Blockchain is seen by many as a beacon of hope for a new age of transparency. The technology enables decentralized solutions to various problems and will thus break up encrusted governance models. But a system that is supposed to create trust and transparency must itself meet the requirements for trust and transparency. The blockchain is designed to be systemically transparent by virtue of its architecture. Nevertheless, a Blockchain network also needs a governance structure. Depending on whether it is a closed or public network and on the objective of the applications, it needs rules, coordination and possibly also a legal entity.
What is the definition of governance?
The term governance must be defined depending on the context in which it is applied. The context varies greatly, in this respect the term must also be adapted dynamically. In the field of political and social sciences, the process of control and regulation of a state, market or social system by a government is considered in particular.
If one considers governance of distributed ledger technology (DLT), i.e., of decentralized databases, one should take a look at the IT literature, where Peter Weill defines governance as a mixture of decision rights, accountability, and incentives.
In summary, governance is an umbrella term for coordination and rules between actors working on a collective problem.
Governance of private blockchain networks
Again, this varies greatly depending on the context in which the network operates and the specific use case. Moreover, such networks operate in an inter-organizational environment that requires cross-organizational cooperation. It must therefore be designed in such a way that all decision-making processes satisfactorily take into account the various stakeholders. This can be exemplified by the topics of funding, partner onboarding, tokenomics for incentivization or role concepts.
Here, it is essential to implement mechanisms for reviewing and adapting the processes. Governance models for blockchain consortia must be understood as an iterative process, taking into account new decisions or members. In addition – since they are cross-organizational networks – legal aspects need to be considered. For example, establishing a separate legal entity for liability and responsibility reasons makes perfect sense in some cases.
Governance models in practice
Here, the Bloxberg network can be considered as an example, a consortium of various universities and scientific institutions with different particular interests that operate a joint blockchain network. Here, the governance model ensures an appropriate weighting of the different interests and determines on a meta-level how the members interact with each other and how individual decisions are made in the future.
In the Bloxberg network, this primarily concerns the qualification and admission of new members and the exclusion of members in the event of misconduct, expansion, additions and extensions to the rulebook, as well as technical improvement proposals and protocol upgrades.
All voting then also takes place on the blockchain itself. The voting weight varies and is based on participation in past votes. The members elect a person for the “Iron Throne” for one year, who executes the decisions (e.g. onboarding of new members) on behalf of all members. The execution will be reviewed and the person executing the decision can be held accountable. Because possible violations of the rules are publicly visible at any time, compliance is guaranteed. Non-compliance would lead to a significant loss of reputation in the scientific community, so the members of the Bloxberg network have a native interest in the correct observance of all regulations.
But do blockchain networks now need a legal entity?
In a perfect world with mutual trust, transparency, fairness and altruistic goals, there would probably be no need for a legal entity. Unfortunately, this is not yet the world we currently live in. In addition, a legal framework makes more sense with increasing requirements for data protection, business continuity, and regulatory compliance, so that a legal organization is responsible for the infrastructure and thus potential liability issues are clearly clarified and processes to comply with all data protection laws are implemented and controlled. For potential customers, a loose consortium may also not be a sufficiently reliable business partner.
In this respect, a company’s own legal organization is a prerequisite for its proper participation in the market.
Which form of organization is most suitable again varies greatly from case to case. Since there is no international or decentralized corporate law, but organizations always operate within the national legal framework and are then recognized internationally, finding the legal form is a process that requires the involvement of all members. First, all stakeholders must agree on uniform goals and principles of the network. Then, based on this and taking into account various location factors, the appropriate legal form can be found.
Public Blockchain Networks
But enough about blockchain consortia and private networks. The revolutionary thing are the public Blockchain networks. Decentrally organized and without a responsible person or organization. As a result, the network itself must have a governance structure and virtually monitor itself. In this respect, public networks need their own processes to manage further developments or unforeseen problems. To ensure this, a consensus process is needed on two levels: the protocol level and the application level. There are different approaches to involve the members of a network. First, the company, startup or initiative is usually responsible and then hands over control to the community. This includes the open source developers, other contributors and the (paying) users of the service. This is then called a Decentralized Autonomous Organization or DAO for short.
What is a DAO?
DAO stands for decentralized autonomous organization. It is a digital and decentralized organization that interacts with people via smart contracts, who in turn perform tasks in the network. The DAO acquires funds by selling governance tokens to new members and allocates funds to teams that contribute to the DAO. Members who hold tokens evaluate proposed improvements and monitor the teams’ work progress. They select which proposals to implement by voting. If individual members disagree with the majority decision, they can sell their tokens if they are publicly tradable, or they can leave the DAO and cash out their share after returning their tokens.
However, since developers should focus on the project itself and not on governance models, there are several frameworks (such as Aragon and DAOStack) to create a DAO with a few clicks and back it up with basic administrative processes. For example, these frameworks provide memberships, applications, voting system and financial management with smart contracts and out of the box user interface.
Liability and the legal handling of DAOs are currently still unclear. Smart contracts are only programmed rules. They do not make any decisions themselves. In this respect, participants in the network can certainly be held liable. However, the anonymity made possible by the network makes this much more difficult than with a normal form of organization.
Governance models as the basis of every blockchain
In summary, a good governance model is essential for both public and private blockchain networks. While private networks have to achieve a balance between different particular interests and create a framework for cooperation via the governance model, governance is the most important basis for public networks to create processes for the success of the network.