Blog: Towards blockchain 3.0 – Codifying Ostrom principles on blockchain to end the tragedy of the commons.
This blog is concerned with utilising blockchain technology to codify commons governance design principles for the purpose of operating scalable and efficient peer to peer businesses as decentralized autonomous organizations (DAO). In the course of investigation, it utilizes Ostrom principles as a means of analyzing existing blockchains, identifies gaps in the current platforms capabilities and proposes a potential path to resolve these.
The world has enjoyed an explosion of wealth over the last 200 years that has been largely driven by the rise of corporations who can better scale than the preceding predominant business models. The corporation’s fractional ownership model allows capital to be raised for large scale projects that governments, sole proprietors and commons business model cannot afford and this scaling better enables the development of specialized skills and provides economic efficiencies. Complex projects, high skills and cheaper products are significant factors in our societies wealth.
Along with an inability to scale and thus a comparative lack of production of these factors, both commons business models such, as co-operatives, have struggled to produce the same levels of wealth as corporations. This is due to the usual situation where individuals acting independently and according to their own short term self-interest, behave contrary to the common good of all users including their own. Hardin termed this phenomenon “the tragedy of the commons”(Hardin 1968).
Despite some clear social and economic benefits of commons businesses, including shared risks, reduced operating expenses, and more engaged stakeholders (Leathers 2006), conventional wisdom says that avoiding the tragedy of the commons and achieving economies of scale is best achieved through corporations that hold private property rights (Hardin 1968).
When combined, two relatively recent developments challenge this wisdom and provide the potential to drive mass human abundance at the same level as have corporations and stock markets over the last 200 years.
- In 2009, Ostrom won the Nobel Prize in economics for demonstrating that the tragedy of the commons does not need to occur if eight principles or rules are present in the design of the governance of a shared resource (Wilson, Ostrom et al. 2013).
- In 2008 Satoshi Nakamoto invented the cryptocurrency bitcoin and its primary innovation, blockchain technology.
Blockchain allows cooperative production whilst economically incentivizing participants to enforce scalable decentralized governance. Blockchains require no central source of trust as rules are embedded in smart contracts that are cryptographically and economically secured(Davidson, De Filippi et al. 2018).
Blockchain allows Ostrom principles to scale beyond the limits of human personal relationships, enabling the creation and operation of efficient DAOs that bypass todays rent taking institutions and redistribute the rewards of economic efficiencies to those who use its services.
The crypto economy or analogue economy
In considering the mechanisms used to ensure the design of a DAO includes Ostrom principles it is important to consider whether the DAO will operate primarily within the crypto economy of if it will have significant interfaces with the analogue (traditional) economy. Interfaces with the analogue economy introduce significant complexity into the design of DAOs and ensuring these also incorporate Ostrom principles is challenging. Scott theorized of a DAO where “a city network of informal street vendors run a collective mutual insurance pool between themselves using only their smartphones to interact with a distributed ledger system, with no central financial institution involved” (Scott 2016). This theoretical DAO would require a mechanism of knowing when an insurable event has occurred and arguably this interface would also need to be aligned with Ostrom’s rules for the entire DAO to be aligned and ultimately successful. Without this, members could game the system for their own benefit. In comparison, subjective operational inputs into bitcoin are restricted to only those that can affect the member that provides the input and as such non alignment of these interfaces with Ostrom’s rules does not affect the overall alignment or success of bitcoin. As a largely self-contained ecosystem, the design of bitcoin only needs to be concerned with itself.
DAOs that are programed within the fabric layer of blockchains are often categorized as Blockchain 1.0 platforms and these are primarily focused on being a form of money. Bitcoin, the most famous DAO is a unique standalone blockchain 1.0 platform that operates primarily within the crypto economy and has limited ability to host other applications. It is the most successful DAO thus far.
When viewed through the prism of Ostrom rules, the reasons for its success and its challenges become apparent. Bitcoins limited use case as money that is primarily used within the crypto economy requires a relatively simple design to achieve a large degree of alignment with Ostrom rules and this arguably is a significant reason for its success. However, Ostrom rules also reveal two primary gaps present within its design.
- Bitcoin lacks specific features that some members require, such as price stability and privacy have driven members to become members of other blockchain communities that better meet their needs, such as Ethereum, or remain outside the crypto economy.
- Bitcoin lacks a structured governance mechanism and this has prevented the bitcoin blockchain from evolving to meet the needs of a larger group of members and better meet the needs of existing members.
