Restrictions of Encryption Economics on Governance (Part 2)
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Voting progress: DAO Committee 3/7 passed
Total bounty: 130USDC
Research Type: Cryptoeconomics, Governance
Original Author: Nathan Schneider
Original: Cryptoeconomics as a Limitation on Governance
continued plutocracy
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The currently popular consensus mechanisms, namely “proof of work” and “proof of stake”, grant governance rights roughly in proportion to a node’s buy-in on the network—through computing power or token holdings, respectively. Applications and organizations built on such networks tend to follow a similar logic of delegating power to those who hold their tokens. Those who own more tokens than others have more decision-making power than others. Thus, Vitalik Buterin (2018) expresses honestly his anxieties about plutocracy. So far, ruling by wealth has been the norm in cryptoeconomic design.
Economic governance is nothing new. AGs are often plutocratic - more shares equal more votes. This arrangement is economically efficient in aligning shareholder interests (Davidson and Potts), even though it may exclude externalities such as fair wages and environmental impacts. However, corporations operate under the constraints of state policy, which ultimately defines obligations between persons recognized by the state, whether legal or natural. The earliest corporations were created to fulfill the charters of a mercantilist monarch; today corporations are at least bound to abide by government rules designed to represent the will of society as a whole, not just the corporate players. Governments set the rules on transparency, conduct, accounting, equity trading, and more. Therefore, although plutocracy is prevalent in the shareholding sector, the government can offset it through progressive taxation, collective bargaining rights, environmental regulations, antitrust enforcement, etc. Such options are not available if the distributed ledger is based solely on cryptoeconomics, without an underlying political order. But if "a DAO is closer to a country than a corporation," participants will expect countermeasures against plutocracy.
Plutocracy may be a common phenomenon in cryptoeconomic systems at present. Ferreira et al. (2019) predict that in proof-of-work blockchains such as Bitcoin, there is a high likelihood of corporate plutocracy. Many hope that effective vote sales (Automata Finance, 2021) or other incentive designs will fend off the influence of venture capital firms in token markets, making tyranny less attractive (Buterin, 2018; Eyal, 2019). 1Hive fends off large shareholders by rewarding non-monetary participation with tokens and making decisions with mechanisms that weigh commitment, not just wealth. But as long as governance can be reduced to economics, it will be difficult to prevent feedback loops between wealth and power from spiraling into upstart outcomes.
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suppress the interests of the participants
Like economics itself, cryptoeconomics is certainly normative as well as descriptive. Ferraro et al. (2005) found in numerous studies that “self-interested behavior is a learned behavior, and people learn it by studying economics and business”. Although this picture of human flourishing has had limited validation in empirical psychology and anthropology, "homo economicus" has spread in organizational life through economics-educated managers. It shapes the institutions people create, and people themselves.
The anthropological principles underlying the design of cryptoeconomic institutions — “explicit economic incentives for good behavior and financial penalties for bad behavior” (Buterin, 2018) — assume that users share a desire to maximize their economic rewards ; incentives based on these rewards form the structure of the organization and guide the behavior of the participants. It couldn’t be more obvious that cryptoeconomic design has produced multibillion-dollar financial networks that are fraud-proof and don’t require governments to enforce their claims. However, perhaps the anthropology embedded in these systems—that is, the human beings that incentives suggest—helps explain why the adoption of distributed ledgers has been primarily in finance-related applications, an area that has been valued the most for self-interest. turned into a premise. Outside of finance, people might expect the system to see different sides of their nature.
The subjectivity of cryptoeconomy jurors on Kleros seeking to earn fees is certainly different than jurors deliberating in legal courts who are repeatedly reminded of their civic responsibilities. “Community” takes on a different meaning when it comes to fandoms of authors who freely share fan fiction, in contrast, Honey holders in 1Hive can profit from the market value of their shared tokens.
In a survey of different areas of governance, Gritsenko and Wood (2020) find that while introducing algorithmic processes can increase efficiency, doing so also results in “reduced room for discretion for those who govern”. Algorithms can also increase the power space of their original designers compared to the power of future users (Galloway, 2006). At the same time, incentive-based systems have a hard time seeing aspects of the world around them that haven't been captured by algorithms.
