How delegating (aka proxy advisors) will take over blockchain
The general election in America is a pretty big deal. The president has a lot of powers and has a great effect on the global geopolitical landscape. With stakes this high, one would expect voter turnout to be higher than only 50 to 60 percent. If the turnout for the general election is already low, what about the turnout for midterm elections, state referendums, or municipal elections? Voter turnout drops even more. Imagine how low that number will go for corporate governance or those blockchain governance tokens you hold[0].
TLDR: people don’t really vote.
In the world of corporate governance, small shareholders don’t vote at all, while large institutional investors outsource their voting to professionals known as proxy advisors[1]. A similar phenomenon is occurring in dPoS blockchains, where token holders delegate to staking pools.
Governance Across Crypto Networks Are Inconsistent
The ethos of a decentralized network is the lack of central powers that have unilateral control. This generally manifests in a system where various stakeholders have some order of influence on the development and operation of a protocol. They can range from token holders to masternodes, core developers to ecosystem participants (miners, exchanges, etc) — in general, a diverse group. But depending on the protocol, only a subset of stakeholders may have tangible power. And to create a quantifiable Schelling point, some protocols only allow token holders governance rights.
Each protocol has a slightly different governance process, different norms and traditions that must be understood. And these processes are not static — the Ethereum EIP process has changed over the years. Even if we focus exclusively on token-based voting and ignore custody and key management, the voting process is inconsistent. For MKR holders, tokens must be locked up in the voting contract. In Decred, one must either create or buy tickets to cast. In PoS, protocol tokens have to be locked up for a certain number of blocks before votes can be accepted, along with an unbonding period before one can switch delegators. And what about those pesky precatory (nonbinding) resolutions and nonbinary votes?
Governance Impacts Are Difficult to Quantify
On the approachable end of governance, Dash has a treasury fund where masternodes vote on various proposals which are generally marketing related. The topics themselves are understandable to a nontechnical audience and a “bad” vote has a low impact on the protocol itself.
Conversely, there are technical governance proposals whose impacts are significantly harder to reason about — what should the updated Dai savings rate be in MakerDAO, 0 or 1 or 1.75 or 8 or anything in between? The cost of a bad outcome can destabilize and bring down an entire ecosystem. Higher interest rates are great for Dai holders, but at what price? What metrics should one optimize for, are there KPIs? What about considering users who don’t have governance rights?
Governance Has a Meta Game
Once one knows how to vote and what to vote for in particular, how should one deploy their political capital? If you only have a trivial percentage of votes, this does not matter. But if you are a large tokenholder with limited political capital one must be careful on how they play their hand.
Back to the Makerdao example. Should a MKR holder signal their intent by submitting a “polling vote”, which is nonbinding? If so, should it be done at the beginning of the polling period or at the end or should they only participate in the executive vote? For Cosmos / Tezos should one take a passive or active role in governance, should one only vote on proposals as they come or should they draft and code and submit their own proposals? Should one submit their proposal immediately or wait all the existing proposals have been wrapped up in hopes that the community will be more focused next governance epoch? But how strong will one’s political capital be after the current voting period? Or how much voting power will one’s supporters have as delegators may have reallocated their tokens? There’s a voting meta game that exists beyond the governance outcomes themselves and one must play their cards carefully in protocol governance realpolitik.
Proxy Advisors Job is to Focus on Governance
Most token holders are passive, they are simply holding the token for yield and staking to prevent loss from inflation. And if they’ve been constructing a portfolio of assets that maximizes their return for a given level of risk, presumably there is more than just one asset. Juggling various governance schedules and proposals for each protocol consumes a nontrivial amount of time. People are busy, even if portfolio management is their full-time job.
In the equities world, index funds and mutual funds both manage portfolios with thousands of equities, why would they care about the governance of a small cap stock that is only 0.06% of their portfolio even if they are a major shareholder? This market need has been filled by proxy advisor firms who are paid to spend their entire existence evaluating and voting on governance proposals on their clients’ behalf. All the client needs to do is set some voting preferences such as pro ESG and pro diverse boards then disappear.
Cryptonetworks need these actors to fill the governance gap. Granted yes one has to pay them, which is already the case in staking. So wouldn’t it be nice to tell a proxy advisor to focus on scalability for one protocol and block xyz collateral types for a stablecoin? Or even have them be proactive and draft proposals and implement code and an actuarial risk assessment too[2]? They can handle all the intricacies of blockchain governance, keep track of emergent politics and allegiances…
Token Holders are Delegating Power Now
Although it is uncommon to use independent[3] proxy advisors for dApps, delegating in dPoS and PoS system is the status quo[4]. In those protocols, the top stakers (by total stake) can actively participate in consensus and governance. In order to be a top staker, one must either be a large token holder or have other token holders delegate to them. If you are delegating their tokens to a staking pool, they are using a proxy advisor. Or if your tokens are in Coinbase these days or any exchange that stakes on your behalf.
