Web3 and the Promise of Decentralized Governance

Philosophers and political scientists have long debated the challenge of balanced and sustainable governance. The problem of collective action or preference coordination has kept power sharing limited. For most of recorded history, humanity has been compelled to choose between chaos and tyranny, with power usually concentrated within a relatively small group led by a single dictator. Perhaps surprisingly, political scientists tell us that “bad behavior is almost always good politics,” meaning that dictators who hoard resources and dole them out lavishly to a small cadre of loyal leaders tend to maintain their hold on power better than those who attempt to distribute resources more equitably across a larger number of constituents. This is because resource distribution gets exponentially messier as the number of beneficiaries grows.

Another term used to describe this problem is the tragedy of the commons. As scarce resources are shared between more and more people, it becomes more and more difficult to coordinate them fairly. Inevitably, one person or group of persons begins to take more than their fair share of resources. Others react in kind, and before you know it, the resource has been ruined for everyone.

Traditionally, centralized authorities have been relied upon to govern these scarce resources, carefully apportioning them to those in positions of privilege or power, or those who seem especially deserving. Thomas Hobbes appealed to the necessity of a powerful central authority, a “Leviathan” that was so awe-inspiring and intimidating that nobody would dare to provoke its wrath. Without the pacifying power of the Leviathan, according to Hobbes, life would be “nasty, brutish, and short.” Tribalism and chaos would prevail, because no faction would be sufficiently powerful to prevent others from trying their luck at conquest.

More recently, representative democracy has begun to gain favor over other more autocratic forms of government. The founders of the American nation relied on the technologies of paper ballots, original and periodic consent, representation, and various checks and balances to distribute power more equitably and keep it in balance. This improved preference coordination but it still demanded significant compromises between expeditious execution and broad consensus gathering. The technologies used for democratic governance haven’t undergone significant upgrades since the American experiment nearly 250 years ago.

New technologies threaten the balance of power. Technological breakthroughs are often accompanied by gold-rush periods where well-capitalized interests quickly drive out other contenders and dominate the competitive landscape. The advent of the public Internet has been no different. Many people have likened the Internet to the invention of the printing press, and it has been accompanied by similar levels of social transformation.

For a while now, we’ve been hearing the term “Web 2.0.” This leaves many people wondering, “What was Web 1.0?” That’s a period most of us forget, but it was basically the days when people who wanted to post content online had to run their own server. If we’ve learned anything since the Internet got started, it’s that people really don’t like to run their own servers. Web 2.0 made it possible for everyday Internet users to post content online without having to run a server. Social media platforms allowed people to share their opinions, or maybe just what they had for breakfast, to the entire world. While many older folks initially wondered why anyone would want to share their personal thoughts, experiences and opinions online, it caught on rather quickly.

But as these platforms have grown in popularity, they’ve gained tremendous control over the flow of information, including control over advertising markets and revenues, over access to news and entertainment, and even influence over the outcome of elections, conflicts between nations and ethnic groups, as well as matters of public health. Value has been captured by these powerful interests and used in ways that are detrimental to the common welfare.

Part of the reason for this is that the protocols of the Internet were not built with monetization in mind, so any value that someone wants to receive for services must be extracted at higher layers of abstraction. If I’m a search engine like Google, for example, I need to build and maintain a lot of servers, networks and software to collect revenue. It’s in my interest to keep people using my services and not others, and to prevent interoperability between my services and those of other competitors. Strengthening them weakens me, and vice versa.

During the last decade, blockchain technology has started to change this dynamic. Rather than relying on centralized servers operated by large companies, blockchains contain shared ledger data running on peer-to-peer networks consisting of many different computer nodes, each of which is operated independently, by both individuals and corporations. If one node goes down, there are still thousands more to replicate the data. Each node can independently verify the integrity of the blockchain ledger with cryptography, and is incentivized to participate in the creation of new pages or “blocks” in the blockchain ledger through monetary rewards. Applications based on these blockchain protocols are often referred to as Web3 applications.

The first blockchain use case was cryptocurrencies. Like cash, cryptocurrencies are bearer instruments that grant direct access to wealth to anyone with access to the corresponding wallet’s private key. Other methods of value transfer, like credit cards and bank accounts, rely on the intermediation of a financial institution that can block access to funds at any time, as we’ve recently seen in Canada.

In addition to tracking debits and credits between users like Bitcoin does, modern blockchains also support storing the state of various operations in memory and executing arbitrarily complex business logic, called “smart contracts.” These blockchains effectively become global computers with an extremely high level of security because their transaction logs can be verified with cryptography. (The notion of cryptographic verifiability is important, because it provides the highest levels of assurance currently known to humanity of the authenticity of a claim or logged event.) Even though the transaction rates on a blockchain are relatively low when compared with an individual computer working in isolation, they enable complex financial transactions and other business logic to be verified by all stakeholders and executed more quickly than present-day alternatives. Scaling up the nominal case and allowing many more legal contracts to be executed successfully is where blockchains really shine. Contractual disputes may occasionally still need to be resolved in court, but trivializing the nominal case is a game-changer.

Take the simple case of a wire transfer. To do that today, you need to call your bank or log into their web site and request the transfer. Several hours later, the bank will call you back and ask some security questions to verify that you actually wanted to transfer this money. Then the wire goes out a few hours later in the next batch of transfers. The receiving bank must also acknowledge the receipt and credit the account of the intended recipient. The typical turnaround time is a business day. Compare this with sending cryptocurrency from your private wallet. The entire transaction is complete and confirmed in ten minutes or less, and it reaches the recipient’s wallet directly, not their bank account.