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discounting externalities
On May 13, 2021, billionaire entrepreneur Elon Musk issued a statement that his company Tesla will stop accepting bitcoins for car purchases due to concerns that cryptocurrencies are depleting fossil fuels due to mining, which will almost immediately lead to bitcoin. 10% drop in the value of the coin (Livni, 2021). Under the guise of a mercurial celebrity with complex business motives, it's a rare case of bitcoin facing at least one responsibility for its energy consumption and environmental impact on a nation-scale. The system is managed by its users, specifically "miners" who perform energy-intensive computations, and these users may benefit from ignoring their collective carbon footprint. A busier network roughly correlates with higher energy consumption and higher transaction prices. Competing cryptocurrencies have pledged to lower their environmental impact, but incentives tied to bitcoin's market dominance have prevented a mass exodus.
Environmental costs are classic externalities—invisible to feedback loops understood by the system, which are communicated to users as incentives. Other externalities associated with distributed ledgers include money laundering, the trade in dangerous drugs and weapons, tax evasion, and the growth of ransomware attacks on public infrastructure facilitated by cryptocurrencies.
Non-cryptoeconomic systems have some similar properties; shareholders in oil companies also have polluting incentives, and paper money can support a dangerous black market. But such abuses are, at least in principle, subject to oversight and enforcement by governments charged with protecting the public interest. The political process enables participants to negotiate compromises among various economic and non-economic interests. If the company itself does not see a particular externality, regulators can force it to do so, for example through disclosure requirements or selective taxation. In this way, the company's incentive structure internalizes this externality. But for distributed ledgers, similar oversight remains crude or non-existent.
The challenge of funding “public goods” is another example of an externality that threatens the sustainability of cryptoeconomic systems (Buterin et al., 2018). As is generally the case with public-based software (Arp et al., 2018), market mechanisms struggle to support critical infrastructure that does not generate immediate financial returns. Before cryptoeconomics, non-market institutions such as governments and (much smaller) charities were necessary to deliver public goods; increasingly distributed ledgers are being funded through fee-based treasuries and donor grant pools. Transform them. In this and other ways, cryptoeconomic designers are beginning to foray into the political arena.
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Beyond politics
Recent cryptoeconomic practices seem to be reshaping some of the old wheels of institutional life. The Kleros judiciary, the board-like Graph council, 1Hive's constitutionalism, the protocol statesmen - they are not like their old world counterparts, but their reemergence also shows a growing recognition of the need for some form of politics mechanism. These implementations break with past practices in intriguing ways, often opening the door to greater participation and transparency. However, if a mechanism like this relies on cryptoeconomics as its sole logic, its liberating feats will be accompanied by limitations on the scope of governance movement.
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The classic, never fully realized napkin sketch of a liberal democracy (Brown, 2015) would picture a market (governed by economic incentives) enclosed in politics (governed by deliberations of the common good). Economics has its place, but the system is not quite economics; the rules that guide markets, and enable markets to exist in the first place, are democratically determined on the basis of the civil rights of citizens rather than economic power. By designing democracy at the bottom of the system, it is possible to overcome the various limitations to which cryptoeconomics is susceptible, such as fighting plutocrats through popular participation, and making external factors that the market may not see visible. In this section, I present several ways to incorporate intentional politics into and around distributed ledgers.
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State regulation
State regulation is a tool for using democracy to constrain the crypto-economy, and it can be a productive tool, especially when the state provides a framework that encourages innovation and discourages abuse (COALA, 2021). But relying too heavily on the government could completely destroy the possibility of a crypto economy. Distributed ledgers can become a design space for democratic practices that governments may not be able to explore on their own due to gridlock or path dependencies. Simply outsourcing politics to governments may not be enough, nor is it desirable.