The following table demonstrates the mapping of bitcoins design with Ostrom rules.
The Bitcoins communities’ response has been to argue that some specific features that members have requested may conflict with each other or conflict with existing desirable characteristics of bitcoin. As such they are introducing new features via separate systems including other tightly integrated blockchains (side chains) and tightly integrated non blockchain peer to peer applications such as the lightning network.
Although these developments have not yet achieved production status and as such it is difficult to determine if they are the most appropriate response, adding these features outside the blockchain prevents them from being a threat to the design principles that bitcoin is currently aligned with. However, it is also arguable that bitcoins unstructured meritocratic governance model does not allow features that could achieve similar or supporting outcomes to be implemented on the blockchain and therefore the best outcome for bitcoin members may not have be achieved. Even if these changes are in bitcoins best interest, it is difficult to escape the conclusion that if Bitcoin does not implement governance mechanisms that are aligned with Ostrom’s principles that future changes or lack of changes will not be the best outcome for the bitcoin ecosystem.
Of course this doesn’t mean that Bitcoin will fail or disappear, rather the addition of off chain technologies that do not jeopardize its current alignment with the rules may better meet and protect its purpose as money. Members seeking additional features will likely also become members of other DAOs. Potentially, DAOs that have other purposes (including providing specific Ostrom aligned services) would operate on alternate blockchains and interface with the Bitcoin network utilizing cross blockchain technology, which the aforementioned side chains and lightning networks are potentially capable of supporting. However, as bitcoin was never designed to support side chains and it would require significant changes at a protocol level for it to do so in an efficient and seamless way and Bitcoins governance model is unsupportive of changes, this possibility seems unlikely.
Ethereum is a unique standalone blockchain 2.0 platform which currently operates mostly within the crypto economy, does intend to have a presence within the analogue economy and is the second most successful DAO thus far. The primary difference between bitcoin and Ethereum is that Ethereum can host applications including other DAOs on its blockchain.
As a DAO, the Ethereum alignment with Ostrom’s rules is similar to bitcoin. It has better programmability, a slightly more structured but also more centralized governance model and has higher price volatility. The Ethereum roadmap also includes features that will solve security, scalability and privacy issues if successfully implemented. However, it is arguable that these differences in themselves are insufficient for Ethereum to replace bitcoin as the predominant blockchain platform unless they also enable DAOs hosted on Ethereum to be better aligned with Ostrom’s rules. As such we will look at DAOs hosted on Ethereum to see the level of alignment that each can have with Ostrom rules.
A significant challenge for the Ethereum model is complexity which must be solved at the user interface layer. Users must pay the DAO and Serving Dapp(s) with unique token(s), Dapps must pay other Dapps with their tokens, and all must pay the Ethereum network with eth cryptocurrency for processing any request. This is a non-trivial friction between new members and DAOs operating on Ethereum and it also creates significant problems in creating DAOs on Ethereum in the first place. Although it is possible DAOs could call upon decentralized exchanges operating on the Ethereum network to purchase all the tokens required for a user to interact with it, it is arguable that the price volatility of tokens will cause unacceptable uncertainty for potential users.
Of even greater concern for the Ethereum model is that the Dapps providing services to DAOs may not in themselves be optimally aligned with Ostrom rules. For instance, a Dapp that provides identity type services to a DAO, is in itself a DAO and therefore must be compliant with Ostom rules to be successful. The Ethereum model for funding the development of such a Dapp is to purchase its tokens in exchange for Ethereum using a scheme called an initial coin offering (ICO). Most ICOs that have occurred thus far have failed to comply with securities laws, and thus have failed to comply with Ostroms rule that requires them to be respected by outside authorities.
Although it is possible these problems may be solved it is arguable that the sum of Ethereum, supporting Ethereum Dapps and our desired DAOs nonaligned with Ostroms rules may be too great for a DAO to succeed on Ethereum. Indeed, authors argue that blockchain platforms currently lack the ability to build trust outside themselves (Hawlitschek, Notheisen et al. 2018).
Towards Blockchain 3.0
An alternate approach that arguably overcomes the Ethereum models constraints and which will allow the successful development and operation of DAO is a blockchain which:
- Has a structured decentralized approach to its own governance.
- Provides functions within a blockchains fabric layer that both inherit the underlying blockchains compliance with Ostrom rules and allows hosted DAOs to comply with Ostrom rules.
- Utilizes a single currency for interactions with Dapps and DAOs.
