The cryptocurrency (and more broadly, blockchain) governance conundrum

The enthusiasm for cryptocurrencies, and blockchain more generally, derives from the sense, to enthusiasts, that an old dream is within reach, thanks to advances in computer technology: governance without (human) discretion. Consider our system of property and contract rights. Many people think these bodies of law allow us to organize our affairs in a fair and efficient way, and that the law can be reduced to a set of relatively simple rules that can, in principle, be applied mechanically. The frustration and tragedy is that we must rely on human beings—judges and other bureaucrats—to apply the law, and these human beings unavoidably make errors and, worse, may be biased or corrupt. The tension is even worse for more controversial areas of the law, such as tax law, where the suspicion that IRS officials enforce the law arbitrarily and with bias, illustrated by the Tea party scandal, is widely held.

But if the laws could be enforced by computer, using open-source software that can be examined by anyone, the problem is solved. Hence the excitement about smart contracts, for example. But more than that: what is wanted is a system of law that is entirely self-contained—made, or at least approved, by the public rather than by politicians, and enforced automatically. This is, of course, the blockchain as applied to the (theoretically) self-enclosed system of currency.

But there is a problem—the governance problem. One source of perplexity is who designs the initial software program. What ensures that he or she designs a program in the public interest? Rousseau was so stymied by this problem in the context of political theory that he believed that the lawgiver must be seen as divine. Satoshi Nakamato, who helped get Bitcoin started by shrouding his identity and achieving semi-mythical status, knows his Rousseau!

But even if this initial problem is solved, the second and more interesting problem is how the law (code) can be updated as events change. In the case of bitcoin, miners who collectively hold more than 50% of computer power can change the protocol. But this creates obvious incentives toward consolidation, which appears to have taken place. Bitcoin is a plutocracy. Other cryptocurrencies keep power in the hands of the founders and designated agents, creating, in other words, an oligarchy.

If we try to imagine democratic alternatives, we run into significant problems. It is tempting to think that we could give every (say) bitcoin user one vote. But bitcoin users are anonymous; the network can’t trace transactions to a single user (since a single user can use different keys for each transaction). Perhaps in a different version of the protocol, a vote could be attached to a bitcoin, so whoever happens to possess a bitcoin (or fraction) at any time could vote that bitcoin (or fraction). Still, the wealthy would possess most of bitcoins and hence most of the political power, and strong incentives would exist to accumulate bitcoins in order to maximize power.

A truly democratic cryptocurrency would be one in which all people (presumably, in the world, since national boundaries mean nothing in cyberspace) would possess equal voting power, including people with few coins or none at all.

Global voting seems scarcely imaginable, and also seems incompatible with anonymity. But put aside anonymity and imagine that every person in the world, or in the relevant jurisdiction if voting based on nationality or some other identity were possible, could vote on proposals to update the protocol. Formidable problems would continue to exist. Standard voting procedures—one-person-one-vote—have significant problems, and would be vulnerable to collusion. More sophisticated voting procedures—like quadratic voting—could made headway with this problem, but would still be vulnerable to the classic weakness of democracy: most people would be both incapable of, and uninterested in, making informed decisions on proposals to update a computer program, as the questions would involve technical issues of both finance and programming. Some kind of representative system might be necessary, but the representatives would necessarily have discretion, and be vulnerable to political influence, and we are back where we started.

For these and related reasons, I believe that the dream remains unattainable, at least in the near future, and with respect to currency supply and other public goods. A more realistic possibility is that relatively discrete blockchain systems would be governed based on users’ contributions in maintaining those systems, much as bitcoin is, but these systems would need to be narrowly tailored to some specific commercial problem and couldn’t be used for public goods, like currencies, that affect everyone. Even in the discrete case, however, discretion probably cannot be completely eliminated, as it is in games like chess. People seem to underestimate the extent to which even straightforward-seeming transactions, an interest-rate swap, for example, involve complex contracts with terms that are deliberately ambiguous so that they can be applied in a discretionary manner by judges if unforeseen circumstances arise. But the scope of discretion can be narrowed, and within the remaining field of decision-making, better or worse governance systems can be used. This is the area in which progress can be made.