensus among the users participating in the blockchain. Through governance, certain general rules are agreed upon to be followed in order to achieve a good development of the system. These rules must be followed to the letter for the management and development of the project.

Through governance, a participant in the system agrees to collaborate or not with the system. Generally, social structures have a governance system. Cryptocurrencies are an example of a structure governed by such systems.

The main goal of governance is to keep the interest in the project behind the blockchain united with the interests of the participants. This is a way to keep the project in constant development and operation in addition to preserving the market value and guaranteeing the existence of the project.

Governance avoids self-destructive tendencies in the community by which it is formed. The idea is, through consensus, to maintain peace and order in the ecosystem. It should be noted that governance implies a certain level of centralization that is completely contrary to the values presented by blockchain structures. This makes the implementation of governance a rather complex task.

The work of blockchain governance involves dealing with different layers of the technology of which the blockchain is composed as well as dealing with different layers of governance. The governance rules will depend on the infrastructure that makes up the blockchain to which it belongs.

Qué-es-un-sistema-de-gobernanza-en-criptomonedas

Types of governance

In blockchain governance, two types of governance can be identified. One occurs within the blockchain and the other operates outside the blockchain. This governance is divided into two main groups, on-chain and off-chain. Below we will see their main characteristics and how they work.

On-chain

Blockchain governance is a relatively new category as it is yet to be implemented in certain projects. The main objective of this type of governance is to democratize important aspects such as decision making on the blockchain directly. This is achieved through on-chain voting systems optimized specifically for each network.

With this type of governance we can find projects such as DASH or Uniswap. These projects exercise their governance through tokens and systems that are powered by actions on the blockchain for decision making

In this type of governance there are aspects that characterize it as a slow development in most systems where they are implemented outside the digital world. However, the solidification of blockchain governance can be accelerated. It all depends on its long-term growth and validity.

In blockchain governance, consensus stands out. Consensus is achieved through direct voting in the protocol representing a democracy with slight optimizations for each blockchain. We must keep in mind that this is a new form of consensus for governance so its effectiveness is still being evaluated. After voting the results are governed by algorithms and their automatic execution is integrated into the protocol.

On-chain governance models have reward systems, unlike off-chain governance. This type of governance wants to move power from the miners and developers to the users of the blockchain to arrive at a fairer and more decentralized system. Another difference with respect to the off-chain system is that the voting results in on-chain are visible to everyone, that is, they are fully public.

Off-chain

This type of off-chain governance resembles traditional governance systems. There are well-known cryptocurrencies that implement this type of governance, including Bitcoin and Ethereum. Off-chain governance, in the case of these two cryptocurrencies is implemented through the balanced implementation of all power in miners, commercial entities that are part of the community and users.

This is a slow implementation, however it admits certain gradual improvements that allow to maintain sustainability in cases such as Bitcoin. New development ideas come through proposal systems such as the BIP or Bitcoin Improvement Proposal. Through this system, developers participate with novel ideas that turn Bitcoin into one of the most powerful cryptocurrencies.

However, off-chain governance maintains a centralized nature that excludes many users because they lack the technical expertise or financial power to participate in the network. In off-chain governance systems, consensus is achieved through community leaders. Fortunately, users of this type of blockchain also have a certain flexibility. This flexibility comes from Hard Forks (if you want to learn more about Hard Fork, we have a more detailed post on our blog).

This option allows users who disagree with the governance system to create their own system by splitting the open source protocol from the original protocol.