Why Blockchain Governance Matters

by Oliver Goodenough

In 2016, developers of Ethereum, one of the most well-known blockchain technologies, made history by crowdfunding $150 million — the largest crowdfunded figure ever, and completely in Ether — for the Decentralized Autonomous Organization (DAO). They were then promptly hacked. A predator exploited a software flaw in the DAO, successfully misdirecting at least $89 million into improper ownership.

The developers mounted a counterattack, reaching out to their Twitter network, and reclaimed the majority of the funds within hours. While admirable in most people’s eyes, the countermeasures were essentially extra-legal, constituting a “posse” of actors undoing the permanence of the ledger that is supposed to be the core safeguard of a blockchain currency.

It’s a sensational example of the potential dangers inherent in a complex cryptocurrency system without clear governance structures, but there are also day-to-day concerns that impact every participant in blockchain activity.

The Liability of Partnership in Blockchain Transactions

Blockchains in general and cryptocurrencies in particular come in a wide variety of structures and “flavors.” While some have been launched on a proprietary basis and managed centrally through traditional business organization structures, a number — including the highly visible BitCoin and Ethereum coins — exist largely as a loose network of independent operators. The technological infrastructure provides the operational framework, rather than any word-based statement of governance principles or structures.

This organizational looseness could pose a number of significant challenges for participants in such a cryptocurrency. One of the most concerning is the potential for collective liability for the participants — without any of the shielding that would be provided by a corporation or LLC.

Under US law, when a group of people join together to carry on business for profit, they’re presumed to be a partnership. The problem with this result is that a simple partnership creates unlimited mutual liability for all the partners for all the debts of the partnership, as well as unlimited mutual agency for the creation of any liabilities that are sufficiently connected with the business of the partnership.

If the miners and nodes of a cryptocurrency were deemed to be partners in its business — and there are good, although not necessarily conclusive, arguments to suggest they could be — they could face the potential of daunting liability.

Market Concerns Over Lack of Accountability

Other governance concerns have arisen as currencies seek to change their architecture to promote efficiencies in recordation and mining or to change the proof of work approaches for better security.  The authority to make such changes is unclear in any chain without a formal structure of some kind.

The need for better governance has been recognized by many in the field.  It was referenced in the January, 2017 FINRA report Distributed Ledger Technology: Implications of Blockchain for the Securities Industry: “For example, recent events have shown that lack of a central governing body for the evolving Bitcoin Network has created concerns for the network, as participants try to determine an approach to handle increased transaction volume. Therefore, a [distributed ledger technology] network based on the use of a trustless network, where no party is responsible or accountable for the proper operation of the system, may present risks to markets and investors.”

The subject is also getting private sector attention: both the Tezos Foundation and Hyperledger have initiatives aimed at developing improved governance frameworks.

Solving the Blockchain Governance Problem

Like blockchain networks themselves, governance solutions don’t all have to follow the same formats, but most should, at the very least, address certain issues:

  • Provisions that permit the governance to be provided in whole or in part through the technological architecture of the system
  • Provisions assigning the roles of members and managers to participants – nodes, miners, etc
  • Provisions granting limited liability protection to these participants and authorizing the limitation of their agency authority with respect to the system as a whole
  • Provisions granting authority for the kinds of counter-hacks that the Ether system has carried out when under attack
  • Provisions creating governance procedures for innovations and changes in the currency architecture.

The missing link in many of the efforts to date is how to get legal recognition and enforceability for the solutions. While many blockchain protagonists like to think that all the answers can be embedded in the code itself, there are places where traditional law can be usefully invoked. Recognizing the governance gap, the State of Vermont recently passed blockchain legislation that creates a new business organization form — a blockchain-based limited liability company, or BBLLC. This law allows blockchain companies to protect owners, managers and blockchain participants from unwarranted liability by forming BBLLCs.  And it provides blockchain companies an enforceable legal framework to create custom blockchain governance structures that perfectly fit their unique technology and circumstances. It also allows a lot of the structure to be expressed directly in code – the preferred outcome in the blockchain tradition.

While other potential organizing structures also exist, a Vermont BBLLC should be considered as a framing structure for any existing or planned blockchain structure.  Going without a well-crafted solution to these governance concerns is a bit like driving without a seat belt – OK until there is a problem, and then maybe too late to fix.

Additional Resources:

Bramanathan, Reuben et al. A Securities Law Framework for Blockchain Tokens, Dec. 7, 2016. https://www.coinbase.com/legal/securities-law-framework.pdf

Goodenough, Oliver. “Financial Technology Report,” Center for Legal Innovation, Vermont Law School, December, 2017. https://www.vermontlaw.edu/sites/default/files/2017-12/CLI_Legislative_Report_2017.pdf

Hacker, Philipp. “Corporate Governance for Complex Cryptocurrencies” Oxford Business Law Blog, Aug 18, 2017. https://www.law.ox.ac.uk/business-law-blog/blog/2017/08/corporategovernance-complex-cryptocurrencies

Norton Rose Fulbright. “Briefing: Legal analysis of the governed blockchain.” June, 2018. http://www.nortonrosefulbright.com/knowledge/publications/167968/legal-analysis-of-the-governed-blockchain

Reyes, Carla L. “Moving Beyond Bitcoin to an Endogenous Theory of Decentralized Ledger Technology Regulation: An Initial Proposal,” Villanova L. Rev. 61: 191 (2016). https://digitalcommons.law.villanova.edu/vlr/vol61/iss1/5/

Samans, Richard & Krieger, Zvika. “Realizing the Potential of Blockchain: A Multistakeholder Approach to the Stewardship of Blockchain and Cryptocurrencies,”World Economic Forum White Paper, June 2017. http://www3.weforum.org/docs/WEF_Realizing_Potential_Blockchain.pdf