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Government-Backed Crypto: How Governance Plays a Role in Crypto

Published
September 9, 2021
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    Cryptocurrencies have evolved from a technical thought experiment to a multi-billion dollar asset class. With many different stakeholders (including miners, developers, investors, exchanges, and others), it's challenging to decide who gets to make decisions about everything from simple upgrades to hard forks following a security breach.

    Let's take a look at the role that governance plays in the crypto markets, where government-backed crypto stands right now, and what it all means for investors.

    What Is Governance In Crypto?

    Governance is simply a collection of processes to control an entity. For instance, public companies are controlled by shareholders with voting rights. The Board of Directors is elected by shareholders to approve major transactions and ensure that the company's executives are acting in their best interest — they can even fire executives!

    Cryptocurrencies have relatively little oversight compared to publicly traded companies. Founding teams exert tremendous control over a project's direction. Crypto investors rarely have a say in hard forks or other structural changes that greatly influence the cryptocurrency's value. These dynamics have already led to major crises in some projects.

    For instance, Decentralized Autonomous Organization (DAO) raised $100 million in the ether in less than two days, making it one of the largest crowdfunded projects in history. Hackers breached the DAO and stole about $55 million worth of ether, which led to a very public disagreement of whether to implement a hard or soft fork to recover the losses.

    There are several different possible governance structures for crypto projects:

    User Governance

    Blockchain governance is handled by blockchain users through on-chain votes.

    Corporate Governance

    Blockchain governance is handled by a corporation that controls the blockchain project.

    Regulatory Governance

    Blockchain governance is controlled by a regulatory body (either state-based or industry group).

    Developer Governance

    Blockchain governance is handled by the core developers that don't take outside influence.

    Cartel Governance

    Blockchain governance is handled by the largest participants in the network.

    Many cryptocurrency experts argue that investors should enjoy the same rights as equity holders since they are directly affected by protocol changes in a blockchain. While Ethereum's investors ended up winning a hard fork, the project's founders could have refused to budge and implemented a soft fork with little to no legal repercussions due to lax oversight.

    Existing Governance Systems

    Most crypto projects are aware of these concerns and are actively implementing their own governance systems. Unlike their equity counterparts, most crypto projects could prefer a self-governed system whereby crypto holders could vote through the same decentralized blockchain. The challenge is making these votes approachable for everyday investors.

    For example, Bitcoin is based on a set of rules inherited from Satoshi Nakamoto's original ideas. Any individual can cast a vote on proposals from the core development team or other users, but in order to use the signal mechanism for voting, they must run a full node. In essence, voting is limited to miners rather than accessible to retail investors.

    Crypto Governance

    Dash's Easier to Use Voting System - Source: Dash

    On the other end of the spectrum, Dash CEO Ryan Taylor acknowledges that the cryptocurrency is owned indirectly by the network and therefore management has a fiduciary duty to them. Dash holders can vote on proposals presented by the core development team via Masternodes and Dash Core is answerable to them. Voting participation, however, remains lackluster.

    Crypto investors should carefully consider a cryptocurrency's governance regime when evaluating the project. In cases where they have no vote or a limited vote, they should assess whether there's a risk of the core development team or largest miners taking actions that could adversely impact their holdings. In cases with governance, they should look at how to vote.

    Impact Of Governance & Regulation

    The introduction of effective governance could have a significant impact on the crypto market. New SEC regulations could increase transparency and open the door to greater institutional investment in the space. Many of these investors have been on the sidelines due to the significant risk, volatility, and uncertainty surrounding crypto projects.

    Improved governance could also open the door to initial coin offerings, or ICOs, as a viable way to raise capital. The large number of fraudulent ICOs over the past few years has shaken investor confidence in the space. With the right disclosure and reporting requirements in place, investors may be more comfortable participating in offerings.

    In addition to promoting transparency and investment, governance-related regulations could increase costs for crypto projects and exchanges. Exchanges would need to reach a critical mass before the cost of compliance made it profitable to serve clients, which means that there could be some consolidation in the space with fewer larger players emerging.

    These developments could have a significant impact on crypto investors — both in the exchanges that they use and the investment options available to them. On the whole, the changes could benefit the industry as it continues to mature into a viable alternative asset class for both individual and institutional investors.

    The Bottom Line

    Governance is becoming increasingly important in cryptocurrency markets. Without proper governance, it's easy for a project's core development team or largest miners to take actions that benefit them at the expense of others. These possibilities have led some regulatory bodies, such as the SEC, to look into new rules designed to protect investors.

    Investors should remain abreast of the new government regulations impacting the market, learn about governance protocols for their crypto holdings, and learn how they can participate in crypto votes to ensure that projects act in their best interest.

    If you’re a crypto investor, ZenLedger can help you quickly and accurately file your taxes by aggregating transactions, calculating your cost basis, and autocompleting common IRS forms, such as Form 1040 Schedule D and Form 8949. Try ZenLedger for free!

    Government-Backed Crypto FAQs

    1. Does Bitcoin have government backing?

    Even though it is a medium of exchange, digital currency is not like regular money. Another striking difference is that cryptocurrency is not backed by the government of the U.S. or any other government or central bank. Digital currency is managed and exchanged on computer systems.

    2. Is there any government-backed crypto?

    Cryptocurrency is not backed by the government. The lack of government regulation doesn't undermine its value. This is analogous to gold and precious metals, which determine their value based on their scarcity.
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