Blockchain Governance Explained for Crypto Investors

When selecting crypto assets to invest in, investors often consider the core team members’ expertise, the asset’s current and potential market share, the consensus model, and especially the asset’s ability to generate yield. As more protocols offer on-chain governance, it’s crucial to also evaluate the asset’s governance model and understand how protocol changes could affect the asset’s value.

On-chain governance allows asset holders to vote on topics that directly and indirectly affect return on investment. As with any form of voting, if you don’t vote, you’re less likely to get your preferred outcome. Governance decisions may lead to asset depreciation. In this article, we provide a high-level summary of the evolution of blockchain governance, the different on-chain voting concepts, and why crypto investors should vote to maximize and protect their returns.

Evolution of Blockchain Governance

Governance is a much-discussed topic in the blockchain industry. When Bitcoin first launched, it had no formal governance written into the white paper or the protocol. As more developers joined and the network grew, the community developed a formal off-chain governance process called Bitcoin Improvement Proposals to decide on changes.

Off-Chain Governance

Off-chain governance is a process in which changes to the blockchain are proposed, discussed, and decided either formally or informally apart from the chain’s code. From Improvement Proposals shared by mailing list and Github to community forums to chats between influencers, many protocols including Bitcoin and Ethereum use off-chain governance. Downsides include the slow speed of adopting new ideas due to the likely need for a hard fork to include code changes, and decision-making power being limited to a small group of core developers and miners rather than the whole community.

On-Chain Governance

Some cryptocurrencies, such as Tezos and Maker, have implemented on-chain governance. On-chain governance is a process in which rules for submitting proposals and making decisions are hard-coded into the protocol, and the decisions are executed automatically into code. One of the benefits of on-chain governance is that the blockchain code can be amended without a hard fork. Downsides include low voter turnout (asset holders must take action to vote) and decision-making power being limited to a small (but different) group of users, in this case those with the largest stakes.

On-chain governance comes in many forms, comprising voting mechanisms that range from staked voting (EOS*, Maker) to self-amending (Tezos) to selected nodes voting (Dash*) to voting by proxy. Here are some on-chain voting concepts explained (note that many governance systems may combine two or more):

Staked Voting: Voters stake a portion of their asset holdings to vote on a proposal.

1. Based on amount: The more you stake, the more weight your vote will have.
2. Based on expertise: The better your reputation (as measured through peer ratings or other mechanisms), the more weight your vote will have.

Quadratic Voting: Voters can purchase any number of votes for the same topic, but the cost of additional votes increases quadratically (1 vote — $1, 2 votes — $4, 3 votes — $9, etc).

Self-Amending Governance: Changes to the voting process and model (even the self-amending part) can be voted on and implemented directly into the code automatically as a result of the vote.

Poll Voting: Vote is for either yes or no.

Approval Voting: Voters can vote for as many proposals as they want, and the one with the most votes (“approvals”) wins. For instance, Maker has both types of voting. They use poll voting for governance issues such as adding a new member and approval voting for executive matters that change the system.

Proxy Voting: Similar to delegating staking or inflation, asset holders can vote by proxy. It’s important to monitor the proxy continuously to make sure they are accurately representing your views. It’s also important to follow the same security measures as delegation when granting voting power to proxies, since your private keys will need to be accessed in order to establish a proxy.

Why should investors vote?

As more chains include on-chain governance, participating in governance is becoming an active and continuous part of investing. Similar to owning traditional voting shares, owning crypto assets that you can vote with allows you to influence asset value both directly and indirectly. Investors should keep an eye on governance questions facing their assets so they will be able to vote for their own interests as needed. Protocols can be revised quickly, and even asset holders’ rights to vote can be amended. The next section explores some scenarios investors should watch out for:

Direct Impact on Returns

Vote outcomes can directly affect your asset’s performance:

• If voters decide to change the block reward amount, your returns on staking will be affected, and the resulting deflation or inflation may also affect asset value.
• If voters decide to change the inflation percentage, your yield through inflation will change.
• If voters decide to change the consensus model, for instance to add another source of validator, the block reward will be split between you, the staker, and the new source.

As the range of yield generation mechanisms grows (staking, lending, margins, etc.), so does the range of decisions that can impact your return on investment.

Indirect Impact on Returns

Vote outcomes can affect an asset’s longevity, and even your ability to vote:

• If voters decide to remove a delegation party you use, you will have to find a new party to delegate to and may lose yield during this time (or the new party’s costs may be higher).
• If voters decide to change the governance model from one where votes are weighted by amount staked to one where each entity gets one vote, then this may affect your influence over future decisions.
• If voters decide to change the consensus model, the security of the network might be at risk, or core team developers might churn.

There are a growing number of changes that could lead to altering the health of a protocol in the long term.

For example: on March 8th 2019, the Maker community voted to increase the Stability Fee from 1.5% to 3.5%. Stability fees may be exchanged for MKR to be destroyed (and therefore removed from circulation), which is a deflationary measure that marginally increases the value of the remaining assets. Increasing stability fees therefore has an indirect effect on asset value.

Why custody on-chain governance assets with Anchorage?

Anchorage is designed to enable active participation including voting for all assets we support, and to keep assets both secure and accessible at all times. Voting allows you to have a say in how your protocol of choice will evolve, which can impact your return on investment.

To learn more about Anchorage, please get in touch.

*At Anchorage, we strive to support all assets. Starred assets are not yet supported on our platform. If you’d like to find out whether we plan to support an asset of interest to you, please email us at contact@anchorage.com.

Services are offered through Anchorage Hold, LLC, which acts solely in a custodial capacity. Anchorage Hold is not registered with the SEC or with any other federal or state regulatory agency. Services are not yet offered to residents of New York. Anchorage Hold does not engage in the offer or sale of securities or crypto assets, or the transmission of funds. Services are provided only to clients that meet specified standards of sophistication and have entered into the Anchorage Hold Custody Agreement. Anchorage Hold is a wholly-owned subsidiary of Anchor Labs, Inc., a Delaware corporation headquartered in San Francisco, California. Nothing in this communication is intended to imply that any asset is low-risk or risk-free. Anchorage does not provide investment, legal, or tax advice.