Blockchain-Based Governance: A Paradigm Shift
By: Roberto Moncada
Tags: Governance, Blockchain, Innovation, Token, Dao

The emergence of a new organizational paradigm

Nowadays, the environment in which organizations operate has witnessed a significant change. The variety of driving forces such as globalization, climate change, and a fast-paced technological advancement has led to workers’ diversity in terms of values, perspectives, and expectations. A reduction in communication and transaction costs has also led to more efficient communication and circulation of information, strengthening public consciousness, and demanding from organizations a more socially responsible attitude towards society at large.

As a result, businesses are required to explore new organizational paradigms to be more sensitive, flexible, and adaptable to stakeholder demands and expectations. Many organizations are abandoning the traditional top-down structures to move towards more “organic” and fluid forms. [10]

This post intends to discuss how blockchain technology may become an enabling tool for a new breed of decentralized governance structures, such as the Decentralized Autonomous Organizations (DAOs). DAOs represent a new form to organize work within a given professional community of interest. These are innovative forms of business organizations, based on decentralization and autonomy. In traditional business, governance focuses on the balance between the risks and the opportunities for decision making. Companies’ hierarchical management structure reflects the struggle in power and interests between the principal -the owners or shareholders of a corporation- and the agent -the decision-makers. Managers lead the business in their best judgment and are responsible both for positive and negative outcomes; owners are concerned with keeping managers’ interests aligned to their own through incentive schemes, i.e., stock options. Decision-makers face different kinds of risks, such as reputational, professional, and financial. In exchange, they are repaid with a higher income; when this balance is disturbed, moral hazards arise.

This scenario is problematic for blockchain-based businesses, as it presents a series of issues. On the one hand, large hierarchical structures show significant limitations in terms of flexibility, adaptation, response time, loss of relevant information across the hierarchical layers, and the presence of political conflicts. On the other hand, such organizational structures allow minimizing the communication effort necessary for the circulation of information within a company. In such contexts, there is a high level of disintermediation between the owners of the business and the decision-makers: this causes exclusion and disengagement of people from important matters that may directly affect their interests [1].

Lastly, the need for third-party authorities used to guarantee and supervise economic exchanges becomes superfluous: DAOs are self-regulating and decentralized, the blockchain ensures the security protocols for safe transactions, thus providing for new entities that rely on security standards and not on trusting the work of external regulating authorities.

In this context, new governance models should focus on simple, flat organization, avoid hierarchy and disintermediation, have a defined set of rules, and focus on efficient and easy ways to let all stakeholders participate in the decision-making process. This new kind of organization can be described in two terms: decentralized and autonomous. Decentralized refers to the fact that it runs on a decentralized infrastructure with no central repository for data. Autonomous refers to the organization’s ability to self-actualize the rules it abides by and that it does not need a trusted third-party authority to validate its operations [2].

For an organization to be autonomous, a set of clear, pre-written rules must be defined. Such rules allow for transparency and un-changing terms and conditions: whoever may want to participate in the organization will know in advance what effort, investment, conditions, and future return the organization offers. A public set of rules also allows for total transparency, both in governance and for the transactions made. Transparency builds trust among the community’s components, as the organization’s mission is clearly stated, and pre-written rules avoid conflicts due to misunderstandings or wrong interpretations to arise [3].

Blockchain-enabled Governance

The introduction of an alternative governance structure without hierarchies needs to face new coordination problems among many participants willing to collaborate for either their common or personal interests. Participants in decentralized governance cannot ignore their ideological perspectives, despite their role in the shared contribution efforts. The legitimacy of their decisions depends on how the different individual realities combine correctly. [4]. The elimination of the hierarchical judgment and these necessities opens for a new scenario where the trust model is a shared consensus protocol, which defines the conditions, permissions, and rules to govern the shared assets, roles, and processes belonging to the organization.

The advent of DLT, and its first implementation (blockchain), has pushed the capabilities of designing and implementing new forms of trust to a new so far unreachable level. We note that blockchains are politically (no one controls them) and architecturally (no central infrastructural point of failure) decentralized. However, they suffer from logical centralization where there is one joint agreement on the shared ledger’s state, and the system behaves like a single computer [5].

A Decentralized Organization (DO) can be shaped like a set of humans interacting with each other according to a shared and transparent protocol specified in code and enforced on the blockchain using smart contracts. A smart contract is the simplest form of decentralized automation, which enforces a transparent and immutable set of rules and agreements through its code, which can be executed by sending transactions to the network. The characteristic of logical centralization of the blockchain is a point of strength due to the necessity of coordination among many individuals when implementing a DO: it works as an organization, but decentralized, leveraging the human component as the only one having decision-making ability [6].

The Decentralized Autonomous Organization (DAO) relies on the organization making decisions for itself, pushing the human component to the edges, as we explained in our third article of the OverTheBlock DeFi Series “Decentralized Autonomous Organizations (DAOs) in Decentralized Finance (DeFi).” A DAO lives and exists autonomously on the internet but heavily relies on hiring people to perform tasks infeasible from the automation perspective (e.g., making decisions on protocol changes). The hired individuals must be rewarded and incentivized to perform those activities, so, unlike the DO, the DAO has an internal capital that is, in some form, valuable [6].

The process regarding the creation of a DAO can be summarized as follows. A group of people with a common interest write the smart contracts to run the organization protocol (e.g., voting, multi-signature, etc.). Next, a token sale period is launched, usually starting an Initial Coin Offering (ICO). The funding period enables individuals to fund the DAO by purchasing tokens representing ownership or stake (some newly DAOs or DACs, such as Vigor, do not do any form of the token sale, and the DAO platform and tokens are immediately usable within them) [11]. Finally, when the token sale funding period is over, the DAO begins to operate [7].

