Blockchain Technology and Polycentric Governance

* Report on Blockchain Technology and Polycentric Governance. By Primavera De Filippi, Morshed Manna et al. BlockchainGov, 2024. Preface by Michel Bauwens.

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Description

"This report presents an overview of the discussions held by the “Blockchain Technology and Polycentric Governance” reading group and additional insights derived from research conducted by members of BlockchainGov. BlockchainGov is a 5-year long (2021-2026) project funded by the European Research Council through a €2M grant, operating at the Centre national de la recherche scientifique (CNRS) in Paris, France, and the European Union Institute in Florence, Italy."

Research questions and findings:

• Are blockchain systems polycentric?

Polycentricity in blockchain systems entails more than just “architectural decentralization.” It involves evaluating the governance of the blockchain system both internally and externally from the perspectives of “insiders” and “outsiders” to the rules governing it. Recognizing polycentricity as a spectrum, the focus shifts from merely determining if a blockchain system is “polycentric” to assessing if it surpasses a specific threshold that distinguishes it from being “monocentric.” Additionally, the nature of polycentricity within these systems is dynamic, subject to change over time, whether through deliberate design or unintended evolution.

• What significant challenges do blockchains face as polycentric systems?

Despite their non-centralized decision-making framework, polycentric blockchains are vulnerable to disruptions that can compromise their stability and integrity. Firstly, multiple independent decision-making centers, each driven by distinct and sometimes conflicting incentives, pose governance challenges, such as achieving consensus. Secondly, security breaches and hacks can precipitate critical “states of exception,” during which the standard governance rules might be temporarily suspended in favor of more centralized interventions by certain actors, thus impacting the system’s overall operation. Thirdly, these systems are not immune to systemic risks; a single decision-making center’s failure or malfunction due to bankruptcy, fraud, or operational shortcomings can trigger cascading effects across the network.

• What makes a polycentric governance system legitimate?

Polycentric co-regulation, or regulation of the governance of blockchain systems by both “code” and “law,” has been highlighted as the most efficient way of governing polycentric blockchain systems. Whether such a co-regulatory effort can be perceived as legitimate is a more nuanced question. The perception of blockchain systems as legitimate by insiders and outsiders is crucial to their survival and sustainability. Endogenously, legitimacy in polycentric systems hinges on the effective participation of all stakeholders impacted by decisions and the option for these parties to “exit” the system if desired. Exogenously, the legitimacy of a polycentric system is contingent upon its operations and outcomes not adversely affecting the broader ecosystem to which it is connected. Simultaneously ensuring endogenous and exogenous legitimacy is challenging but not impossible. It requires a deep and continuous understanding of all stakeholders’ expectations and the development of pragmatic regulatory frameworks that bring clarity but enough flexibility to allow for responsible technological innovation.

Case studies

• The Bitcoin scaling debate, which took place between 2015 and 2017, illustrates the challenges that can arise in polycentric blockchain systems when interests within and between different decision-making centers become misaligned.

• The DAO Hack, occurring in 2016, is an example of a “state of exception” within the Ethereum network. After a hack into The DAO, community members voted in favor of a hard fork to reverse the transactions that led to the theft. Some members who disagreed fundamentally with the decision remained in the original blockchain ledger, now called Ethereum Classic.

• The Terra/Luna collapse, catalyzed in May 2022, presents an example of how the failure of a particular component in the DeFi ecosystem can have a cascading effect, impacting the broader cryptocurrency market. The failure led to the insolvency of numerous projects and inflicted significant financial losses on investors, amounting to billions of US dollars.

• The downfall of FTX in November 2022, a centralized cryptocurrency exchange, had ripple effects across the ecosystem, which attempted to self-regulate through informal norms and standards by doubling down—albeit temporarily—on their commitment to “decentralization.”

• The Ethereum Merge, or the transition of the Ethereum network into Proof-of-Stake, finalized in September 2022, is a positive example of how the delicate balance between exogenous legitimacy and endogenous legitimacy can be struck.

The sanctions on Tornado Cash by the United States’ OFAC in 2022 illustrate the challenges for blockchain systems in achieving exogenous legitimacy. Importantly, it highlights the risks individuals such as founders or software developers face in blockchain projects, showing how legal actions can still target them, which can profoundly affect the entire blockchain system.

More information

This piece is one of a series of multidisciplinary writings investigating the governance of blockchain systems and specific assumptions about their decision-making structures, namely:

• Report on Blockchain Technology, Trust, and Confidence (De Filippi et al. 2022a), assessing the role of confidence and trust in blockchain systems;

• Report on Blockchain Technology and Legitimacy (De Filippi et al. 2022b), addressing the challenges of legitimacy in blockchain systems;

• Report on Blockchain Governance Practices (De Filippi et al. 2024), analyzing the multifaceted models of blockchain governance in various blockchain communities.