What is On-Chain Governance?

On-chain governance is a decentralized framework that allows the users of a blockchain network to vote on any updates or improvements of the underlying protocol. Rather than relying on a centralized authority, many blockchains have delegated communities that manage the processes of protocol enhancements and fixes.

Blockchain governance is responsible for making two types of decisions:

• The underlying rules of the protocol in the code;
• The economic network incentive system.

The process of governing a blockchain is complicated due to its decentralized structure. On-chain governance is frequently used in distributed cloud-based systems to meet the agility needs and guarantee that the resources are appropriately allocated.

DFINITY networks use proprietary AI systems alongside on-chain governance principles to distribute computing power throughout its network of companies and applications that connect to the same cloud architecture.

Digital currencies like Tezos (XTZ) or Decred (DCR) apply on-chain governance by allowing the user base to vote on the vision of the platform, as well as make changes to the protocol that can improve user and developer experience.

On-chain governance is one of the cornerstones of decentralized autonomous organizations (DAOs). DAOs act as community-run platforms. Members hold governance tokens that they can use to decide on the rules of the protocol and have a direct impact on the development of the product.

Some cryptocurrencies, like Bitcoin (BTC), use off-chain governance methods, which do not provide the same level of flexibility for investors that on-chain governance offers.

In on-chain governance, three mechanisms are in play – consensus, incentive, and information.

Consensus

Consensus means that the members of the network can directly vote based on the principles of democracy. All decisions, updates, and changes are made on the distributed ledger protocol. By voting, users can implement improvements to the blockchain system without an intermediary.

Incentive

Following the principles of incentive, users and developers can promote changes that may positively affect the performance of the protocol for their sake but negatively impact others. Such changes can include reduced transaction costs. Miners can suggest changes that may increase the block rewards they receive for their job.

Incentives may be favorable only to the parties suggesting the changes and can cause issues to the network in the long run.

Information

Information provided in on-chain governance systems must maintain transparency. Some of the advantages to on-chain governance are:

• Effective decision-making thanks to decentralization. No one person has more power over the network than the rest;
• On-chain governance offers more transparency as all network users have access to the code and can see what changes are being made;
• On-chain governance helps prevent hard forks, which may occur if the interests of some stakeholders clash with other organizations.

Users that hold governance tokens and are part of the protocol management process may receive certain incentives to encourage further participation.