A fundamental issue faced by groups of people is to make decisions over situations that involve a community, which determines specific rules enabling individuals to express their opinions. A flat organization can efficiently decide through voting, allowing universal participation, relatability to decision-making, and a new declination of meritocracy and efficiency. The casted ballot can be identified as representing the individual’s preference over the proposed options. The community’s components can be seen as equals from a decision-making perspective since the final decision must consider everyone’s opinion, at least in democratic political systems. However, this cannot be implemented in corporate environments since hierarchical organizational structures generally characterize them.

As mentioned in the first paragraph, blockchain technology’s application to organizational structures creates DAOs that can pursue profit-making purposes by maintaining equality and independence, in decision power terms, among the organization’s components. In a DAO, a corporation composed of individuals organized in a decentralized fashion can contemplate the possibility of applying voting rules to make internal decisions regarding the submitted proposals. Tokens play a fundamental role in the blockchain infrastructures as we mentioned in our first article of the OverTheBlock Tokenomics Series, “Tokens are all about decentralized trust,” where a token is described “as a socio-economic dummy tool to promote the coordination of the actors in a regulated ecosystem towards the pursuit of a network objective function, through a set of incentive systems.”

We can think of DAOs as digital interaction environments where the community’s components act voluntarily (so they are free to leave and join at will) and share their incentives to grow the platform. These actor categories are nodes within a graph, as depicted in Figure 1. The arrows which connect nodes represent in and out interactions among them (i.e., elementary operations). Figure 1 shows an exceptional case in which all the elementary operations are carried out, and so, there are no nodes with more central roles within platforms than others. The arrows also identify the communicative burden that each node bears in decentralized ecosystems. Therefore, as decentralized organizations allow to solve some typical problems of centralized realities (e.g., misalignment among stakeholders), they still have limitations (e.g., scalability), which require careful consideration of the choice of governance that each organization makes.

Figure 1: Example of a fully decentralized graph with 4 actor categories (nodes)

This representation allows us to understand the categories of actors that act within the platform, its activities, and its degree of decentralization. We can identify the degree of decentralization using the degree of cooperation as a proxy, which tells us the engagement degree of nodes within the platform. Figure 2 shows a graph in which node C covers a critical function within the platform, making it less decentralized concerning the example presented in Figure 1.

Figure 2: Example of a partially decentralized graph with 4 actor categories (nodes)

The graphs show that voting rules can be applied in contexts where individuals are equal and independent in terms of decision power, to have a business organization that can contemplate the application of such rules. The actor interactions map must be of the type presented in Figure 1. We reach the highest degree of decentralization (i.e., equal to 1 on a scale between 0 and 1), representing the “perfect” DAO: a profit-making organization characterized by maximum resilience and fungible actors.

Blockchain contribution in DAO voting contexts

DAOs have digitized and automated several existing forms of governance, mimicking the process but revolutionizing its effectiveness. In the early stages of DAOs, founders can control all corporate decision-making power, behaving like typical startups. As classic hierarchical organizations like Linux Foundation, W3C, and many more, some DAOs can elect an elite council to oversee the governance, decentralizing the control away from founders towards core developers (e.g., Bitcoin, Ethereum, Monero, and more). However, the most widespread form of governance is a representative democracy. The individuals have the right to elect a group of officials to make decisions and form policy on their behalf, resulting in a direct or delegated (proxy) form of representatives voting mechanism. DAOs, which have adopted this form of governance, confer voting power to individuals through the ownership of governance tokens, which grant governance rights (e.g., Maker (MKR), Compound (COMP), and more). This kind of mechanism can also be implemented to manage an entire blockchain’s governance, as we can see in the Delegated Proof of Stake (BFT-DPOS) consensus mechanism, currently used in the EOS blockchain. The EOS.IO software enables blocks to be produced in rounds of 126 (6 blocks each, times 21 producers). At the start of each round, 21 unique block producers are chosen by the preference of votes cast by token holders either directly or through proxies[12]. Shortly, DAOs governance structures still mirror the forms of shareholder governance used by most public corporations [8].

Blockchain technology improved the efficiency and coordination of these classic governance mechanisms’: the paradigm shifts from centralized to decentralized, while not contributing to new forms or variations of the voting process itself. Nonetheless, The DAO, a completely decentralized blockchain-based association, shows that the lack of a centralized authority can create a sub-optimal situation. Despite The DAO’s failure, the blockchain offers new possibilities to facilitate the relationship between stakeholders, thereby creating trust and transparency [7].

This technology allows for instantaneous vote delegation, which democratizes proxy delegation services, significantly improving the entire proxy voting process. Proposals can be issued on a particular matter whenever people want to propose changes to stakeholders, eliminating the burden of requesting a mandate, and mitigating stakeholders’ disinterest. Once a specific proposal is placed in the blockchain, stakeholders who hold tokens can exercise their voting rights during the voting process’s predefined duration. The voting results become instantly available after the process deadline. These advantages guarantee the process’s consistency, auditing, fair, and transparent permission mechanisms along the entire DAOs lifecycle [9]. Also, the issues regarding the transparency of votes, verification of the process, availability of the protocol, and correct identification of stakeholders and their stakes, are directly linked to the advantages of blockchain technology and the concept of smart contracts (i.e., implementation of on-chain rules, law specifications, access, and voting rights).

As we have seen so far, the blockchain seems to be an irreplaceable technology for a DAO’s operations. How this technology advances the governance processes for a DAO needs to be further investigated. This series will continue by analyzing how existing voting mechanisms apply in a DAO context.