Before we take a look at different types of governance, let’s first discuss what governance is in blockchain. Governance is a system that runs each blockchain and project that is part of these blockchains. Governance is a decision-making mechanism that creates certain rules in the ecosystem and something that looks over the whole project. It determines who holds the power and who makes the decisions, which then determines the development path of these projects. It affects both macro and micro decisions on the blockchain, and depending on the governance structure used, determines which blockchain path these projects follow. 

When it comes to different types of governance systems, there is no universally accepted system that is perfect in every condition. Governance systems are adapted to each project based on the goals of these projects. A well-designed and thought-through governance system is what makes projects advance and develop into something meaningful. 

When it comes to different governance systems, there are two major governance styles that we currently see in the blockchain world. These are centralized and decentralized governance systems, and the major difference between these two systems is who is in control. Taking a deeper look, we also meet two other governance systems, which are on-chain and off-chain governance, which are closely associated with decentralized and centralized systems. So what are these different systems and why do they matter?

The major difference between centralized and decentralized governance is who makes decisions and who is in control of the system. Centralized governance systems are traditional governance systems that we see everyday. This is a system, where one singular power stands at the top of the ladder and this power is what makes every major decision. For example, the traditional banking system is a centralized governance system, where banks have complete power over the system, they can record every piece of information needed, they can make changes as they see fit, and so on. In the case of blockchain, we can see this example with centralized exchanges, such as Binance. Binance is controlled by a single entity and every transaction is recorded and processed by Binance, this gives them control over your activities and they can implement changes as they see fit. One clear example of the amount of power these exchanges hold is custodial wallets, which every major exchange implements. When you deposit funds in your exchange account, these funds go to the wallets controlled by these exchanges, and you don’t hold the private keys. This gives them control over your funds, and while most of these exchanges will not take your crypto and do as they please, there have been examples of this happening, with the most notable example being FTX.

On the other hand, a decentralized governance system removes this complete power and distributes it among every participant. The goal of decentralized governance systems is to remove middlemen and make the interaction between two parties private. Decentralized systems use smart contracts and consensus mechanisms to give every participant in the project a say in every matter. These projects are also not controlled by any single entity and even the people who created this have no final say of what is going to happen. For example, Decentralized Autonomous Organizations are blockchain projects and networks that give people the right to vote on everything related to the project. These organizations have what’s called Governance Tokens, which give people who hold these tokens the right to vote on different proposals regarding the project. The distribution of these Governance Tokens is very important because if one single party holds the majority of these governance tokens, the whole point of decentralization goes out of the window. 

Why Decentralization

When we are talking about different governance structures, in most cases the main emphasis is always made on decentralization. This is because cryptocurrencies were created for this purpose, to remove power from centralized authorities. When Satoshi Nakamoto first created Bitcoin in 2009, he was angry with the centralized banking system, as decisions made by a few individuals created a worldwide economic crisis. Because of this, he wanted to introduce a new financial asset class that could not be manipulated and controlled by a single entity. As time went on and blockchain became more advanced, this decentralized governance system became more advanced, giving more power to people, and also creating automated systems that create equality between everyone. 

When it comes to control of who owns what and where these transactions are going, a decentralized governance system removes the main risk of a single point of failure. When transactions are made on the blockchain, these transactions have to go through multiple authenticators and these decision-making processes are available for the whole network to see. This creates a system where no central authority can make decisions and changes behind closed doors, as everyone can see everything. This also removes the possibility of one single entity making decisions that will benefit them, while not protecting the needs and wants of the people involved with the project. 

In order to better understand why people are calling for decentralization, we can look at the recent FTX collapse. There is a huge debate about whether centralized exchanges are good or bad, and FTX might have proved its flaws. FTX, which used custodial wallets, started using user funds and made very bad investments. Since this was a centralized system that operated behind closed doors, people only caught on to this problem when it was too late and damages could not be repaired. The same thing could not have happened to the decentralized exchange, since these exchanges don’t control user funds and also have a very high level of transparency and everyone can see what’s going on with the project. 

Problems With Decentralization

As you can see, a decentralized governance system brings many benefits and creates fair and transparent systems. But if it was so perfect, then why is everyone not on board with this “perfect” governance system? Well, the most obvious answer to this question is the oppression from big centralized organizations that don’t want to give up their power and control. But there are other problems that hinder the development and mass adoption of decentralized governance and decision-making systems. First of all, it is a question of the collective ability to make important decisions, and there can be times when decision-making is very prolonged. In centralized systems, important decisions can be made very quickly as only a few are in control. But in decentralized systems, very important decisions can be stretched to weeks, months, or even years. 

Another problem with decentralized governance is the ability and knowledge of the people involved. Looking at centralized systems, people who are in charge are typically very knowledgeable and have a lot of expertise in the field they are working in. These people can make well-educated decisions that are based on past experience and knowledge they have accumulated. While on decentralized systems, we don’t know the level of knowledge and expertise of the people involved. There can be a very important decision that needs to be made, and the masses might not see the full picture due to a lack of knowledge and experience and make very bad decisions. There are numerous examples of Decentralized Autonomous Organizations failing for this very reason. 

A decentralized governance system also brings problems with criminal activities. Decentralized systems don’t oversee and control the people involved, meaning that you can very easily retain a good level of anonymity. While it has its own benefits, it also creates a space for criminal activities and makes it much easier for people to manipulate different things without being caught.

