DeFi Governance is a hot topic among industry pundits and regulators. Most decentralized finance (DeFi) users do not grasp the crucial importance of blockchain governance protocols to the industry’s future. For this reason, practices such as vote bribery are commonplace in platforms such as Aave.
DeFi “bribe” protocols such as the BRIBE Protocol allow proposal lobby teams to bribe token holders to sway the on-chain governance process.
Governance attacks are also commonplace in the sector. As an illustration, in early February 2022, Justin Sun, the founder of the Tron platform, allegedly took a 99,000 COMP token loan to sway a governance vote on the Compound lending platform.
The controversial Sun then sent his $13 million COMP token stash to the Binance exchange. The following day, a COMP token holder made a governance proposal on Compound proposing the addition of TrueUSD (TUSD) as a collateral asset on DeFi’s most popular decentralized interest rate protocol. The TUSD stablecoin is a regulated and legally protected ERC 20 token.
Justin Sun could also be the pseudonymous address that proposed a similar vote in the same style in MakerDAO in January 2022. In this instance, an address took out an MKR loan, the MakerDAO governance token from lending platform Aave, presumably to vote on a stability module that defines the TUSD-DAI on MakerDAO.
However, the address returned the borrowed MKR, and the MakerDAO community voted down the proposal before it had its day in a formal voting session. A TrueUSD representative later wrote to the MakerDAO community that they “wouldn’t risk working with Justin Sun, or any whales, to manipulate votes.”
The Tron founder stands accused of ‘Governance Attacks,’ a term that describes an attempt to manipulate the DeFi governance process using large sums of governance tokens as capital.
DeFi Governance – Off-chain vs. on-chain governance processes
Blockchain governance systems keep centralized entities from decentralized systems. Governance is so vital to the blockchain space that it can help alleviate the blockchain trilemma challenges of security and scalability.
Governance protocols can, for instance, vote on efficient consensus protocols for the network to solve the scalability problem. They can also set the right incentivization processes and enhance decentralization and security.
Most DeFi users will steer clear of centralized systems and stand against government interference and regulation in the space.
However, they will not partake in governance processes and voice their opinion on the advancement and future of the Defi space. In Code and Other Laws of Cyberspace, Professor Lessig warns that private interests step up when regulators step aside from cyberspace.
” When the government’s interests are gone, other interests take their place. Do we know what those interests are? And are we so certain they are anything better?” asks the professor.
How Blockchain Governance Works
Satoshi Nakamoto’s blockchain-based incentive protocols that ward off the double-spending in the bitcoin blockchain have created a massive $683 billion market cap crypto asset. The Bitcoin blockchain’s 40,000-plus node network and huge dedicated developer network reach consensus on network development via off-chain governance protocols.
Off-chain governance starts as a social decision-making process. Afterward, it morphs into an active on-chain process whereby developers code protocol proposals to the blockchain’s code. For example, Bitcoin’s off-chain governance process starts with improvement proposals (BIPs).
A developer will send a BIP to a mailing list to the community. The community will then decide on the future of the BIP. The off-chain process is a democratic and politically charged process whose antics mirror real-world politics.
Interest groups that favor BIPs will lobby and attract more votes to their cause. Finally, after extensive online deliberations, the core development team will gauge the community, node, and miner sentiment on the BIP and implement changes.
If the community is at loggerheads with the core developer’s decision, they are free to hard fork the protocol and maintain the blockchain protocols as they were before the BIP vote. Consequently, off-chain governance processes give a blockchain’s core development team and its mining network more influence on the future and functioning of a network.
The Ethereum network also leverages an off-chain governance system via its Ethereum improvement proposals (EIPs). Developers will submit EIPs to the Ethereum Github official repository and rope the community into the conversation via social media channels.
How DeFi governance works
DeFi platforms use on-chain governance processes that are hardcoded into their protocols. On-chain governance gives DeFi users the right to vote on protocol changes. Consequently, developers will code DeFi platform proposals into smart contracts. The platform’s blockchain protocols will only execute these modifications when the community ratifies them via a voting process.
The on-chain voting process is only successful when the right number of votes ratify a proposal. Consequently, governance tokens are vital to the on-chain governance process. Furthermore, most governance tokens are ERC-20 tokens because most DeFi protocols are Ethereum Virtual Machine compatible.
To partake in the DeFi on-chain voting system, you must hold governance tokens as collateral or stake them on a platform’s staking protocol. DeFi platforms distribute governance protocols to their users as a reward for their support and use of the platform.
Governance tokens also attract liquidity to a platform and could rise in value when a platform achieves success. The on-chain governance process kicks off with a discussion on community social media and governance forums.
The teams that support the proposal will lobby and convince the governance community of their proposal’s benefits. Next, the proposal will undergo a community review. Afterward, an on-chain voting process will occur.
A proposal is only successful if an adequate number of token holders meets the platform’s minimum voting percentage ratio. Consequently, governance token holders that hold these tokens for speculative purposes place the protocol at risk of on-chain voting process failure or centralization of the voting process.