September 20, 2023
Foundation

Democracy and Decentralization

This article is part of The Hivemaker’s Code series:

How Do They Fit Together?

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Authors: Oliver Lukitsch, Michal Matlon, Gregor Žavcer, Thomas Fundneider, Markus Peschl, Lena Müller-Naendrup

The world we live in today is unjust. Glaring inequalities exist between the global North and the South, but also within European economies. All this can make it challenging to feel like there is progress happening. It seems we are moving backward, leaving humankind in a worse state than we found it.

Nonetheless, there is progress to report. Despite all the atrocities, our democracies have evolved for the better. Minority rights have become more important to policymakers, and although there are setbacks to be felt everywhere, we live in more liberal, democratic societies than we did four decades ago.

It’s easy to get lost in the face of major setbacks, like the devastating blows to women’s rights in the US. But the public reaction to Black Lives Matter and #metoo shows that our moral standards have refined too and that we are increasingly sensitive to injustice and unequal power relations. Though democratic values are at the height of their moral punch, they are being threatened by reactionary and authoritarian bents in almost equal measure.

A similar ambivalence has gripped the digital sphere. Internet giants have gained more power than ever. They collect information and exert a growing influence on elections and other political processes. In contrast, there is the GDPR in Europe and the vision of decentralized digital infrastructure, the Web3. Especially the latter is a bearer of hope and potential a realizer of democratic ideals. And we’ll now take a look precisely at this technology.

It should be no surprise that the quest for a more decentralized economy and society is an important phenomenon of our time. We want to take our lives into our own hands and not let others dictate how we should live. We strive for a strong sense of individual autonomy and self-determination. And yet our society is highly centralized. Power is in the hands of a few, and most economic wealth belongs to a small minority. This is an obstacle to a more humanistic, individualistic society.

Although they were heralded as saviors for freedom and autonomy, the Internet and Web 2.0 have not helped either. The power structures of our economies have become entrenched, and new, powerful oligopolies have emerged. The providers of digital ecosystems are now not only the most valuable but also the most powerful and influential companies in the world: Google, Apple, Meta, Amazon, Microsoft, and others.

The vision of a free Web3 is opposed to this prospect. It gave us a new perspective on how we can organize socially. It holds the promise of redistributing power, creating a genuinely self-organized, decentralized economy in which everybody who participates can own a piece of the pie. Is it set in stone that Web3 delivers on its promise, however?

One of the biggest threats to Web3 is that its promise of a self-sovereign and decentralized internet remains broken while becoming a playground for venture capitalists and early adopters.

Emphasizing the importance of decentralization is a good premise for a more open and fair web. But will it suffice? A fundamental value of a truly open and democratic community is that a society must maintain a balance between individual freedom and restriction. We can only achieve personal freedom by preventing other individuals from undermining each other’s ability to act.

This culminates in philosopher Karl Popper’s idea that an open society must defend its openness if it’s not to compromise its liberal democratic foundation. Any restriction an open society accepts must ultimately increase the individual’s freedom, sovereignty, and possibilities.

Let’s take Popper’s principle as a starting point as we look at how blockchain and Web3 can promote a genuinely democratic Internet. In other words, let us look at how a Web3 ecosystem can enable a fundamentally open society.

Blockchain Oligarchies

There is growing evidence that the value of existing blockchain assets is in the hands of a minority of “whales,” the significant shareholders of those assets. And although the blockchain’s server infrastructure is fundamentally decentralized and distributed, many blockchain ecosystems promote unequal value distribution.

One reason is that some ecosystems seem prone to gaining traction in almost a pyramid scheme-like snowball. For instance, Elon Musk was advertising Dogecoin on Twitter, thereby driving his gains as a shareholder.

This example shows that it’s not all about owning a big slice of the pie. Instead, it’s about influencing a critical mass to support and drive your initial investment. Being an early adopter means you can acquire cheap assets while also being the reason for its increasing value.