These staking as a service providers are making governance decisions on your behalf. The question is do they have your best interest at heart? They don’t have a fiduciary duty to you, and you probably based on a mix of convenience and fees (particularly in protocols where delegators can’t get slashed). The next time you stake, try to understand what your staking provider’s stance on particular governance subjects are. There are staking providers who have specific agendas, such as promoting privacy tech. It would be unfortunate to indirectly support a proposal that you are against, especially if votes cannot be individually recast (in the case of Tezos). Or if your hashpower was supporting a fork you personally disliked (unless one is optimizing purely for profits then it might not matter à la Nicehash).
The Future is More Delegation
Proxy advisors traditional perform the process of voting on behalf of their clients, however in the cryptoverse keys cannot just be handed over as the advisor may run off with your funds. In order to safely delegate onchain, the voting mechanism must be independent of the spending mechanism[5]. dPoS and PoS protocols generally have these features built-in[6]. But for dApps, there has to be more infrastructure created, in the status quo large MKR holders don’t vote because have to move their tokens out of cold storage to the voting contract. Whether the solution is SGX, MPC or some smart contract, infrastructure has to be created to separate voting from spending[7]. With that welcome the future of more centralized and institutionalized governance.
Fun Thoughts
- Another way to think about proxy advisors is institutionalized liquid democracy (something DFINITY is working on)
- Yi Sun noted: Governance controls can be subdivided into two categories: controlling external assets (e.g. Ether locked in a smart contract) vs controlling only internal assets (e.g. Ethereum inflation rewards). This can lead to unexpected outcomes for the parent protocol. If the expectation that only n% of Ethers are in circulation because of staking and DeFi and all of a sudden circulation has increased dramatically — what happens?
- What happens to governance if your tokens are in a tokenset or a comparable contract.
- When will a protocol implement tenured voting? Though there are clever workaround here.
- Will exchanges allow their users to vote with their deposited tokens that are staked?
- If you’re lending out a token and there is a dividend, what happens? (the default is not what happens in the equities world)
- What kind of damage can a rogue proxy advisor cause? Along with the recourse mechanisms that protocols will build to counteract this threat (e.g. an exit game: MakerDAO emergency shutdown or REP universal fork)
- If one is delegating their governance tokens are work tokens and DAO tokens are up next?
- What would happen if there are multiple types tokens with varying voting powers? Like Google class B which has 10x the voting rights as Google class A. (There’s also a class C share that has no voting rights, oddly there is a sub 1% premium for class A over class B, implying shareholders don’t value governance). Or perhaps variable voting rights based on the size of the staking pool, forcing delegators to trade-governance rights for fee optimization (credits to Tarun).
- What if the largest staking providers collude to have a developer fund pay out to their own addresses as a dividend, or more politically tenable — to a burn address?
- Proxy advisors are getting new regulation in the corporate world
Footnotes
0. I should have clarified this is intended towards retail investors voting for both blockchains and corporate governance. Most corporate shareholders are dominated by institutional investors who do vote (albeit through proxy advisor firms) and voter turnout is greater than the US elections.
- Proxy advisors submit proxy votes on behalf of their clients. The votes themselves are submitted by proxy as historically shareholders (even large ones) did not want to physically attend the annual general meeting. Some public companies don’t even have in person AGMs.
- Tarun from Gauntlet noted how an actuarial risk assessment is desirable
- Protocols / dApps have foundations who often make professional risk / governance suggestions to the community which are generally accepted by voters, however they are not an independent third party.
- Yes before this there were mining pools but the connection between allocating hash power and a pool supporting a specific fork is not as strong as say token based voting.
- On some levels this is at odds with “Dark DAOs”, by creating this separation it also makes it easier for vote buying to occur. It would be interesting to see protocols implementing systems to make delegation more difficult through “complete knowledge proofs” or other forms of coercion resistance. This is important as it proves a key holder has complete control over their key and that a briber does not have partial control over the key (e.g. the ability to sign votes but not transfer funds).
- Sans bond pooling in Tezos where the delegator gives complete control of their tokens to the staker. Tezos also has conventional pooling.
- Or more simply, dApps can have a special voting key that is derived from the private key.
Special thanks to Tarun Chitra, Matteo Leibowitz, Yi Sun, Dev Ojha, Yi Sun, and Jon Kol for helpful feedback, comments, and insights.
