Bitcoin’s Governance

THE GOVERNANCE DILEMMA

Governance has always been a contentious issue in human society. On one side, groups of people
usually need leadership of some form in order to be effective and competitive in a free market
economy. There are many models for this governance ranging from pyramid hierarchy to more open,
flat and progressive structures. On the other hand, particularly in the realm of governments, how can
the voice of a few be truly representative of the collective whole such as the public.
Generally speaking, it becomes increasingly difficult to govern effectively as the group size increases
(more competing voices and perspectives) and when ideological splits start to emerge. We see this play
out in smaller economies where there is often a relative alignment of ideals and values and governance
tends to be fairly predictable. However these points of solidarity start to break down as nation states
increase in size, we see migration of people and cultures and increasingly the traditional values and
beliefs are challenged by new ideas, new people and evolving technology.

I once attended a talk on leadership and an anecdote still sits with me. The presenter was an ex-
Australian SAS soldier who had found a new career as the director of the road and rail infrastructure
authority. He spoke about the difference between governance and negotiations in politics and business.
In Business, 95% of the time during a negotiation, a reasonable compromise is reached where both
parties give a little to take a little and achieve the end goal. The driver is completion of the project or
venture as it has a favorable outcome for both.

In Politics, your world exists in the remaining 5% where nobody wants to give any ground yet demands
that you give up yours. The magnitude of competing drivers and motivations are often mis-aligned with
the end goal and unfortunately stimulated by the next election rather than the future generation.
The incentives and competing drivers behind people and their decisions is so important to understand
for effective governance to exist. If incentives behind decisions do not align with the success of the
system, it will inevitably fail.

BITCOINS GOVERNANCE

Blockchains are global systems which created a new paradigm for what is considered money. What is
classified as Money is a social belief and agreement. In Australia, we have agreed that we accept AUD
and don’t accept USD, GBP, Yen, Silver, Butter or even Gold as payment for goods and services. As we
wind back through history, the objects that have been accepted as money has evolved many times over
and changes for different parts of the world.

What fascinates me is that Bitcoin is starting to be accepted in more and more places as money. In
places, you may now pay for goods in AUD and BTC. The norms of what is accepted as money are
starting to shift and this is an event which has only happened a handful of times in human history. In
fact, this has only ever happened twice before on a global scale after the Bretton-Woods agreement
making the gold-backed USD the global reserve and then again in 1971 when the gold backing was
dropped creating fiat currencies.

So how is a distributed, uncensorable money system governed? How can the incentives for all actors in
the system be structured such that the system survives long-term?

This was Satoshi Nakamoto’s biggest innovation, the balance of game theory that underpins Bitcoin. On
the latest TFTC podcast with Jack Mallers, Jack presented an interesting perspective on this. He noted
that the true commodity behind Bitcoin are people. Bitcoin survives because it is useful to people as a
store of value, as money and as a means of global transaction. The more useful it can be, the more
people will sign onto the agreement that it is money. Bitcoin is a digital organism that survives because
it can pay people to keep it alive.

This is why the Proof of Work consensus mechanism is pure genius. It provides an overhead cost to
acquire bitcoins via mining which creates compulsory sellers. These sellers have an ever growing pool of
buyers due to Bitcoin’s scarcity and monetary properties which has proven to be reliable over time. The
governance of Bitcoin seems complex on a human level, but to Bitcoin at the protocol level it is actually
quite straight forward. In essence it has three parties who make decisions that it must satisfy:

Miners who secure the network and are paid to do so. They are the compulsory sellers who create
supply to recuperate operational costs and act on their own profit driven incentives. There are two
drivers, one to produce as much hash-rate as possible to acquire the Bitcoins and the second to protect
their CAPEX investment in ASICs which are useless in any other application. Miners are ultimately
responsible for protecting the Bitcoin blockchain and will do so long as it remains profitable to do so.