At least on its commercial end, crypto finance lacks democratic incentives and enablers. If you already have an extensive network, capital, and influence, this will allow you to adopt early and push the value of your assets by getting others to invest in them.

If you don’t have the influence and lack the audience, you will have to rely on speculation, second-hand information, and good faith. Such an approach might work in your favor, but how the value of an asset develops is ultimately not in your control – if you’re not Elon Musk, for that matter.

Many idealists (“regens” in internet slang), however, help build blockchain ecosystems because they believe in a different economy. A sense of purpose and passion rather than financial gains drives them. Countless individuals contribute voluntarily. And movements like Solarpunk are getting organized around purposeful social progress.

But even looking at the community as a whole and disregarding the uneven distribution of power and value, various blockchain communities don’t seem to have the best inclusivity track record.

Inclusivity and Web3

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In his 2022 study, Koray Caliskan, a Strategic Design and Management professor at the New School, investigated a blockchain community called Electra. Specifically, how power was distributed and organized in its ecosystem.

His conclusion: While the community was very open to inclusivity and driven by ethical concerns, it mainly consisted of “well-educated men who live in the West.” Fortunately, as the researcher made the community aware of the problem, it reacted promptly and decisively by founding initiatives to address these shortcomings.

Electra is, of course, a singular phenomenon of the emerging Web3. Yet, it serves as a fitting example of the emerging blockchain universe. There is openness and inclusivity – everybody is welcome. But just as Electra serves as an example of the uneven distribution of value in a blockchain ecosystem, it also shows how easy it is to be misled by the overt, visible power structures and leadership representation on platforms like Twitter.

In the case of Electra, the official leadership does not make the most critical decisions that move the entire community in different directions. It is primarily the community’s administrative circles that shape the ecosystem’s future.

This was evident when Electra temporarily collapsed and was almost instantly revived in 2020. Then known as ECA, it collapsed when its anonymous founder sold his share of hundreds of millions of coins, thereby decreasing the currency’s value to zero. Once again, this shows that influential shareholders easily thwart the promise of participation.

However, Electra’s community was more than just an appendix to its technological assets. Within only a few days, the community was able to re-establish their currency under a different name – Electra Protocol (XEP). The episode is a vital sign of the liveliness and autonomy of a community that effectively lost its founder and visionary. But it is also worthwhile to take a closer look at how this reorganization occurred.

Blockchain Democracy in Practice

That’s why it’s worth taking a closer look at how the Electra ecosystem is regulated and controlled. It is a notable exception here as well. While in many crypto communities, the Bitcointalk Forum and Twitter are considered essential venues for their affairs, for Electra, the role of Discord is of the greatest importance.

Discord community managers mediated the above transition from Electra to the Electra Protocol. The members of its Discord are the de facto governing body of Electra. The community, therefore, refers to its Discord forum as the community’s “parliament.”

Electra’s Discord platform had only around 360 members, involving only a fraction of the thousands of community members worldwide. Yet, what happens on Discord is decisive for the entire community and its stakeholders. Even though the representative leadership is on Twitter, the community makes significant decisions on Discord.

However, in the case of Electra, it is hard to get invited to Discord. Also, once invited, new users only have weak contribution rights. In the beginning, a member can only read and post. Decision-making authority, or the power to change and shape critical decisions, is a privilege of an even smaller minority within the Discord. Moreover, the moderators in the forum can silence members who act too “impulsively” – they can remove their right to post content on the platform.

Therefore, the political process within Electra more closely resembles the democratic organization of traditional Western political parties than the grassroots democratic organization often referred to as the vision of Web3. There is tension between the original vision and the actual governance of a blockchain. Let’s take a closer look at this tension.

The Difference Between Ownership and User Agency

Decentralized ownership in crypto ecosystems is real. Blockchain technology forces any ecosystem based on its infrastructure to be owned by those who contribute to network maintenance. But it’s only real in one sense of the word.

