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Bitcoin Governance as Decentralized Financial Market Infrastructure

Hossein Nabilou- Faculty of Law, Economics and Finance, University of Luxembourg.


-- A decade after the birth of Bitcoin, its governance has become increasingly contentious to the extent that even certain well-known proponents of the cryptocurrency declared that Bitcoin governance is broken, and that Bitcoin project should be liquidated (Hearn 2016). Despite those protestations and doomsday predictions, the Bitcoin network has continued to grow. However, the legitimate question remains to be whether there are deficiencies in Bitcoin governance that could warrant interventions by third parties, such as private sector stakeholders or governments. My recent working paper entitled "Bitcoin Governance as a Decentralized Financial Market Infrastructure," studies Bitcoin and its governance in light of its main value proposition, i.e., its censorship resistant property, and the developments that highlighted the need for censorship-resistant financial market infrastructures (FMIs).


The governance framework of an organization or network is a function of the objectives of the organization, the differences in objectives require different governance frameworks. My paper argues that Bitcoin’s main value proposition, which is its censorship-resistant property that allows participants to transact in an environment with minimum social trust (Szabo 2017), is what distinguishes Bitcoin from other networks or organizations. Bitcoin is a distributed peer-to-peer (P2P) system that brings together a decentralized P2P network (the Bitcoin Protocol), a public transaction ledger (the blockchain), a set of consensus rules for independent transaction validation and native asset issuance, and a mechanism for reaching global consensus on the valid chain in a decentralized manner (Nakamoto 2008, Antonopoulos 2017). The censorship-resistant property of Bitcoin is rendered possible only because Bitcoin relies on an open-source protocol, a distributed tamper-resistant timestamped globally synchronized ledger that embeds a settlement asset that is denationalized, decentralized (peer-to-peer), divisible, digital, and globally transferable, while offering certain levels of anonymity to its users. It appears that it is this very unique value proposition of Bitcoin as a censorship-resistant store of value and value transfer infrastructure that is likely to maximize value for all Bitcoin stakeholders including users, miners, node operators, developers, exchanges, custodians, and wallet providers.


The censorship-resistant property of Bitcoin is most prominently reflected in the design of the Bitcoin network. The clearest manifestation of this property is in the trade-off between efficiency and censorship resistance. Rather than opting for fast and efficient payments, Bitcoin goes a long way to create extreme inefficiencies by introducing a distributed ledger that should be maintained, updated and validated by all fully validating nodes, only to make sure that no single or small group of participants violate the rules of the Bitcoin protocol, modify the ledger arbitrarily or censor other stakeholders from participating in the network. Such a trade-off has been made because Bitcoin and blockchain technology are not created to replicate the functions of centralized technologies in a faster or cheaper fashion, but to create an asset and infrastructure that would give its owner near-full control so that she could hold and transact with the asset using a secure and trust-minimized network. In this account of Bitcoin, the objective of becoming a fast and efficient global settlement layer is secondary and should yield when conflicted with the objective of censorship resistance.


Although censorship resistance in Bitcoin has been achieved through a combination of technological innovations hardcoded in the network, preserving and enhancing or otherwise dispensing and undermining the censorship-resistant property of Bitcoin ultimately depends on its governance, which encompasses the processes and procedures for effecting changes in the rules governing the Bitcoin network. To preserve this unique value proposition, the governance of Bitcoin should be highly decentralized. Despite allegations that Bitcoin governance is highly centralized because of the disproportionate role of relatively centralized miners and developers in Bitcoin governance, Bitcoin achieves decentralized governance by putting users at the center of its governance model.


In Bitcoin governance, users may employ a variety of mechanisms to participate in the governance of the network. Firstly, to resolve disputes in the Bitcoin network, unlike other political decision-making processes, in addition to open and free entry and exit, each and every participant can fork the codebase or the blockchain and create her own version of Bitcoin and try to persuade other users to follow her version of the chain or code. By providing for the technical possibility that the new chain maintains the history of the blockchain going back to the genesis block, as well as the fact that the holders of the legacy coins receive the new coins proportionate to their holdings in the legacy chain, Bitcoin is most open to competition provided by forks. Within such an idiosyncratic network, it appears that the ultimate decision is principally made by those who can successfully fork Bitcoin and convince the majority of users to shift to the new chain. In this regard, the users of the Bitcoin network seem to possess the ultimate authority that decides which software to install and run or which implementation to follow. By refusing to run the software proposed or implemented by developers, users can exert considerable influence in Bitcoin governance. Meanwhile, the possibility of forking and the prominent role of users in the process mean that unlike many other modes of resolving the societal collective action problems, which ultimately rely on coercion, Bitcoin governance is based on deliberation, persuasion, volition, and choice.


Secondly, users, especially those running fully validating nodes, have considerable leverage against miners, because Bitcoin governance largely relies on the emergent consensus through a network-wide agreement of rules that are ultimately enforced by the users running full nodes. Although miners may use the threat of forks (Miner Activated Soft Forks (MASFs) or hard forks) or they may even use the threat of a 51% attack after the fork to kill the parallel chain as a mechanism to exert influence on Bitcoin governance, ultimately, it is the user community who decides whether to use the fork supported by miners. This is because, in Bitcoin, miners have to create blocks according to the rules of the protocol and submit them to the network of full nodes for validation. Then, full nodes validate the block by downloading the block and verifying if those blocks match the consensus rules of the client. If the block does not match the criteria of a valid block or does not have the most accumulated Proof of Work (PoW), it will be rejected by the nodes. Therefore, the users running fully validating nodes may threaten not to validate certain blocks broadcast by miners.


Thirdly, users may vote with their feet by choosing different forks, implementations of the code, or by choosing to leave the network altogether. The importance of network effects in Bitcoin renders foot voting a very powerful mechanism in Bitcoin governance, because abandoning the project by its users could amount to its immediate demise. Although foot voting is available to all participants in Bitcoin governance with varying degrees of costs and benefits, it seems to be the cheapest option for users, compared to miners or developers. This enables users to leverage this powerful device in any dispute over Bitcoin governance, ultimately resulting in a market-driven bottom-up decentralized form of governance for Bitcoin.


The precedent in Bitcoin’s decade-long history shows that users have decided to even ignore Nakamoto consensus due to the fact that the longer chain or the chain with the most accumulated PoW did not represent the social contract the users were perceived to be parties to. This happened in the 2010 integer overflow bug and in the 2013 inflation bug incidents. Ultimately, the key takeaway in Bitcoin governance is that users are not bound to follow the miners or developers if a majority of the users do not share the same ideas about the future path of the network. In addition, if there is a disagreement over how to maximize network utility, users can suspend Nakamoto consensus and disempower miners. In this sense, unlike the mainstream perception that Bitcoin is controlled by miners or developers, Bitcoin’s current governance framework, which puts the decentralized network of users at the heart of its governance model, is suited for the purpose that it is created to serve, i.e., establishing a censorship-resistant store of value and value transfer infrastructure.

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