Note that in both cases, the transactions are irreversible. Wire transfers cannot be clawed back. Some have complained that mistakes with cryptocurrency can be more catastrophic, and in some cases they certainly can be. We are only beginning to develop robust solutions around key custody that balance recoverability with self sovereignty. But in many cases, the systems they are replacing are not any better. If the irreversibility of a crypto transfer is insufficient for a certain use case, a simple smart contract can be devised to hold funds in escrow while both parties confirm that their conditions have been met.

Cryptocurrencies were the first use case for blockchain, but there are many others. More recently, non-fungible tokens or NFTs have captured the public imagination. The reason they’re called non-fungible, as opposed to fungible, is that NFTs contain specific information about a unique digital asset that is different from all others. If the NFT was minted appropriately, the wallet holder can cryptographically prove that they own the digital assets it describes.

Till now, NFTs have mostly been used for art and other collectibles, but they have many other practical use cases, including domain name registrations, streaming media purchases and rentals, and ownership of both physical and digital assets, including fractional real estate. NFTs can also ensure that content creators are properly paid their fair share of royalties in real time whenever someone consumes their content.

In addition to value transfers and tracking assets, blockchains are being used to provide decentralized financial services, or DeFi, including token trading, bonds, borrowing, lending, options, futures and derivatives. All of these services are being rendered without brokerages, banks or other intermediaries. The rules governing these complex financial services are encoded in smart contracts and executed on the blockchain for all stakeholders to observe in real time. Properly coded business logic ensures that transactions occur as expected without the possibility of human error.

Of course, these services present new risks, such as contract risk, which occurs when hackers exploit a previously undiscovered bug in a smart contract that allows them to steal funds from the contract’s treasury. New services are emerging to insure against such risks, and contracts that have proved their security through long experience become trusted over time.

Despite all these risks, many DeFi projects have been highly successful, as demonstrated by the explosive growth of the space over the past two years. Many DeFi services offer more favorable interest rates than their traditional counterparts, and many of them are structured in a way where much larger percentages of the rewards are shared with users. In general, the value captured by project contributors in DeFi is roughly ten times less than what you could expect from a typical firm on Wall Street or Canary Wharf.

These applications are only the beginning. In addition to the decentralized settlement layer provided by blockchains, decentralized alternatives are being developed for all the other layers that current centralized applications need to run properly, including decentralized file storage, decentralized databases, and decentralized computing services. Eventually, because they are running on self-healing peer-to-peer networks that route around failures, our applications will be running everywhere, and nowhere.

Rather than creating walled gardens where participation in one ecosystem detracts from another, decentralized apps, or dapps, are permissionless and composable. Anyone who wants to can access them without intermediaries, and their data can be combined to create other services. Unlike in Web 2.0, where interacting in one platform detracts from other platforms, in Web3, each successful project makes the network more valuable.

These technologies raise the possibility of restoring power to individuals and communities through disintermediation, that is, by “eliminating the middleman” from various current ecosystems and allowing them to be governed democratically, including financial services, social media, sharing economy platforms, media and entertainment. Imagine Facebook, Twitter, AirBnB, Uber, Netflix etc. but without the corporate structures behind them. In their place, decentralized autonomous organizations or DAOs that are governed by project contributors and users. Streamlined “high-touch” democracy allows project stakeholders to vote easily on project initiatives and other decisions.

This is a new frontier, and DAO management strategies and voting protocols are rapidly evolving. Simple one-person one-vote strategies are difficult to implement, because it is easy to duplicate crypto wallets to get extra votes. Requiring wallets to prove personhood can improve this, but often at the expense of stakeholder privacy. That said, blockchain privacy features are also rapidly improving.

Beyond merely replacing the web services we currently use, DAOs are being organized with even more ambitious goals. According to the founders of AllianceDAO, four emerging megatrends are converging that will lead to DAOs becoming digital nations:

1. The Digitization of Everything. Every aspect of life from work to social life is going online, but more importantly, the world of bits has been driving innovations throughout the world of atoms. Robotics, energy, biotech, space, and many other fields are all undergoing a renaissance thanks to decades of rapid advances in computing.
2. Decentralization of Global Superpowers. The U.S. has been gradually losing influence as the enforcer of global order. The European Union is far less united after Brexit. China’s values are fundamentally incompatible with the West so it isn’t capable or willing to assume the role of world police either. This has created a vacuum that no single nation state can fill.
3. The Fourth Turning. We’ve entered an era of great internal division between the establishment and commoners, between progressives and conservatives, between boomers and millennials, between the wealthy and the poor, and between capitalists and socialists. Ordinary people become increasingly frustrated with these societal issues, yet the vast majority cannot choose the society, government, and country they belong to⁠—they are born into them.
4. Rise of Web3. Thanks to Satoshi and all the other giants we are standing upon, a new technology has arrived and gifted us the ability to implement property rights via encryption, constitution and laws via smart contracts, taxation via token issuance, transparent policymaking via an open ledger, and international trade via DeFi.

DAOs sit at the intersection of all these megatrends. They will prove to be the first primarily digital, transnational, frictionlessly opt-in opt-out, blockchain-enabled nation states.

Already, DAOs have been created with the goal of acquiring physical assets, including land. Some projects, like CityDAO and Praxis Society, are raising funds to acquire land on which they intend eventually to build charter cities that are managed and governed more transparently using the technologies I’ve mentioned.

It has been transformative for me personally to be involved in this space. As I’ve developed blockchain protocols with my colleagues and attempted to create the necessary checks and balances for them to operate autonomously, I’ve often felt like I was witnessing a sort of constitutional convention similar to what the founders of our nation experienced when they debated how best to craft laws and achieve a separation of powers. While it is still early days and there is still much work to be done, I find hope and inspiration in the many useful applications that are being developed, and continue to believe in the possibility of developing systems that can help us to govern more effectively and to come closer to building better communities.