The hardware contributing to the shared storage that gives rise to the crypto sphere often belongs to the people who contribute to the nodes. And since the integrity and completeness of the blockchain depend on the collective functioning of multiple nodes, the blockchain belongs to everyone and no one at the same time. Each node in a distributed blockchain system stores a copy of the entire blockchain.

However, there is an essential difference between material ownership and members’ power to act. If you truly own your assets, you have much more control over them than if you can only access them through a third party.

If someone holds you captive so you cannot move, you still own your body. But you have lost the power to move, act, or dispose of what is yours. That is to say, while users can co-own the infrastructure of a blockchain, they might lack the agency to act as they desire.

The case of Electra shows that you can tick all the boxes of ownership by using blockchain infrastructure while failing to distribute and decentralize agency and user empowerment.

There are two non-exclusive ways to solve the tension above. The first is to set up governance structures that organize the blockchain so that no accumulation of power can happen. The second is to use a blockchain protocol that does not favor users with considerable power.

Proof of Work, Proof of Stake, Proof of Personhood

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A major obstacle for any blockchain prevents it from unleashing its democratic and power disseminating potential. This potential is undercut by how blockchains enable open participation in its consensus mechanism while simultaneously preventing “Sybil attacks.”

For any blockchain, it is essential to avoid that a single user can act as many, increasing its influence on the network. For a decentralized network, this would mean that a single person could use many profiles to accumulate power within the network.

Hence, any blockchain faces the security risk that pseudonymous users might not be real and thus lack real stakes in participation. Blockchains such as Bitcoin use the Proof of Work consensus mechanism (PoW) to ensure this is the case.

Proof of Work requires specialized and costly hardware, and only a privileged minority can afford to mine new blocks effectively. Moreover, it is widely accepted today that Proof of Work has an unacceptable carbon footprint as it is computationally costly. Yet, it is precisely this reason that makes it so effective.

The well-established alternative is Proof of Stake (PoS), and it’s significantly more energy-efficient. Users stake their assets, such as coins, to validate transactions. Yet, staking often means owning more assets will allow you to create even more assets, as users are receiving percentual rewards for the staking. This can create a self-reinforcing mechanism that grants more power and minting capacities to those who already own more.

While being a game changer regarding energy efficiency, a necessary step during the climate crisis, Proof of Stake can create an unjust environment for the users. While the power of users is no longer dependent on hardware, it nevertheless boosts the power of a few users who own a large share of the ecosystem from the beginning.

A single person can thus use their influence to create new tokens and steer the network in a preferred direction. Therefore, the accumulation of power is highly incentivized in a system based on Proof of Stake.

However, there are alternative consensus mechanisms that remove this specific limitation and attempt to make blockchains more democratic so that each user counts equally.

One example is the Proof of Personhood (PoP) or Proof of Individuality (PoI) consensus mechanism. It is based on so-called “pseudonym parties,” where users meet in real life. It is not important to prove the real identity of the people participating.

It is sufficient that, at the end of the party, each participant receives exactly one identity token representing their virtual identity. All of this without revealing any sensitive information. At present, it is almost impossible to fake that you are a real person if you have to show up at a physical event with other human beings present.

Your anonymity is thereby compromised, at least to a certain extent, which contradicts one of the central promises of cryptocurrency. Yet again, you can retain your anonymity and omit your actual identity. What counts is that you are a human person who can accept a token at a physical venue. This is called the “setup phase.”

The second phase is all about minting. The minting pool consists of everyone who received a PoP token in the setup phase. In the minting phase, anybody who is part of the minting pool can create new blocks and thus also mint new coins.

In Proof of Stake, staking more coins means an increased chance of being able to mint new blocks and receiving the reward. Proof of Personhood, however, means that everybody who received a PoP token has an equal chance of minting new blocks.

Shortcomings of PoS

While PoS has presented itself as an attractive, more climate-friendly alternative to PoW (it consumes 1000 times less energy), it favors those who already own a critical amount of assets on-chain. Yet, if not deployed consciously with methods preventing this, PoS can render the decentralized, democratic promise of Web3 hollow.

