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What Is Blockchain Governance?
Blockchain governance is a system of checks and balances within a blockchain or a community that allows participants to decide what is best for the blockchain and cryptocurrency. There are many that use community governance systems, so it’s important to know how these systems affect investors.
Key Takeaways
- Cryptocurrency investors can be directly affected by protocol changes in a blockchain.
- Most cryptocurrency investors are not involved in blockchain and cryptocurrency development decisions.
- Bitcoin and Ethereum have systems in place for decentralized representation, such as Improvement Proposals.
- Other options for governance include hybrids of off-chain and on-chain systems, while others are purely on-chain or off-chain systems.
Why Cryptocurrency Governance Matters
Equity markets have clearly defined stakeholder structures for investor recourse. These structures have resulted in governance systems that protect investor interests and prevent rogue executives from running amok with companies. Cryptocurrencies are regulated in many jurisdictions, but most are only governed by a small group of developers and an interested community.
In most cases, token holders’ lack of governance involvement is not due to being blocked by developers. Instead, it is because most governance issues are technical and use industry jargon, and many holders are unaware they have a voice.
Many blockchain projects offer governance rights to token holders. These rights are not monetary or financially rooted but give the holders an opportunity to help decide what happens with the blockchain the cryptocurrency is built on. This may not seem appealing to some, but for those investing in cryptocurrency, it should be.
Governance rights allow interested parties to vote or participate in a cryptocurrency’s development. When a cryptocurrency’s programming changes, it should be of great interest to investors because significant changes—such as switching from proof-of-work to proof-of-stake or redirecting the project’s purpose—can influence market prices.
Example of Governance Importance
In 2017, Bitcoin investors were bystanders in a drama that culminated in a fork to its blockchain. Developers and participants could not agree on a proposed change, and the blockchain split, with some supporting the original chain and others supporting the new Bitcoin Cash blockchain and cryptocurrency.
This fork could have gone much worse for those invested in Bitcoin at the time. Had the Bitcoin Cash crowd succeeded in attracting more followers and interest from other investors, it could have replaced Bitcoin as the top cryptocurrency. At the time, the only people who really had a say in which direction the Bitcoin blockchain went were the developers and miners because they were the ones who made the changes and uploaded them to their nodes. Luckily for investors, this fork didn’t cause a permanent price dip as many anticipated, but it could have.
Blockchain developers forked the Bitcoin blockchain and made the changes they wanted. Miners either loaded the latest version or didn’t, and investors were left out of the decision-making while they had money invested in the tokens. They were rewarded in the end because Bitcoin token holders received an identical amount of Bitcoin Cash (BCH) tokens for free from the fork—worth more than $345 per token on Nov. 2, 2024. However, developer disagreements and actions like this don’t always benefit investors.
When investors become more involved in governance, there are more voices supporting or rejecting changes. In this way, cryptocurrencies might retain their democratic and decentralized origins rather than being directed by a small centralized group.
Types of Governance Systems
Generally, there are two types of blockchain and cryptocurrency governance systems: on-chain and off-chain.
On-Chain Systems
Some blockchains allow all token-holders to vote through automated voting processes. For example, Decred allows all token holders to cast votes by locking some tokens to “purchase” voting tickets. These users then cast votes through a Decred voting service provider or Decrediton, the blockchain’s user interface.
Off-Chain Systems
Bitcoin and Ethereum use off-chain systems, using proposals and community discussions to get feedback from users and participants. The developers then make the necessary adjustments to the network and protocols and rely on participants to update their clients.
Hybrids
Other blockchains might use a combination of on-chain (automated voting) and off-chain (discussions and review) for governance.
Popular Cryptocurrency Governance Systems
Bitcoin and Ethereum have systems in place to implement decentralized representation. The core of these systems is Improvement Proposals, suggested by developers or users to enhance the functionality and performance of their respective blockchains. However, changes must be accepted by centralized communities of developers and certain network participants.
Ethereum’s improvement proposals must undergo peer review, feedback, and community discussion before being approved or rejected. Investors can participate, but doing so requires a level of technical understanding many don’t have—this is also true regarding Bitcoin.
Solana uses a community voting process, weighing votes based on the amount of stake network validators have. When there are proposed changes, validators can cast votes in favor of their supported actions. This can be beneficial for investors who have staked their tokens because it gives them a say in active development. However, if an investor only holds their SOL and doesn’t stake any, they aren’t given a vote.
What Does Governance Mean in Cryptocurrency?
The term “governance” in cryptocurrency refers to a community’s ability to participate in a blockchain and cryptocurrency’s development. Participation in blockchain governance is similar to a shareholder casting votes for the actions a company takes—it gives investors a say.
What Governs Cryptocurrency?
Governing cryptocurrency is different from regulating it. Governance involves decisions made by developers, a community, or both about a cryptocurrency’s blockchain. Regulatory agencies like the Securities and Exchange Commission or Commodity Futures Trading Commission regulate certain cryptocurrency uses.
What Is the Governance Structure of Bitcoin?
Bitcoin uses a community improvement proposal process where anyone can submit a change after a review. The developers make changes, and miners and node operators accept and upload the changes, or they don’t.
The Bottom Line
Cryptocurrency investors should be concerned about blockchain development occurring behind the scenes. The more popular cryptocurrencies are being actively developed, which means changes to the coding, programming, and the blockchains to which they belong will change over time.
Changes in blockchain design and functions might affect how a cryptocurrency is perceived by the market and cause price fluctuations. Governance systems allow users, participants, and investors to have a say in how the cryptocurrency they invest in evolves. Thus, investors who don’t follow and participate in developments are missing out on an opportunity to participate in their investments.