At first glance it appears that only structured decentralized governance is required to be implemented initially as arguably it can be used to select and implement mechanisms that meet the other requirements. However, this assumes that the other requirements are not a dependency for successful structured decentralized governance.
The EOS blockchain, launched in May 2018 attempts to solve the governance problem by using a form of representative democracy that is coded within its blockchain. EOS members hold voting and block validation (mining) rights that are proportional to the amount of EOS cryptocurrency they hold. Delegates compete for these rights by returning a portion of the rewards the EOS blockchain provides for validating and producing blocks. The 21 delegates who attract the most rights are elected as the member representatives. Quoting a blog post from last year (Ehrsam 2017):
Vitalik Buterin, the co-creator of Ethereum, in his 2018 blog (Buterin 2018) criticized the EOS governance model, stating that the EOS model of using economic incentives to buy votes is bribery. He argued that bribery will ultimately either lead to cartels or a single entity controlling EOS, a prophecy that is becoming true at the time of writing this blog(Trustnodes.com 2018). Both of the Vitalik predicted scenarios can be considered a centralized form of governance, that require members of EOS to trust that the controllers will act in their best interests. As these controllers are unregulated and have no long term history, it is arguable that not only has EOS’s attempt at on chain governance created a situation which undermines the primary value of blockchain technology – the removal of the need to trust an intermediate third party – it actually creates a higher level of risk for its members than if they were to use their existing institutions. When viewed through the prism of Ostrom rules, EOS’s governance fails to comply with all but two of her rules and it is therefore unlikely that EOS will succeed as a DAO. EOS appears consigned to compete with cloud platforms such as Amazon Web Services (AWS) as an applications hosting platform.
Although Vitalik is critical of the EOS governance model, he has opinionated that other on chain governance models may be successful and and has hypothesized about using a concept called futarchy as a means of governing Ethereum (Buterin 2014). Robin Hanson created this concept as a means of improving democracy from his observations that predictions (betting) markets are consistently better at analyzing information and predicting outcomes than experts. He proposed a model where communities vote on what they actually want and prediction markets then decide how to best obtain the desired results. He describes it as a model where people “vote on values and bet on beliefs”(HANSON 2013).
The Tezos blockchain, launched in September 2018, has implemented liquid democratic governance within the fabric layer of its blockchain. Unlike EOS, Tezos has a permissionless delegate market that supports a theoretical maximum of 70000 delegates (EOS has 21) and a more dispersed ownership of tokens. By providing members with a greater choice of delegates, including themselves, Tezos avoids the formation of cartels and obtains better compliance with Ostrom rules. However, when viewed through the prism of Ostrom rules, Tezos needs to do more than merely avoiding the EOS design flaw to successfully support the formation and operation of DAOs that that interface into the analogue economy. Also, to ensure its own success as a DAO, Tezos must also overcome the gaps that bitcoin has by providing the features that current and potential members require. Additionally, it must overcome the Ethereum design issues and provide the services that DAOs require in a manner that allows DAOs to be designed in alignment with Ostrom’s principles.
In a 2018 blog (Brietman 2018), Arthur Brietman the founder of Tezos, proposed to use Futarchy as an efficient, and decentralized mechanism of selecting proposals that upgrade Tezos’s fabric layer. He also identified the need to subsidize market makers to ensure participation, proposing to build in incentives into the already decentralized Tezos blockchain rather than use a Dapp with its own token. If successful, Futarchy will enable Tezos to autonomously innovate and change to a state that is optimally aligned with its member’s best interests. Additionally, by providing incentives for the Futarchy predictions market from the Tezos blockchain, the Futarchy will be utilizing the underlying Tezos cryptocurrency as its source of value, avoiding the complexities that Ethereum is facing, whilst also better aligning the predictions market with Ostrom rules. As a DAO, Tezos, currently better meets the needs of members than either Ethereum or bitcoin by providing programmability that is functionally equivalent with Ethereum and more secure, a structured and decentralized governance model and as it will also provide members with an income stream it will likely alleviate some of the concerns of higher price volatility.
Although, As a DAO, Tezos better complies with Ostrom rules than either bitcoin or Ethereum, the Tezos ecosystem is significantly lagging behind both and history abounds with examples (Quora 2014) of later but better technology failing to be adopted. Arguably Tezos and all blockchain 3.0 candidates best chance of achieving mass adoption is for them to successfully implement a Futarchy that causes the features needed by DAOs and that this is implemented in a manner that the blockchain + Futarchy are aligned with Ostrom rules.