PoP or PoI (Proof of Identity) is a radical and consistent solution to the problem. However, it has notable downsides. It can diminish the incentive for engaging in minting. That is to say, if the returns for minting diminish progressively, users are more likely to feel like staking more of their coins isn’t worth it. Moreover, for some users, attending pseudonym parties is not sufficiently private and sometimes physically impossible.

While PoP is safe and safeguards equality, it might also discriminate against those who are hesitant to participate in physical events or might be otherwise incentivized by the financial promises of Proof of Stake networks.

Hence, methods like “progressive staking” and “quadratic voting” are a promising way of combining the incentive structure of the original PoS while making it less prone to exploitation by powerful shareholders.

“Progressive staking” means that every additional coin a person stakes would have less power than the previous one. It could discourage entities from concentrating staking power because of diminishing returns.

While progressive staking looks like a promising alternative to existing consensus mechanisms, it still faces a more general problem: What would prevent a person from creating a lot of addresses, staking only small amounts of coins each?

The Web3’s Soul

It turns out this question touches upon one of the challenges of the crypto world as a whole. With time, it became clear that the way blockchains work can’t be entirely separated from the complex realities of human relationships.

Many social interactions can’t be based purely on trusting the trustless network but include the factors of reputation and commitment (see previous article in the series, “Satoshi’s Dream”. They require specific people (or entities) that a person can trust. They also need that a person can trust that a particular entity they interact with stays the same over time. That there’s the same person or organization behind it.

In the recent paper, “Decentralized Society: Finding Web3’s Soul”, coauthored by Vitalik Buterin, the authors suggest a solution to this challenge. The solution has a form of so-called “souls” and “soulbound tokens.”

These allow specific entities (souls), whether individuals or organizations, to build up a reputation through valuable interactions with others by releasing soulbound tokens with a verifiable tie to their originating souls. In the case of progressive staking, these souls could be the units to which the stake is bound. Perhaps it could also require that the participating soul has a certain reputation level.

Fairness and Openness as Conflicting Democratic Values

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Blockchain certainly has economic promises. In part, the public awareness and hype about blockchain can be traced back to its financial promise. Yet Web3 promises to establish a worldwide web that its users own, where the agency of single stakeholders such as corporations and states is limited, while the agency of a majority of users can grow. That’s the democratic promise of blockchain.

Blockchain technology is consistent with the idea of a fundamentally decentralized Web3. But being consistent is not enough. In the mid-term, PoS seems to be the modus operandi of blockchain systems. The question is whether a second-layer consensus mechanism such as PoP could assure that everybody can rely on a base level of agency and freedom.

You might object that Proof of Stake will create an even playing field for everyone, regardless. After all, the system does apply the same rules to all the users.

Web3: How to Create an Open Society?

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In many global economies, the unequal distribution of resources is a fundamental systemic condition. But there are political institutions that can counteract these tendencies. For instance, states impose taxes, prevent monopolies, and regulate fair competition between market players. Hence, while it is not (and cannot be) the main function of a blockchain to counter inequality, it can only be the role of its governance.

Some might see this as a political intervention that undermines the neutrality of an otherwise basic, neutral infrastructure. However, we must not confuse the question of neutrality and political partisanship with the question of openness and freedom. The question is how to think of basic infrastructure as democratic or open.

Openness is considered a core democratic value, made famous by the liberal philosopher Karl Popper. The rejection of any intervention to regulate the distribution of assets can be understood as an attempt to guarantee and protect the openness of a blockchain ecosystem.

This point of view argues that it’s worthwhile not to restrict the consensus mechanism to preserve the blockchain’s openness and users’ freedom to maximize their profits or keep their investments afloat.

Moreover, liberal economists argue that the “elite circulation” phenomenon means that although the value is unequally distributed in liberal economies, over time, large shareholders fall outside the circle of those who own the most. The circle of the wealthiest users of the blockchain remains in flux, like a ship whose planks are constantly being replaced. They claim we must accept this phenomenon to maintain an open, liberal network.

