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How Can Decentralized Networks Make Better Decisions?

June 17, 2022
Minute Read Time

In this article, we explore the way decisions currently get made and how NovaFinance are looking to tackle Governance within our protocol.

A short intro on governance in DeFi

In the last few years, Blockchain technology has made sound advancements in operational consensus from tried and trusted Proof-of-Work (POW) systems like Bitcoin and ETH1 to more experimental Proof-of-Stake (POS) protocols like Algorand and Cardano. 

However, decentralized networks have taken a big turn in recent times with the emergence of DeFi and this has exposed a lack of advancement in another type of consensus: Directional Consensus.

Previously, forums and improvement protocols served well, especially on primary layer solutions. Communities were niche and development was executed through volunteering or institutions supporting core developers. Until the rise of ICO’s, decentralized networks having a “budget” wasn’t particularly commonplace. 

Nowadays DeFi protocols not only have budgets but a means of consistently generating resources through fees and other initiatives. It's clear that those funds should be used for advancing the protocol but how exactly should those decisions be made?

Asset Based Voting

The most common way of voting within DeFi is by utilising token ownership to weight opinions. 

This model is straightforward and generally works well for relatively simple decision making. It ensures that participants with stakes in the network, often achieved through investing capital, have the largest say and influence in the future of the network.

There are some challenges within this model which, when making more complex and interconnected decisions, could lead to risk of protocol endangerment if the wrong or low quality decisions are made:

  • Voter Turnout

Voting rarely exceeds a turnout of 10% of supply for proposals. This means that a very small group in most ecosystems are directing decisions. One of the most famous examples is the Ethereum Carbon Vote in 2016 on DAO bailout proceedings which received less than a 5% turnout for a very critical event in Ethereums history. 

Voting has become more accessible in recent times with web3 wallets assisting with direct engagement and DeFi platforms like yearn and curve designing governance to be within the direct user experience flow throughout the protocol. Perhaps these advancements will increase voter turnout and allow protocols to maker higher quality decisions with a more diverse set of opinions in the future. 

  • Wealth bias

Often, those who get the largest influence in asset based voting are those who have invested the most value in to the platform. This seems fair as they have the most to lose if a protocol fails. But there are 2 examples here that show how this kind of bias can hinder a protocol in the long term.

1. In blockchain, wealthy often means you got there first

Yearn finance launched out of the blue in 2020 with a yield opportunity which had a 1 week YFI distribution model. Those who were lucky enough to hear about it and try it out, got the majority of YFI tokens either for free via yield incentives or purchased at significantly lower prices than the asset is worth today ($30,000+ at the time of writing). Crucially, those who accumulated tokens early on voted to cap supply at that initial distribution and left Yearn in a limited position for incentives and developer resources for many months (until the 6,666 dev fund got approved recently). 

2. The wealthy don’t always know whats best

In March 2020 as the Covid-19 pandemic hit full stride, Cryptocurrency seen one of the largest daily declines ever seen as -70% was seen across the board. This led to a landslide of liquidations within Maker’s DAI protocol. The liquidation engine was unable to keep up and at some points, sold ETH for zero DAI. The platform was under-collatoralized and CDP owners collectively lost over $4.5m worth of value. In the aftermath, MKR holders voted on chain not to reimburse these CDP owners despite many community polls showing overwhelming support for reimbursement. While governance is entitled to make these decisions, this really highlights how contrasting different areas of a community’s opinions and incentives can be and also how wealth bias can overrule valid opinions and a majority.

Quadratic Voting

Quadratic voting is the idea of structuring a decision not as a binary yes or no, but as a scale on how much you agree or disagree with various aspects. These are common place in the mainstream with personality tests, feedback sheets and even political systems. Quadratic Voting hasn’t had much adoption in the crypto space but the little utilization it has received has flown under the radar.

Many will not realize but Gitcoin Grants, a popular developer hub for funding blockchain development, operate under this model where donations given are given bonuses or match funding from institutions based on what the community allocates thier funds to. 

While this model works really well for funding in the blockchain space, it's hard to effectively replicate this in other aspects because of the natural incentives and participation rules that users donating money and match funding sets up. 

Most users of DeFi protocols are not willing nor need to pay money for a decision to be made. Without any kind of personal consequence, the decisions an average person makes can have varying degrees of quality and thought behind them.

If you want to explore quadratic voting further, Vitalik wrote a great in depth article on his personal blog in 2019.

A new idea: Meritocratic Voting

The NovaFi team have been interested in merit based decision making for a few years and have been trialling experiments and decision making processes around this idealogy during this time. We believe that aligning decisions with values creates higher quality decision making and should in turn, allow the Nova protocol to make better and progressive decisions and actions.

In a nutshell, meritocractic voting is the idea that decisions that are in strong alignment with the networks values will be the most rewarded and prioritized.  Essentially, values are the thing that the participants care about achieving and maintaining over time. For example, prosperity is the success in generating value through action and sustainability is the success in doing an action in a way that brings stability and longevity. This might seem a little abstract but the examples below should make the practicalities clearer and also highlight few interesting benefits: 

  • Voter alignment

If a participant votes highly in values that suggest prosperity but low on values around sustainability. It suggests that the user cares more about prosperity in the shorter term. If everyone within the meritocracy cares about prosperity over sustainability, that is perfectly fine. However if the participant is one of the few to vote this way, it shows that they are not aligned with the common values of the meritocracy and their vote is potentially worth less.

  • Voter Understanding

Similarly, if a proposal was made that meant prosperity would happen but that sustainability would not, a participant that votes high on both values suggests they do not understand the consequence of the proposal. These votes could be weighted less compared to votes that shows a greater understanding of the consequence of the proposal.

  • Prioritization of action

All successful proposals will gather a score from the collective participants based on all the common values. Some may score higher than others. If we know what values are most important to the protocol, we can prioritize action based on what is most important. 

Alongside these ideas, we’ve also got some mechanisms to increase voter participation and remove wealth bias from decision making. We’re excited to share our meritocratic voting system in the coming weeks and how it can be used once the platform and Nova token has been deployed and distributed.

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