Brexit, Bitcoin And Ethereum: Governance Gone Awry, With Beach Reading

Brexit

Brexit shows just how important good governance is. Committed anarchists read no further.

For everyone else, human communities have always needed rules to get the best out of each other — because we can make each other better off in so many different ways — and to prevent the worst of each other — because, face it, even good humans do bad things.

One of the rules is how to make the rules and change the rules. Should we have a dictator, let a simple majority of everyone in the community decide, representative democracy where the community delegates the decisions, or many other possible variants. I’m not a political scientist, so I probably shouldn’t go too far out on a limb, but most communities, when given the choice of how they want to adopt rules, don’t actually choose to go with majority voting — 50% plus 1 vote wins — as a routine matter.

The United States is a representative democracy for example. At least at the national level nothing gets decided by majority voting. And really consequential things, like amending the constitution, require a whole lot more. Neither is the United Kingdom. People vote for members of parliament and then they decide. Many other “democratic societies” function the same way. By and large, with representative democracy, the representatives don’t cast their votes based on what a simple majority of the voters happen to want at any particular point in time.

Why isn’t simple majority voting adopted more? Especially now that we are all online it would seem to save a lot of money and we wouldn’t have to listen to windbag politicians anymore. There could even be an app for that so people could vote anywhere, anytime.

I suspect the answer is that sensible people over the years have recognized that it would make communities worse off over time, including whatever majority that happens to vote for something today.  For one, majorities can change. Letting simple majorities decide things can lead to uncertainty and instability. For another, majorities can impose bad things on minorities. Since most people are in minorities on many issues, majority voting can make most people worse off.

Brexit provides a very good example of why simple majority voting should be used with care. Exiting the European Union is a very complex and costly process with uncertain outcomes. It poses a risk that the members of the United Kingdom will split off. Now, this isn’t an omelet. If the “majority” changed its mind it is possible that one could put all this back together again. But it would be difficult indeed. Since the present is known and future isn’t, there’s a good reason not to change things unless one is very sure.  Letting elected officials decide is one way to do it. Requiring supermajorities of people, or elected officials, is another.

Now, the thing about Brexit is that it seems like someone spiked the tea of the elected officials with something that made them really stupid, with perhaps Prime Minister Cameron getting the heaviest dose. Forget about suggesting that such a momentous decision was going to be left to a simple majority vote in the first place. Here’s the situation now. The fact of the matter is that the referendum isn’t binding on Parliament. These elected officials, in a representative democracy, have to actually make the call.  Yet Cameron and others are saying that they can’t or shouldn’t and what’s done is done.  Like a teenager screwing up their face and saying “fine.”

Then there’s the fact that the electorate now has evidence of the horrible consequences that are likely to result from exiting the E.U., and mounting evidence that some elected officials misrepresented the benefits and costs of Brexit. Hard to see why elected officials shouldn’t take that into account.

Suppose, for example, that a reliable poll did showed that the majority of people, including many of those who voted for Brexit, wouldn’t now. Would David Cameron, and others, really say that in face of proof positive that it was all a horrible mistake and misunderstanding that they must follow the will of the people because “it’s the democratic thing to do?” Maybe Brexit should go forward based on the majority, but surely if it became clear that it was a mistake, and people recognized that it was a mistake. It would just as surely be nuts to codify a mistake — well, just because.

Bitcoin, Ethereum, and Other Virtual Currencies

So that brings me platforms, where I’ve studied governance extensively, and to virtual currencies that I look on in horror almost as much as I do the U.K. at the moment.

The lack of sound governance mechanisms has been one of the major obstacles to virtual currencies achieving their earlier promise.

Part of the problem is that there has been a tension between those interested in developing financial services innovation and those interested in political innovation. For some, virtual currency schemes, like bitcoin and Ethereum, are ways to pursue a libertarian agenda that eliminates central authorities. One way to do that is to make everything based on code and rules that humans can’t interfere with. Others just want the damn thing to work so they can make alt-finance innovations on top of it.

This tension was highlighted with the Ethereum “diversion” of around $60 million from the DAO which broke the intent of DAO it not what was allowed by the code.  Some, including the founder and leader, the brilliant Vitalik Buterin, wanted to reverse the diversion and had a way to do it. Others insisted that it was more important to avoid human intervention in the code.

I don’t have a dog in this hunt. If people want to try to come up with political and social innovations that put the power in the code, so be it. I mean, after all, “Person of Interest” was a lot of fun to binge watch.  And if people think that blockchain technologies can solve financial services problems they should go at it.

They can’t do both though. If you are interested in financial services innovation, you probably don’t want to bet the farm on a code-based system of governance. The notion that code could run a platform without human intervention is an unproven hypothesis whose truth is far from self-evident.  And if you are interested in political innovation, I don’t think you’d want to tie your future to people that are really interested in making money.

The other part of the problem, though, is that the founders to some of the leading virtual currency platforms do not seem to have thought through governance and have ended up with systems they probably didn’t intend.

The bitcoin virtual currency platform, for example, has to decide whether or not to expand the capacity of the network. That has resulted in a fierce battle between those for and against making the necessary changes to the code. The decision as a practical matter is up to a majority vote of transactions of one constituency within the community: the bitcoin miners. As the mining industry has evolved it has consolidated into a handful of players. As it turns out they are located in China, as described by Nathaniel Popper recently in The New York Times. In fact, four companies in China account for 70 percent of the bitcoin transactions.

A majority vote by the miners also determines, in effect, how Ethereum will deal with the DAO hack. That could decide the long-term fate of the virtual currency platform.

If you are interested in maximizing the value of a public platform to its participants, giving the decision-making power to one group of participants isn’t likely to accomplish that objective. So letting the miners decide seems obviously wrongheaded. Making the decision based on the majority of transactions is also dubious since it can allow a small number of large players to dictate the result for all participants.

Brexit, bitcoin, and Ethereum all show the importance of good governance. Right now, they all seem to be heading off of a cliff, each from insisting on “democratic” voting that most communities, given a choice, decide not to use. The U.K. actually has a representative democracy in place that could pull it back from the brink. Bitcoin and Ethereum, unfortunately, have hardwired governance systems that are incapable of maximizing the value of these platforms for their participants.

Beach Reading

For those of you interested in beach reading, here are some suggestions related to this topic. My  Governing Bad Behavior paper and Chapter 9 of “Matchmakers: The New Economics of Multisided Platforms” provides background on why and how platforms, whether physical or digital, old or new, do this. My paper on Rules and Standards for Software Platforms shows that most sophisticated software platforms have and enforce rules and standards for developers. Not-for-profit platforms are another source of ideas on governance for virtual currencies. My HBR blog post with Dick Schmalensee describes many of these. Interesting, standard setting organizations, which have been responsible for laying the foundations for many important technologies, typically have supermajority voting, often requiring 70 percent of more of the votes.

Don’t forget the sunblock.



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