However, Popper also argued that a fully open society might allow authoritarian and anti-democratic tendencies to grow as there cannot be any restrictions on its freedom. Does this mean that an open society is defeatist? Popper’s answer is no.

To ensure that a system is truly democratic, it must be defensible. An example of this is the German constitution. Among other things, it contains a passage prohibiting anti-democratic policies even if they are implemented by democratic means, thus introducing a meta-perspective on democracy. PoS consensus mechanisms often lack such “constitutional amendments” to avoid a minority getting their hands on the blockchain network, though it could be argued that a fork presents such a mechanism.

Whether a system can self-regulate sufficiently to overcome and balance such dispositions is both an empirical and ideological question. It is essential to keep it in mind when designing a decentralized network protocol that is intended to give more control and sovereignty to its users.

Moreover, it is crucial to remember the possible paradox that intervention can lead to more fairness while openness and non-interference can sometimes reduce it. When these issues are ignored and real-life power tendencies come into play, the best intentions to create a more open network can fail.

Most importantly, the paradox that freedom sometimes requires intervention and rules ensues because there exist two conflicting notions of freedom in the first place.

Negative and Positive Liberty

When people discuss freedom or liberty today, they usually have in mind what’s called “negative liberty.” Negative liberty, simply said, is the individual’s freedom from outside interference. For example, this would mean that if a person wants to buy bread at a bakery, no one will forbid him/her from doing so under the threat of violence.

In the case of cryptocurrencies, this means that the network is built in a way that doesn’t restrict anyone from taking part in running and governing it, using the same rules and mechanisms. It also means that no centralized authority is included in the initial design of the network.

On the other hand, there’s the notion of “positive liberty.” It means that a person, under specific conditions, is actually able to fulfill their wish or purpose. Coming back to the bakery example, it means that not only there’s no one preventing a person from buying the bread, but also that they have the money and other necessary means (like the ability to talk to the baker) to buy it. Positive liberty is focused more on freedom being the actual outcome rather than the starting condition.

Since this notion of liberty is usually not preferred in libertarian thought, it has rarely been used as a framework for designing cryptocurrency networks. While Bitcoin and Ethereum are designed as permissionless and decentralized, the reality is that the power within them has become quite concentrated. Because the designs of the networks didn’t include additional mechanisms for maintaining a more equal distribution of power, as seen through the lens of positive freedom.

The DAO Democracy

So far, we have emphasized the role of a blockchain protocol as a keystone for digital ecosystems, in which an open society (thus based on democratic values) can flourish. The focus was on how technology can enable such values.

Yet, the topic of democracy is crucial not only for designing consensus algorithms but also for how people (rather than their digital tools) organize themselves in the virtual world. Community governance is still missing from the majority of blockchain whitepapers. At the same time, a well-working governance system may soon become one of the distinguishing features when choosing what project to participate in.

New crypto communities are now often adopting DAOs, Decentralized Autonomous Organizations, as a governance framework. DAOs are built on the premise of direct, fully transparent democracy on the blockchain. For example, members who own tokens can submit suggestions, design smart contracts, and vote to decide which of them will be put into reality.

However, it seems that DAOs face the same challenges as any other democratic system in the physical world. Voting turnouts can be low, as members don’t have enough time or expertise to stay informed and make frequent judgments on complex topics. Power can get concentrated in the hands of the few.

Some have suggested that DAOs should look for inspiration in how traditional democratic governments work instead of trying to reinvent the wheel. Based on these learnings, they could strive to make voting less frequent and only touch upon the most important issues. They could allow people to elect transparent representatives with predictable term lengths. These representatives could then employ expert managers to take care of everyday responsibilities.

While taking the best from what we already know about democratic governance, DAOs could use their blockchain-based, digital form to amplify the positives and mitigate the negatives. For example, by employing tools to transparently track the actions of the representatives and fostering open communication.

The Tenet for an Open Blockchain Ecosystem

To conclude, we will briefly summarize the synergies and discrepancies between blockchain-based infrastructure and the goals of the democratic web. Let us start with the negative aspects.

