Layer Two Governance — Part I

Introduction

Effective governance is a crucial element in any crypto project as it directly influences the involvement of stakeholders in decision-making processes. Users need to understand how they can actively participate in governance activities to contribute to the growth of the project and community. Each project adopts its unique styles and structures to meet its governance needs. In this inaugural article of our Governance Style and Architecture series, we will delve into various governance styles, including token-based and reputation-based approaches. Additionally, we will examine the governance architecture of prominent Layer 2 protocols like Optimism, Boba, and Metis. By exploring these topics, we aim to provide readers with a comprehensive understanding of different governance models and their implementation in Layer 2 protocols.

Off-chain and On-chain Governance

Blockchain governance initially emerged as an off-chain procedure, where stakeholders coordinated and determined the direction of a protocol through channels like conferences, mailing lists, and online forums. However, off-chain systems often lead to imbalances of power among stakeholders.

Ethereum follows an off-chain governance approach, involving diverse stakeholders in decision-making.

While Ethereum’s protocol-level governance remains off-chain, many applications built on the Ethereum network, including Decentralized Autonomous Organizations (DAOs), embrace on-chain governance.

To address the need for increased individual user participation in the governance process, on-chain governance has emerged as a mechanism allowing stakeholders to vote directly for protocol changes on the blockchain. In this system, governance proposals are often implemented as smart contracts and executed if they meet the required threshold of votes for ratification. Many DeFi platforms extensively utilize on-chain governance mechanisms.

Participation in on-chain governance typically requires holding a governance token, which grants the right to vote or propose changes. While on-chain governance has significantly improved user inclusivity, it has also faced criticism for its potential plutocratic nature. This criticism arises from the fact that the weight of an individual’s vote is often determined by the number of tokens they hold. Despite this critique, on-chain governance has proven valuable in fostering direct user engagement and decision-making within blockchain networks.

Layer 2 Scaling Solutions

To address Ethereum’s challenges and enhance transaction speed and cost-effectiveness, Layer 2 scaling solutions have been developed on top of the Ethereum blockchain. These solutions, including projects like Arbitrum and Optimism, aim to maintain the blockchain’s decentralized and secure nature while enabling faster and more affordable transactions. The high fees on Ethereum have pushed users towards Layer 2 solutions, leading to a similar predicament in decentralized governance. On-chain voting has become excessively expensive, making it impractical. However, the adoption of Layer 2 solutions as a means to reduce costs also presents an exciting opportunity to explore innovative decentralized governance models.

Different types of governance models exist, ranging from token-based to reputation-based systems. In this context, we will examine the governance structures implemented by Optimism, Boba, and Metis to understand their unique approaches.

One Token — One Vote Governance Structure

Sample image

At its core, participation in a protocol’s governance involves acquiring governance tokens, which grant users the ability to vote on issues that govern the development and operations of a blockchain project. This approach allows projects to distribute decision-making power among their communities, typically with a one-token-one-vote system. The most popular governance structures in DeFi and protocol governance generally follow a similar process:

1. Discussion and Improvement Proposal: Governance begins with discussions among stakeholders to assess community sentiments and gather input on specific issues and potential changes. These discussions take place on official governance forums and informal communication channels. Improvement proposals are then systematically and transparently presented using a standardized template that includes the proposal’s context, description, and potential code changes.
2. Quorum: To pass a vote on a proposal, a minimum level of participation is typically required. This ensures that sufficient participants are actively engaged in the decision-making process.
3. Voting: Voting is often conducted on-chain, allowing token holders to vote on the proposed changes. Some protocols may also employ the Snapshot tool to gauge the community’s sentiment and preferences.
4. Proposal Execution: The outcome is determined based on the voting results after the voting process. If the proposal garners the required support, it proceeds to the execution phase, where the proposed changes are implemented.

