Why governance will eat the world
Thesis: if crypto will eventually have a commanding place in this world, it is governance that will have a commanding role in crypto. (perspectives from sovereign investing)
To the extent that you buy the premise that crypto-networks more resemble economies than corporations, (see perspectives from Placeholder VC, for example) it is worth considering what the hallmark traits of successful economies are. If I had to boil it down to one thing, based on years in emerging market sovereign investing and policy-making, it would be: governance.
Let’s explore a few indicators closely tie governance to the success and level of development of sovereign nations.
- World Bank’s Worldwide Governance Indicators
Let’s start with a simple but widely-used indicator: the World Bank’s Worldwide Governance Indicators. It’s a broad look across 200 countries, mostly developing, across six dimensions of governance: 1) voice & accountability 2) political stability 3) government effectiveness 4) regulatory quality 5) rule of law and 6) control of corruption. There is a broad recognition that good governance is a vital ingredient to economic development, and this indicator provides a comprehensive perspective on the ways in which the institutional, legal and cultural backdrop is conducive, or not, to development.
Do any of these sound familiar to crypto? In some way, shape or form, they all should: 1) voice & accountability: what is the process of enfranchising token-holders or other stakeholders in any governance frameworks? 2) political stability: what warring factions may threaten the network’s viability? BCH anyone? 3) government effectiveness: how can important decisions be executed by the community or delegated authorities, with good results? 4) regulatory quality: this may seem less relevant, but this may speak to the conditions that protocols place on users or environment for developers building on top 5) rule of law: is there any way to constrain, punish bad actors? 6) control of corruption: perhaps most applicable to something like DPoS configurations with token suffrage, a la EOS.
In the world of economic development, the topic of governance weighs heavily when making development aid decisions at the World Bank. The key question is: who is able to effectively steward resources to produce desired economic and social results? At the World Bank, countries that score higher on the WGI scale are likely to receive more aid — it’s not just a function of need. Likewise in crypto, the governance process should be an important indicator as to whether resources (let’s say tokens generated by inflation for projects) will be used effectively or not. Or if upgrades are performed in the long term interests of the network. More generally, good governance can help ensure that the network achieves desired outcomes over the long haul.
2. World Bank’s Doing Business Report
Let’s take another related example of how governance can be measured and serve as a predictor to an economy’s success. The World Bank publishes an annual report called the “Doing Business Report,” which is basically a country competitiveness report that details how easy it is to do business in countries around the world. The framework uses several indicators that speak to the ease of starting business, paying taxes, engaging in trade, accessing credit, getting electricity, enforcing contracts. Unsurprisingly, countries with strong growth records like Singapore rank high whereas countries with nearly failed states, like Sudan, fall to the bottom.
Again, does this look relevant to crypto here? It should. With the proliferation of base protocols, it seems logical that there will eventually be indicators of “chain competitiveness” in the future based on a host of indicators, such as ease of building applications, scalability, security, interoperability, token suffrage…etc. And just like in real world economies, the most competitive networks will grow the fastest and enjoy the highest levels of activity. The effectiveness of a project’s governance will likely be a critical determinant as to whether a chain can evolve in a way that makes it usable and attractive for users and developers over the longer term.
3. Back to the World Bank’s Government Effectiveness sub-indicator
Let’s look at one final example — going back to the World Bank’s WGI, one indicator that has become particularly important for investing in emerging market sovereign debt is Government Effectiveness. For context: when conducting relative value between sovereign bonds, investors typically assign a credit score (AAA being highest quality, CCC being speculative). When assigning credit ratings to sovereign nations, one can then plot that rating against their price (expressed in spreads over US Treasuries) to create a relative value curve, as shown below. Bonds priced above the best-fit curve are generally considered cheap, below the curve, expensive.
But what dictates the credit score? It turns out that Government Effectiveness is one of the most important indicators. It’s just as important, if not important, than traditional metrics like indebtedness. Moody’s acknowledged the importance of Government Effectiveness in their own credit rating modeling, and our own research at T. Rowe Price validated this. The rationale is similar to that of World Bank lending disbursements: resources should be allocated to countries that can best steward them. If a government is effective at implementing policies to foster long-term growth, the more capable it will be able at also doing right by its investors. (ie servicing its debt)
There are clearly limitations to applying sovereign investing to crypto investing. For one, governance may be a minimal feature of projects — a series of smart contracts may be enough to largely automate everything— and, in fact, most projects will probably try to minimize the amount of human discretion so as to not impede scalability or finality or introduce the possibility of other centralized points of weakness. (e.g. vote buying…) And, this analysis is probably most applicable to base layer protocols instead of apps. Nevertheless, unless an app or network is perfectly baked from the outset, it’s hard to get away from the importance of forming a credible governance process that ensures the stated objectives of the project are met in the long run. This applies to projects that have more conservative (BTC) or more free-flowing (ETH) governance processes, more formalized (EOS) or less.
The overall point of this exercise is to hypothesize that to the extent that crypto-networks take on a quasi-sovereign-like status — where networks develop their own institutional norms, formal or informal, and enfranchise users or stakeholders for the network’s development and evolution— understanding lessons from real economies will become increasingly relevant for crypto investors. And if sovereign investing is any guide, then all roads will lead to the primacy of good governance.