In its purest form, a blockchain-based infrastructure uses its decentralized powers to ensure the freedom and anonymity of its users. However, user freedom can be compromised by the formation of oligopolies that can take control of the network at the expense of the agency of others. Blockchain aristocracies, as seen in the Bitcoin network, can make even the oligopolies of today’s mixed economy look balanced by comparison.

There are different ways to address and prevent this:

Fair Infrastructure

One way to address these issues is at the infrastructure level. For example, we can change the consensus mechanism to ensure that early adopters are not in too strong a position. This makes it worthwhile for others to engage by creating equal opportunities for established and new users.

Fair Governance (and how DAOs can enable it)

Another way to ensure the agency and equal opportunities for the majority of users is to address the implementation of liberal-democratic values and processes on the level of governance.

There are different ways to establish a fair, participatory, and transparent governance framework. We have already mentioned a framework in which users formed an informal parliament on Discord. This is only one way and will probably become more sophisticated in the future.

A promising avenue for the governance of Web3 ecosystems is the DAOs (decentral autonomous organizations) where smart contracts regulate the organization’s governance, there is transparency in decision-making, and members vote on what the DAO is supposed to do and how.

At this point, it should also be noted that the same problem that applies to PoS also applies to voting in many DAOs. For instance, to vote in the MakerDAO, a user requires Maker tokens (MKR). Users must “lock up” their tokens – and the more tokens they lock up, the more voting power they acquire.

One way to discourage users from investing large sums of tokens to increase their number of votes is “quadratic voting.” While one vote will cost one token, two votes will cost four instead of two. Such a mechanism increases the cost of voting progressively. However, the wealthiest users could still afford a costly power play while others would lack the means to counteract it. Another alternative is “reputation based voting”, which is used in systems such as Colony.

Moreover, the governance of DAOs can lead to problems such as “whale chasing.” Suppose the governance of DAOs is organized so that larger shareholders have more voting rights. In that case, any decision, for example, to change some of its smart contracts, means that large shareholders (whales) have to be brought on board to support it.

In many cases, DAOs can help organizations to sustain their autonomy and to increase the participation rights of all shareholders. Yet, exploring how DAOs can enable truly distributed shareholder participation is still worthwhile. While it might not be the most efficient way to maximize the DAO’s economic goals, it can also enable the emergence of a profound and self-sustained democratic organization.

Conclusion

Blockchain, a technology that enables financial autonomy and self-determination for those who use it, has been criticized for its contradictory vision. One that emphasizes the participatory virtues and self-empowerment of shareholders, users, and members. However, this vision is undermined by the reinforcing feedback loops that allow those with the biggest stakes to gain even more.

One of the biggest threats to Web3 is that its promise of a self-sovereign and decentralized internet remains broken while becoming a playground for venture capitalists and early adopters. A democratic internet should be sufficiently open to allow entrepreneurs and investors to do their business. But it must also give rise to ecosystems where truly democratic, self-empowering, decentralizing processes and communities can emerge.

Key insights

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  • The crypto sphere has the disposition to exacerbate inequality and create oligopolies and crypto-aristocracies.
  • Openness does not (necessarily) lead to more inclusivity and fairness
  • Democracy flourishes most when power in society is distributed.
  • Blockchain cryptocurrencies were introduced with the promise of decentralization.
  • In practice, they offer people the ability to buy power through fiat money, and network power is often concentrated.
  • Libertarian prioritization of negative liberty could be one of the reasons.
  • Positive liberty is an alternative take that takes into account the actual outcomes of power distribution.
  • Progressive staking could be one of the ways of maintaining the distribution of power.
  • Crypto projects need to solve the problem of assigning unique and persistent identities that can build a reputation.
  • Soulbound tokens and Proof of Person could be the solution.
  • DAOs face the same challenges as traditional democracies.
  • They can learn from how these challenges were solved in the physical world by implementing transparent, representative democratic structures.

References

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