Now, let’s delve into the challenges associated with the conventional token-based governance structure. The “one person — one vote” approach can give rise to the following issues:

1. Whale Voting: This refers to situations where large token holders, known as whales, possess a disproportionate amount of voting power, potentially skewing the outcomes in favour of their interests.
2. Early Adopter’s Influence: Early adopters often accumulate a significant number of governance tokens, granting them a higher degree of influence over decision-making processes, which may not necessarily align with the broader community’s interests.
3. Vote Sales: In some instances, token holders may engage in vote trading or selling their voting power, which can compromise the integrity of the decision-making process and lead to outcomes driven by financial motivations rather than the merits of proposals.
4. Low Voting Activity from the Community: Apathy or lack of active participation from token holders may result in low voter turnout, limiting the representation of community interests and potentially leading to decisions that do not reflect the broader consensus. The vote can be delegated to trusted representatives to ensure proper engagement during voting.
5. Abuse of Power by Voting Delegates: Delegated voting systems, where token holders delegate their voting power to representatives, can be susceptible to abuse or manipulation by these delegates.
6. Time to Pass Initiatives: The governance process, including proposal discussions, voting, and other procedures, can take time, leading to delays in implementing necessary changes or addressing urgent matters.
7. Inexperience or Lack of Knowledge: Some token holders may need more expertise or sufficient understanding of the domain related to specific proposals, leading to suboptimal voting decisions that do not consider the long-term implications or potential risks.

L2 Governance Models

Let’s look at the governance model in Boba, Optimism and Metis.

Boba Network

Boba, developed by the Enya team as core contributors to the Boba Foundation, is a Layer 2 scaling and augmentation solution for the Ethereum blockchain. It is an Optimistic Rollup chain compatible with the Ethereum Virtual Machine (EVM) and built upon Optimism’s framework. Boba Network facilitates cheaper and faster transactions and a unique new technology, “Hybrid Compute”.

Boba operates under a governance structure based on token ownership. The $BOBA token is vital in managing the Boba DAO, which is responsible for community initiatives and shaping the network’s future. Token holders possess the right to submit proposals, vote on proposals, and delegate their voting power following the governance guidelines.

A minimum of 100,000.0 BOBA + xBOBA is required to create a DAO proposal. The xBOBA tokens can be obtained by staking Boba tokens, enabling users to participate in the governance process.

Community discussions occur through the Boba forum, serving as a platform for engagement and exchanging ideas. Holders can submit proposals using the DAO service page. Once a proposal gets submitted, there will be a two-day buffer period, after which users can vote for, abstain from, or vote against the proposal. If the quorum is not reached, the proposal is considered defeated.

Optimism

Optimism governance is a collaborative effort between the Optimism Foundation and the Optimism Collective. Optimism Collective is a bi-cameral governance system, which is governed co-equally by two houses:

1. Citizen’s House
2. Token House

Venn diagram shows the rights and duties which are specific and common to Token and Citizen House.

Token House

The governance of the Optimism Collective commenced with the introduction of the OP token and the establishment of the Token House. OP tokens were initially distributed to numerous addresses that actively participated in community-driven activities with a positive-sum approach.

As members of the Token House, OP holders are responsible for contributing by submitting, engaging in discussions, and voting on a wide range of governance proposals. When fulfilling these roles, OP holders can directly cast their votes or delegate their OP voting power to eligible third parties.

Citizen House

To become a member of the Citizen House, one must hold Citizenship conferred by Soulbound non-transferable NFTs. The Citizens’ House represents a significant experiment in non-plutocratic governance and the retrospective funding of public goods. It functions with the Token House to oversee the governance of the Optimism Collective.

During its initial stage, the primary responsibility of the Citizens’ House is to vote on retroactive public goods funding (RetroPGF). The initial set of Citizens for this stage is determined through a combination of criteria established by the Optimism Foundation and a special election conducted within the Token House.

In subsequent stages, the role of the Citizens’ House will expand beyond RetroPGF voting. Alongside the Token House, it will govern protocol profit allocation, collaborate on defining criteria for Citizens’ House participation, and contribute to a system of checks and balances that upholds the Collective’s Codes of Conduct.

A significant difference between these two houses is related to the transferability or saleability of governance rights.

Now, let’s look at more details about how the users can get their citizenship through soulbound NFT tokens in the next section. Soulbound Citizenship can neither be transferred nor sold to a different entity.

Soulbound Token for Citizenship

The distribution of NFTs follows a specific approach. These NFTs are not intended for sale, and their distribution is carried out partially by projects operating on the Optimism network. The Optimism Foundation provides NFTs to projects, and the projects, in turn, distribute them among their respective communities. Some projects may receive their NFTs earlier than others, creating a phased distribution process known as “iterative experiments” where the supply of NFTs grows over time.

During the distribution process, NFTs are more likely to be allocated to active contributors who engage in activities such as participating in Discord communities, contributing to Github repositories, and participating in governance discussions. This approach prioritizes rewarding active participants rather than simply users of the applications built on Optimism.

