Decentralization is part of the cryptocurrency industry’s core, with various protocols trying over time to achieve the level of decentralization that
Decentralization is part of the cryptocurrency industry’s core, with various protocols trying over time to achieve the level of decentralization that Bitcoin (BTC) managed to get as it grew organically from a white paper published to a mailing list to a new asset class.
Decentralized finance (DeFi) protocols have brought the idea of decentralization to a new level with the use of governance tokens, which give holders the right to vote on or submit proposals regarding issues that govern the development and operations of a project. Governance tokens often represent investors’ ownership in decentralized autonomous organizations (DAOs), which operate using smart contracts.
Governance tokens and DAOs are native to layer-1 blockchains that support smart contracts. Often these tokens are bought for investment purposes and kept on centralized trading platforms, which inadvertently gives centralized platforms an outsized power over the protocols they govern.
Last month, cryptocurrency exchange Binance accidentally became the second-largest voting entity by voting power in the DAO behind the largest decentralized exchange, Uniswap. According to Binance’s CEO Changpeng Zhao, an internal Uniswap (UNI) transfer automatically delegated tokens.
Binance later clarified it doesn’t vote with user’s tokens, but the incident highlighted a problem affecting how decentralized protocols maintain decentralization with custodial services being as popular as they are.
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Through its accidental token delegation, Binance could propose governance votes as it had 1.3% of the total supply of UNI, far exceeding the 0.25% threshold. The exchange, however, couldn’t pass votes on its own due to a 4% quorum requirement.
Its influence — if the exchange chose to use it — would have nevertheless been significant.
Sasha Ivanov, founder of blockchain platform Waves, said that potentially centralized control from custody service providers is a “serious issue with decentralized governance,” adding that the “promise of decentralization” is “totally unrealized with a single token governance model.”
To Ivanov, there’s “nothing to stop centralized custody services from exercising their right as token holders,” which means that if Binance wishes, it could “make proposals, vote for them and change the direction of the platform and community.” Ivanov’s solution is a governance model “based on more than just token ownership.”
Speaking to Cointelegraph, Hamzah Khan, head of DeFi at Ethereum scaling solution Polygon, said that it’s important to keep in mind that governance tokens have control over each protocol, with every protocol being different in how control is exercised.
Khan added that UNI tokenholders, for example, cannot make changes to the protocol’s code or control users’ assets but can make other changes, such as deciding fees on an individual liquidity pool basis, for example.
Daniel Oon, head of DeFi at blockchain network Algorand, told Cointelegraph that users usually monitor what centralized platforms are doing with their governance tokens and seek them over a lack of faith in supporting applications, including wallets and poor tokenomic designs.
Per Oon, there are various DeFi governance platforms that “ask their users to read multiple proposals, participate in mandatory voting, do X,Y,Z, and stake their tokens” to receive yield as a reward. He added:
“In face of all of these administrative tasks, the user decides to hand it over to third-party centralized platforms to handle the voting process so that they can obtain some yield ex-fees charged.”
As centralized platforms are known to share generated income with users, the simplified use of governance rewards naturally attracts users to these platforms. This leaves DeFi protocols with the challenge of remaining truly decentralized.
Decentralization as a goal
To Ivanov, the challenge of remaining decentralized isn’t currently achievable with single-token governance systems, as protocols using these can only remain decentralized if their token is also decentralized.
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Ivanov said that the industry is in a phase where “decentralization is very much still a goal and not a reality,” as crypto users must “interact with centralized entities to on-ramp and off-ramp into the decentralized economy.” A change will happen, he said, when “we have real-world payment systems through decentralized services.”
Khan took a different view, saying that DeFi protocol teams need to remain conscious of what specifically can be changed through governance votes, adding:
“As long as the protocol is open-source, permissionless, enables self-custody and has no governance control over user funds or material protocol upgrades that would affect user funds, it remains decentralized.”
Khan added that veTokenomics models used by protocols…
cointelegraph.com