The DeFi explosion that took place between the last quarter of 2019 and 2020 up to the early parts of 2021 can be attributed to some degree on the type of governance infused by these DeFi projects during these periods. Governance a word in centralized business encompasses the system by which an organisation is controlled and operates and the mechanisms by which it and it’s people are held to account. This type of governance is wholly the responsibility of the founding members and executives.
Blockchain technology enables network of participants that do not know or trust each other to agree on the state of shared administration without relying on human intervention, a central point of control or regulatory supervision. Therefore, in these terms, blockchain governance is defined as the means of achieving the direction, control and coordination of stakeholders within the content of a given blockchain project to which they jointly contribute. Different models are used to achieve this.
A) Founders Control
Majority of projects when in its infant or early stage in the blockchain industry are controlled by the founders; this is to achieve faster growth and development of the project. A fully developed DeFi project or project in transition more often than not, depending on the function of the project tend to distribute power of governance among stakeholders as seen in many projects.
B) Council Control (Off-chain)
As the name suggests, the power of governance rests with a group of people who devise strategies and lay road maps. The bitcoin and ethereum are note-worthy examples of this type of governance where core developers are the council.
In this type of governance, core stakeholders coordinate and determine the direction of a protocol through conferences, mailing lists, online forums and other forms. However off-chain systems often results in situations where some stakeholders are more powerful than others.
C) Liquid Democracy (On-Chain)
This mechanism enables stakeholders and participants of a protocol to vote for changes affecting that protocol directly on the blockchain; proposals are coded into smart contracts and executed automatically if the required amount of votes are achieved. It was developed to provide community members and users with more influence in the governance process. Also known as delegated or proxy voting, it allows representatives to be selected by votes, new components to be introduced into the platform by vote, and other decisions affecting the platform to also be voted for through the use of what’s called governance token. This type of governance is what is known today a decentralized governance.
What is A Decentralized Governance?
A decentralized governance is the type of governance which transfers the agency’s responsibilities, decision-making power and control of the management of the platform from a small group of founding members, employees and executives to the large group of decentralized community of stakeholders and participants who interact with this platform and are globally distributed through the issuance of governance tokens.
This aspect of governance was introduced by DeFi projects and it’s most practiced by projects of this nature, it has increased and influenced the relevance and presence of transparency in the blockchain (which had been widely acclaimed by Crypto and blockchain enthusiasts) and hence attracted more investors and a larger community who are irrevocably committed to DeFi.
Decentralized governance in DeFi is made possible through governance tokens issued by these protocols and a series of processes which will be discussed later.
What are governance tokens?
These tokens allow token holders to govern a blockchain protocol and enable them capture direct value from the DeFi application. In other words, governance tokens allow it’s holders to vote decisions that influence and shape the future of the ecosystem. The decision is proposed by the executives or any member (depending on the laid-down criteria) in many cases and then vetted and voted by the community token holders through on-chain processes.
Governance tokens are typically ERC-20 standard tokens and usually must be staked or held as collateral by users in order to vote on proposals. In most cases, organization who let users control the development of their systems are called decentralized Autonomous Organizations (DAOs). Example of a governance token is Maker (MKR) for Compound protocol. This token allows it’s holders to vote on decisions concerning the DeFi protocol that DAI runs on. Other examples are UNI for Uniswap, YFI for Yearn.Finance, AAVE for Aave protocol, 1INCH for the 1inch protocol and so on.
Some of the decisions that are usually voted for includes;
- A lending platform may use it’s governance process to determine the amount of collateral required to borrow money or make changes to its interest rate models.
- A decentralized exchange (DEX) could use it’s governance mechanisms to allocate funds for the plaform’s development or to change the way liquidity protocols are managed.
- MKR holders can vote to change the complex economic rule that govern the decentralized lending that allows DAI keep its price stable.
- A yield farming platform could use it’s governance process to hire someone to audit its code.
- A data integration company like COVALENT could use it’s governance process to choose which blockchain to be indexed into its API or decide the type of App as relevant to the community to integrate into the API.
Decentralized Governance Processes
Once governance tokens have been distributed, the hard work of actually governing a platform begins. The most popular DeFi governance structures all follow the same general process below, although not all follow through all the processes listed, but these are the ideal process/procedure for decentralized governance.
Discussion is the first step of Decentralized governance, as stakeholders attempt to gauge the sentiments of the community around specific issues and potential changes. Discussions happen across a platform’s official governance forum and informal communication channels. Ideas and policies are ideally the center of conversation, but politicking often occurs as users try to convince others in the community to support their ideas or proposals.
2) Improvement of Proposal
Improvement of proposals are an attempt to systematically and transparently put forward new changes to the system by using a generalized template consisting of the proposal’s context, description, and potential code change. For now, most improvement proposals are technical, quantitative, and mainly submitted by developers. Once a code change is proposed, it can be discussed and reviewed by the community — then changed further if necessary.