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cooperative design
Cooperatives are businesses with democratic ownership and management among active participants, rather than for profit-seeking outside investors (Schneider, 2018). They combine human-centered governance (one member, one vote) with market-based incentives (sponsorship dividends proportional to participation). Co-ops have historically been the social and legal framework for activities that DAOs and other distributed ledger projects seek to achieve, such as accepting small early-stage investments from participants and distributing financial rewards. The cooperative principles of autonomy and member control resemble some cryptoeconomic aspirations (Davila, 2021; Walden, 2019), while a “focus on community” encourages the internalization of social externalities (International Co-operative Alliance, nd) . Corporatism provides a framework for democratic governance that can help counter plutocratic tendencies. For these reasons, more and more blockchain projects are incorporating legal entities into cooperatives. For example, Kleros operates in France through a cooperative legal structure. American entrepreneur John Paller took advantage of Colorado's flexible partnership statute to form the legal basis for two tokenization projects. Opolis is an employment platform, while ETHDenver is a conference that attracts international Ethereum developers and investors (Ahonen, 2021).
Collaborative ledgers can govern a specific application, as is the case with Opolis or Kleros, or span a larger ecosystem, similar to the role of the Ethereum blockchain in setting the ground rules for the various contracts built on it. Democracy through state regulation may come from outside the network, while collaborative democracy depends on network participants investing in egalitarian spaces—as some cryptoeconomic projects already do.
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mission oriented
This design allows cryptoeconomic networks to serve purposes that cannot be reduced to economic feedback loops. 1Hive does just that, combining a values-laden community convention enforced through a cryptoeconomic dispute resolution system; the community uses this as a replicable model, called Gardens, for other communities to Adoption (Sacha, 2021). Protocols could also incorporate “golden share” mechanisms whereby purpose-driven foundations or member-managed cooperatives could have veto power to ensure that the network does not deviate from its intended purpose (Purpose Foundation, 2020). Governments have also used golden shares to retain some control over companies that manage privatized services (Pezard, 1995-1996). An executable task orientation can resist plutocracy and make external factors more visible in the system.
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time regulation
Long-term incentives are inherently no better than short-term ones. However, introducing different time frames enables different inputs, making a system responsive to broader concerns.
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gossip
The trend toward more complex forms of cryptoeconomic governance reflects a recognition that one-size-fits-all mechanisms are not enough to meet the needs of projects or their communities. As Shagun Jhaver (2021) argues, multi-level governance is an essential component of successful online communities. Whereas Voshmgir and Zargham (2020) describe blockchains as complex systems, inevitably subject to overlapping influences and emergent properties. As far as the polemic I offer here is concerned, it should not be understood as a call to replace it with another unified theory, but rather as an acknowledgment of the polycentricity that already exists in the field (Ostrom, 2010).
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in conclusion
in conclusion
At the Bitcoin Conference in early 2009, Vitalik Buterin introduced Ethereum for the first time, and concluded his talk on the possibility of distributed ledgers by mentioning Skynet, the fictional computer system in the Terminator movie, determined to Destroy the humans who created it (Buterin, 2014). This hyperbole raises what may still be fundamental questions about cryptoeconomic governance. How do we design programmable systems that are still responsible for humans and the things we care about that can never be programmed? Long before blockchain, old world stock exchanges and corporations created incentives that hindered efforts to tackle collective challenges like climate change and economic inequality. However, the autonomy of cryptoeconomic systems from external regulation may make them more susceptible to runaway feedback loops, where narrow incentives override public interest. Designers of these systems have shown an admirable ability to devise many kinds of cryptoeconomic mechanisms. But for cryptoeconomics to achieve the institutional scope its advocates hope, it needs to make room for less economical forms of governance.
Some might read this as a cliché for an emerging technology whose possibilities are still only partially explored. Perhaps this is similar to Vili Lehdonvirta's (2016) "blockchain paradox": "Once you solve the problem of governance, you don't need a blockchain anymore". What good is cryptoeconomics if it needs a political layer and is no longer self-sufficient? One answer may be that cryptoeconomics can be the basis for ensuring more democratic and values-centered governance, where incentives reduce reliance on military or police force. Through mature design combined with less economic purpose, cryptoeconomics may expand beyond its original limitations.
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epilogue
epilogue