Users and Hodlers who are incentivized to buy coins to take advantage of Bitcoin’s monetary properties.
Nodes are incentivized to validate the network to support the decentralisation and censorship
resistance which protects both the value proposition of their investment. The more nodes are
operational, the harder the Bitcoin code is to change. As Bitcoin becomes more financialized, running
nodes will likely become a ‘household box’ that provides secure access to the decentralised economy.
Whilst miners are responsible for selecting the longest chain, nodes are responsible for selecting the
version of the Bitcoin software that validates them. Nodes enforce the consensus rules, Miners must
operate under those rules. This is the power of proof of work as it provides this check-and-balance
where users of the network (nodes) are actually responsible for the protocol not the miners.

Developers who are incentivized by the ethos of building a new financial infrastructure and in many
cases are also Hodlers. Bitcoin is actually fairly unique in this regard in that it does not need to appease
developers due to its reputation, simplicity in design elements and the fact that the community could
walk away today and it would keep on running. Bitcoin development is entirely community driven
however we are seeing increasing institutional support both in terms of funding and projects supporting
the Bitcoin financialization as these parties stand to benefit from the advantages Bitcoin adoption
brings. Bitcoin developers are a small and elite group who are incentives to maintain the core principles
whilst adding only the functionality deemed absolutely necessary.

Bitcoin’s governance is an off-chain system. Decisions are made by the people who interact with the
network. Given the immense adversity faced by Bitcoin from regulatory, dark market stigma and continued social and technical attack vectors, Bitcoin has developed a social skin that further ingrains it’s
resistance to change. Not only must the game theory and technological elements be overcome but there
needs to be a social consensus for proposed changes else there will not be a consensus from the node
operators who ultimately govern which version of protocol is operated.
So overall, how is well Bitcoin governance working?

EXTREMELY WELL.

Bitcoin’s price may fluctuate up and down, but the hash-power dedicated to the network has been in a
single massive bull-run since Bitcoin’s inception and just broke its ATH. Bitcoin has never been so secure
so the incentives for miners are indeed working as planned.

More value currently flows through Bitcoin on a daily basis that Paypal, Western Union and OTC gold markets and it is quickly closing in on VISA, Mastercard and most likely SWIFT. Not bad for 3 transactions per second.  Bitcoin is clearly showing it is useful for users as a payment network.

For those who do not understand what Bitcoin is yet, there are only so many boom-bust cycles that can be ignored until they just buy it to not miss out. Bitcoin is becoming increasingly financialized, accessible, accepted and trusted. The stock-to-flow ratio of Bitcoin will flippen’ Gold in the 2024 halving making it the scarcest financial asset on earth. I believe this will be the catalyst that sees massive money outflow from the Gold and Silver markets into Bitcoin and will be the true phase of financialization and acceptance.

Development on Bitcoin has never been more impressive. Lightning network is live and continues to onboard more and more users and liquidity. New financial products are being introduced by new institutions and the pipeline of products continues to grow. Big names like Microsoft, Fidelity and Square are entering the Bitcoin market. Funding is now secured for multiple developer groups by large institutions who also have an incentive to support the ecosystem which will bring them customers and trust in their services.

As the final layer, the blockchain re-org that was recently proposed by CZ immediately initiated the social defense mechanism. The community both challenged the idea as being against the core principles of Bitcoin whilst at the same time having the debate around whether it was technically feasible or likely in the future. What happens here is that it engages many minds and ideas to establish what is considered the status-quo whilst also being flexible in that when these issues arise again (say when Bitcoin becomes reliant on a fee structure) the fore-thoughts has already occurred and social consensus is more educated when the time comes.

Final thoughts

Governance is a hard problem in all situations. Blockchain has opened up this problem on a decentralised and global scale. It’s worth noting very few if any examples of effective governance on a global level exist, Bitcoin may well be the first. Alt-coins have a whole new challenge needing to bootstrap their incentive structures without the organic growth and reputation of Bitcoin.

Alt-coins have achieved governance with various models and levels of success. Some of the more interesting ones are Ethereum, Decred and DAOs like Maker and Moloch. Personally, I think poor governance, mis-alignment of incentives and lack of sustainable funding will be the reason most projects fail. I believe that in the long term (5 to 10years) there is only space in the blockchain world for a handful of platforms (probably less than 10 in a Pareto distribution) and differentiation on governance will be the thing that ensures survival.