Each holder of an NFT holds a position akin to a Congress Senator. These NFT holders can allocate 20% of the $OP token distribution and potential future revenue from the sequencer as retroactive public goods funding. This shift represents a trend moving away from rewarding every user through airdrops and targeting individuals with a positive reputation within the Web3 ecosystem.

Over time, a user’s profile will accumulate reputation points contributing to their overall Web3 reputation, translating into increased opportunities and benefits within the ecosystem.

Governance Process

The Token House of the Optimism Collective follows a four-phase process for its governance proposals:

1. Proposal Preparation and Community Feedback: The proposer initiates the proposal by sharing it on the forum, allowing the community to provide feedback and engage in discussions. This phase helps refine the proposal before its formal submission.
2. Formal Proposal Submission: Based on the community feedback, the proposer prepares a formal submission that incorporates the input received. The proposal follows a designated template. To indicate readiness for voting, at least one delegate with a voting power of 0.5% or higher must signal their support for the proposal. Once ready, the proposal is formally submitted for voting.
3. Off-Chain Voting on Snapshot: The voting process takes place off-chain using Snapshot. Different proposal types have specific approval thresholds required for implementation. The quorum for all proposals to pass is set at 30% of the votable supply of OP tokens.
4. Implementation by the Optimism Foundation: Once Token House governance proposals are approved through the voting process, they are forwarded to the Optimism Foundation for implementation. The Optimism Foundation takes on the responsibility of executing the approved proposals.

Metis DAO

Metis is a Decentralized Autonomous Company (DAC)-centric platform to power the web3 economy. The Metis Stack is reputation-based, highly customizable, and dynamic.

DACs — A New Opportunity

DACs, short for decentralized autonomous companies, introduce a fresh opportunity for governance. Unlike DAOs (decentralized autonomous organizations), DACs employ a different governance system where individuals with a reputation for contributing to and enhancing the organization are chosen as decision-makers rather than those holding the highest number of governance tokens. Reputation is showcased through badges or non-fungible tokens (NFTs), tangible representations of an individual’s contributions and value.

The significance of DACs lies in the contributions made by its members, rather than solely relying on the value of governance tokens or the organization as a whole, as commonly observed in DAOs

Proposed Governance Structure

The proposed governance structure by the MetisDAO Foundation is based on Reputation Power. The core entity within the ecosystem is the DAC (Decentralized Autonomous Company), which can be represented by an individual or a group of people. Individuals have the option to join existing DACs or establish their own.

Image showing the relation between Citizens, Commons, Econodes

To become a “citizen” of the platform with voting rights and the ability to propose changes, individuals must stake Metis tokens and accumulate veMetis. These individuals, known as Commons, play a crucial role in identifying areas of improvement within the Metis ecosystem and putting forth proposals to address them. Once the MetisDAO Foundation and existing EcoNodes approve a proposal, the respective Common becomes an EcoNode, providing specific services to fulfil the identified needs. EcoNodes operate as independent entities within the Metis ecosystem, having their business models and relying on self-funding. The MetisDAO Foundation provides shared services to support these EcoNodes in their operations.

Comparison of Boba, Metis and Optimism

In conclusion, the governance structures of Optimism, Boba, and Metis DAO demonstrate the diverse approaches to decentralized governance in the L2 ecosystem. Each project has developed unique models to foster community participation, transparency, and decision-making, while some try to address the challenges associated with traditional governance systems.

Optimism embraces a bicameral governance system consisting of the Token House and Citizen House, where token holders and non-transferable NFT holders have distinct roles in shaping the platform’s governance. This approach balances token-based voting power with reputation-based decision-making, encouraging active participation from both communities.

Boba adopts a token-based governance structure, where Boba and xBoba token holders can propose and vote on governance matters. The Boba DAO facilitates community initiatives and decision-making, empowering token holders to contribute to the network’s development and future direction.

Metis DAO introduces a reputation-based governance model through its Decentralized Autonomous Company (DAC) concept. By emphasizing the value of individual contributions and expertise, Metis DAO aims to create a governance system where reputation and meritocracy play a significant role in decision-making

In the next part of this article series, we will delve into the governance style adopted by Curve and Uniswap. Our main objective is to understand better how these protocols or Dapps have designed their governance architecture, with a specific emphasis on L1 Ethereum, despite being deployed on multiple chains like Arbitrum, Polygon, Optimism, and others.