With this in mind the following table analyses the Tezos with the addition of an on chain predictions market used to inform a Tezos Futarchy that can also be leveraged by DAOs operating on the Tezos blockchain.
Both the Ethereum and Tezos proposed Futarchy are heading towards state where the amount of cryptocurrency owned by each member determines the weight of their votes. This is at odds with both Hansons Futarchy, where “Vote on Beliefs” is intended to be democratic (HANSON 2013) and Co-operatives, which are our oldest and most successful decentralized organizations, where equity ownership is separate from governance voting, with one member = to 1 vote (Mutuals 2018). Furthermore, it is arguable that that this approach is also not aligned with the Ostrom rule that those affected by the rules have the ability to participate in modifying the rules. Hanson uses the example of sustainable and long term GDP increases as a potential belief that members would vote on. Considering this, it is conceivable that a proposal may be put forward to increase the price of fees which are distributed to block producers. This would likely fail in a purely democratic vote where it affects everyone, but may succeed where a vote weight is based on cryptocurrency holdings as those with the largest holdings would have the most to gain. The potential threats to a Futarchy that do not have clear boundaries include:
Collusion — malicious actors submit dishonest feedback and collude
Reputation Cashing — Agents cashing in on their good reputation
Strategic Deception — Establishing initial trust for new agents more dynamically
Faking Identity — Agents faking identities to steal disbursed, charitable resources
It is arguable that the mitigation against this risk is a more democratic voting mechanism, ideally where 1 member = 1 vote. Although at first it may seem like this is a simple matter of provisioning one vote to each block producer and reducing the minimum threshold required to produce votes, large holders could fractionalize their holdings into multiple block producers and thus still retain voting power according to their holdings. It seems that the only way to truly resolve this risk is to develop a mechanism that provides members with a blockchain based identity, that cannot be easily reproduced and to use this as the basis for voting.
The proposed methods for establishing identity can be broadly categorized into two groups. Group one includes Dapps such as Uport which provides self-sovereign identity on the Ethereum blockchain which requires a trusted third party to provide initial verification and the Verity proposal that utilizes biometrics to establish and incentivized peer to peer networks to verify self–sovereign identity. Group two includes proposed standalone blockchain platforms such as DREP which rely on the evolving digital identities to a point of verification through reputations markets. Although the reputations market approach does address Ostrom rules better, in that it establishes identity which can be used to define clear boundaries, provides a system for members to monitor behavior, and includes graded sanctions for rule violators, the additional complexity of the system makes it extremely difficult to bootstrap and for it to be compliant with Ostrom rules. It is arguable that the best approach is to establish identity is through a Verity type proposal, that is integrated into the blockchain so that native cryptocurrency incentives can encourage participation, other DAOS and Dapps can leverage it, the complexity of multiple tokens is avoided, and a Futarchy can be enabled. The Futarchy can then be used to drive the protocols evolutions – including reputations markets – as required.
Blockchains such as Bitcoin and Ethereum are both decentralized autonomous organization that operate within the crypto economy, and potential platforms for the hosting of DAOs that interface into the real world. The author has used Ostrom rules
as a framework for analyzing both the validity of their designs as DAOs and the validity of their designs when features proposed to allow these blockchains to interface with the real world are added.
The results of this analysis were fourfold:
- In the literature review that was conducted prior to the writing of this blog, there were no discovered academic literature that used Ostrom rules to analyze blockchain technology and we believe this is a first.
- The use of Ostrom rules as an analysis method shines new light on blockchain technologies potential, immaturity and provides a guide to the path blockchain practitioners should take for it to fulfill its potential. In the literature review that was conducted prior to the writing of this blog, there were no discovered academic literature that used Ostrom rules to analyze blockchain technology and we believe this is a first.
- Although Futarchy is in theory an optimal means of identifying and implementing the changes a blockchain must undertake to meet the need of DAOs, Futarchy depends on the establishment of proof of individuality prior to its implementation.
- DAOs that operate or interface with the analogue economy, the DAO/Dapps and the underlying blockchain they leverage should all be in alignment with Ostrom rules.
Additionally, the research suggests that many of the features required of DAOs are best implemented in the fabric layer of a blockchain so they can be leveraged by multiple DAOs, complexity is reduced and a mechanism of decentral bootstrapping and incentivizing participation is available. Further research into this is recommended.
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