A quorum is the minimum amount of participation required to pass a vote. For example, a proposal may have 100% support from voters, but if the number of token holders who vote fails to meet the minimum percentage required, then the vote is often automatically cancelled. One of the biggest problems in DeFi governance is low participation. People often want to hold tokens for speculative purposes and may not want to participate in governance because it is time-consuming, less instantly gratifying, and/or they do not have a strong view — or any view at all — on the proposed change to the protocol.
4) On-Chain vote
For most DeFi protocols, one token equals one vote, and a simple majority of more than 50% is enough to execute a new proposal. The more tokens an entity holds, the more weight their vote carries. If a token holder does not want to vote directly, their voting power can be delegated to another address. Once a vote is passed, the proposal can be executed.
Once the voting process is concluded, the outcome of the vote can then be implemented as required.
Importance of Blockchain Decentralized Governance
The decisions which are proposed are voted on for implementation by the protocol. The totality of the process is made public form the first stage to the implementation stage through smart contracts, hence ensuring transparency in governance. This is the major advantage of decentralized governance over the normal centralized governance we’re used to, thus increasing the trust placed on these protocols by investors and the community.
2) Distribution of Power
Stakeholders, and the community are more involved in the decision-making process of the protocol thereby giving a feeling of ownership and thus improving the level of confidence generally among members.
3) Unbiased Decision
Since the decision is not solely the responsibility of the founding members or an individual alone, rash and unwholesome decisions concerning changes to the platform cannot be made. All decisions go through the voting process, where the community and stakeholders are involved, hence the best decision for the well-being and improvement of the platform are made through collision of ideas.
4) Community Growth
The community involvement in governance will lead to more active and robust participation in other aspects of the protocol therefore increasing the numerical growth of the platform.
5)Increase in Value of The Governance Token
The governance token which is the key tool at the center of decentralized governance will increasingly grow immensely as more proposals are made and more votes are casted increasing the use case of the token. Also, more tokens will be purchased for more voting power.(more tokens, more voting power); the demand across exchanges for this token will definitely increase which increases the market value of the token. This is most notable in a protocol with a large community with constant platform changes and proposals.
Tools Recommended for COVALENT In Decentralized Governance
a) The Governance Token
There is no decentralized governance without 3the governance token, for decentralized governance to take place efficiently, the stakeholders and communities need to be involved. This is only possible through the issuance of Governance token. Although balanced procedure should be adapted in the distribution of these tokens to stakeholders to avoid accumulation of of the token within a few hands hampering the decentralization of the platform.
b) Separate Platform for Proposals
Some platforms are more decentralized than the others, this has been seen to be caused by the percentage of tokens held by founders and the community involvement in governance proposals, e.t.c. Some platforms only allow for decentralized voting process and centralised proposal assessment. What this means is that, a number of proposals are selected by the inner core team to be voted only the token holders, where as token holders should also be involved in the screening of proposals or initiation of a number of proposals.
In this light, the COVALENT team should create a separate forum for ideas and proposal listing by the community and ensure that this forum is not neglected. The valid ideas are selected after rigorous considerations to be voted on.
c) Incentive for Voting
One of the major setback for decentralized governance is low participation from the community. Most small token holders in the community might feel reluctant to participate in voting process because they might think their vote won’t count or they stand to gain nothing for voting, some are it as waste of time as nothing is propelling them to vote. COVALENT should do things differently by implementing small benefits for participants of a voting process, this will help boost the number of voters.
Gnosis and Snapshot have collaborated to develop SafeSnap, a product that allows for automatically executing successful governance votes on Snapshot. The module combines features of Gnosis Safe Multisig and the Snapshot off-chain governance platform.
Snapshot is a “governance-as-a-service” provider for a number of decentralized finance projects, including Yearn.finance, SushiSwap, Balancer and others. It provides a simple interface to create governance proposals and lets users vote on them by connecting their wallets and the governance tokens contained within.
Snapshot proposals are not binding. Team members and multisignature key holders for the projects are expected to execute the proposals, but the process relies entirely on their goodwill. SafeSnap changes that by introducing the option of automatically executing transactions that would enable the proposal once the governance vote passes.
SafeSnap uses the Reality.eth crowdsourced oracle to verify the outcome of the off-chain vote. Once verified by the oracle, the transaction triggering the particular change can be triggered by anyone. The requirement of manual intervention is a design necessity given by smart contract limitations.
The SafeSnap mechanism would make Snapshot-based projects look closely like the Compound’s governance model. Proposals on Compound can only be submitted if they include the Solidity code that would directly implement the idea. The on-chain governance module then automatically integrates the new code if the vote passes. Compound’s governance model presents relatively strong barriers to entry, while at the same time being more uncensorable and code-based.
The SafeSnap module allows projects to choose how to implement their proposals, possibly conducting major upgrades through a more decentralized mechanism while still retaining the gas-saving measures. Check them out.