Blockchain governance that takes place on the blockchain protocol itself, known as on-chain governance, grants project developers the primary authority to make decisions and propose changes through voting. This decentralized model allows people to collectively vote and make decisions, eliminating the need for a central governing body. The voting power of each person depends on the amount of Governance Tokens they hold, rather than following a one-person-one-vote principle.

On-chain governance offers the advantage of fast decision-making, provided the design functions smoothly and as intended. Proposed changes are directly incorporated into the project's code, and developers are incentivized to vote promptly, especially when voting and implementation deadlines are present within the code. 

But there is also a problem of low voter turnout, especially if there is no good reward system that will give voters a reason to participate in the decision-making. This then creates a problem of undemocratic voting, where people with a large number of Governance Tokens can greatly influence the decisions made and make projects take the path they see fit. This creates a threat of these systems becoming controlled by wealthier individuals, and those who have more money have the biggest say. This returns us to the problem of centralized voting, where only a few entities are in charge of making big decisions. 

On the other hand, off-chain governance is similar to the traditional governance structure and much easier to understand. It is a more centralized governance system, where authority is mostly given to select groups, such as community leaders, major mining associations, or developers. In off-chain governance, decisions are made outside of the blockchain and are mostly verbal. Once these decisions are made, they are then implemented into the blockchain manually by the people in charge. 

Unlike on-chain governance, off-chain governance relies more on human involvement and less on code and smart contracts for decision-making purposes. This removes the threat of something bad happening to the code that commonly happens with on-chain decisions. However, here we run into the problem with transparency as decisions are made behind the scenes, leaving network participants with very limited insight into the decision-making process. 

Now let’s take a look at some of the different blockchain networks and see how these networks apply these governance models. 

Bitcoin is the world's largest and leading open-source blockchain network and it serves as a good example of a decentralized governance model. While most don’t know, the primary decision-makers on Bitcoin are not the developers themselves, but people who own Bitcoin and those that mine it. The same can not be said about Ethereum, which has one single entity behind the decision-making, its founder, Vitalik Buterin. 

Bitcoins’ governance model can be seen as a mixture of on-chain and off-chain governance, considering the involvement of community leaders outside the code development process. The Bitcoin protocol is open to participants and there is no specific requirement, except for following the protocol itself. As long as you can contribute computing power and mining, you can engage in Bitcoin development. 

Miners, who supply computing power to the network, play a big role in Bitcoins’ governance, alongside regular users. Major decisions are usually made through a peer review process among users, followed by consensus among the biggest and most active miners. In this case, miners with more significant input have a proportional influence on decision-making. This is one of the main reasons why Bitcoin is less likely to move to a more eco-friendly proof-of-stake protocol, like Ethereum, since big miners will never let the vote go through, since they will be giving up on their bread-and-butter. When this voting takes place, Bitcoin’s core developers will oversee the process. When voting finishes, the proposed changes are either implemented or rejected.

While on the other hand, we have Ethereum which has long been looked at as a centralized network. While it is considered to be a decentralized network, its founder Vitalik Buterin still holds a very large amount of power over the network, and Ethereum heavily relies on his input. But Ethereum still implements a similar voting system as Bitcoin and network-wide software alterations are usually voted on through Ethereum Improvement Proposals. This voting process goes through multiple stages from draft to final status, before it’s manually added by developers. 

Tezos is widely recognized for its on-chain governance model, which distinguishes it from other blockchain projects. What sets Tezos apart is its unique cyclical voting system, with each quarter of the year dedicated to a specific purpose. 

In Tezos, each voting cycle serves a distinct function: The first cycle focuses on consideration, the second on actual voting, and the final cycle involves actual live updates. The third stage, where implementation or rejection takes place, operates on a simple majority model, requiring 80% of the votes. The proposed changes that receive at least 80% approval are then introduced to Tezos mainnet. 

The Tezos governance model serves as a good example of on-chain governance, and it puts importance on determining the exact number of votes necessary to advance changes. This ensures a well-defined voting system and any governance framework should be based on a similar system. Tezos system also allows participants to vote on the voting system itself. This innovation solves the problem of dominant stakeholders and low voter turnout, presenting a good and creative solution to improve governance and project efficiency. 

Overall, Tezos’ on-chain governance model showcases a thoughtful and adaptable approach to decision-making within the blockchain network, which takes into account the needs of its community and makes sure everyone is satisfied with the decisions made. 

Governance is one of the most important aspects and characteristics of any blockchain and networks associated with this blockchain. Looking at where we are today, blockchain governance has become a hot topic of discussion, with some calling for full decentralization while others still think it's too early. Since governance is associated with decision-making, most people think that all those who are part of the project should have a say. Because of this, we are seeing a lot of decentralized blockchain projects that utilize governance tokens in order to spread voting power in a democratic way. But looking at some of these projects there are still some flaws in it, with some decentralized spaces still being controlled by a few powerful entities. But despite this, we are seeing a lot of advancements in this field, which is fueled by continuously failing traditional governance systems that rule traditional financial institutions. These advancements aim to bring not only democracy and take away the power from single individuals but also to bring transparency into the space. What’s left for us to do is to watch how things develop and where this decentralization takes blockchain in future.