Decentralization is one of the key differentiating features of crypto; this is not controversial. But what does it mean for the governance structure of a given protocol to be sufficiently decentralized? This is the subject of ongoing debates. Critics will accuse certain crypto projects of “governance theater” – i.e. going through the motions of being decentralized while the actual decision-making power is held by a centralized group of actors. This is more than the G in ESG (Environmental, Social, and Governance) – it gets to the core value proposition of some tokens, which begs the question, do governance tokens have utility?
Starting in January 2023, Uniswap’s two major token holders, Andreessen Horowitz (a16z) and Jump Crypto, engaged in a showdown to determine the bridge for expanding Uniswap’s Decentralized Exchange (DEX) to the BNB1 chain. In the end, Jump Crypto’s Wormhole bridge emerged victorious over a16z-backed LayerZero. Despite the apparent simplicity of the outcome, the event sheds light on a maturing crypto ecosystem that is gradually embracing greater decentralization.
Governance is a crucial aspect of many blockchain-based applications, including Decentralized Finance (DeFi) protocols. These protocols are designed to provide access to financial services and enable activities that don’t exist in the analog world, such as tokenized asset liquidity and permissionless collateralized borrowing. In particular, decentralized exchange (DEX) protocols use something called a liquidity pool to offer a permissionless way for users to trade tokenized assets without the need for an immediate buyer or seller. Uniswap, one of the largest decentralized exchanges in terms of total trade volume (Figure 1), has become an essential piece of DeFi infrastructure that allows traders to swap with liquidity across multiple chains.
Figure 1: Top DEXs on Ethereum by Seven-Day Trading Volume
Source: Dune, @kaispace_xyz, Grayscale Research, for illustrative purposes only used to depict the top DEXs on Ethereum from 1/22/23 – 1/29/23. Trading volumes are subject to change.
The growing popularity of a protocol like Uniswap not only brings in users, but also stakeholders. Unlike traditional web apps that implement changes based on centralized actors, decentralized apps typically make changes that utilize on-chain token-weighted voting. It’s a core differentiating factor. For instance, Uniswap’s public governance forum enables token holders to initiate a change by writing a proposal and gathering feedback and support. If sentiment is positive, token holders begin voting on the proposal using the protocol’s native tokens. If the proposal gets enough token votes, the change is implemented (Figure 2). For Uniswap, governance is particularly essential for deciding on critical issues, such as voting on liquidity pool fee tiers, deploying the Uniswap protocol to new chains, and distributing grants.
Figure 2: Governance Proposal Example of Uniswap
The Setup: Uniswap’s Strategic Expansion to BNB
In December 2022, a Uniswap UNI token holder proposed that the protocol should expand to the BNB chain in order to capture a portion of the ~$1bn of total value locked2 and +1M potential new users. Although most stakeholders were aligned with the expansion, there was disagreement over which cross-chain “bridge” would be used to deploy the Uniswap protocol to the new chain. In crypto, a bridge is defined as a set of smart contracts that enables the transfer of assets from one chain to another.
Considering that Uniswap currently accounts for the majority of trading volume3 on Ethereum, the chosen bridge could potentially accrue value from the decentralized exchange through transfer fees, which is an attractive prospect for investors. Of the bridge options available, two of them — Wormhole and LayerZero — are backed by large UNI holders Jump Crypto and a16z, respectively. These large holders reasonably have an incentive to make governance decisions beneficial to their portfolio, and were each partial to Uniswap using their preferred bridge.
In predictable fashion, Jump Crypto voted in favor of selecting Wormhole as the bridge provider during the temperature check (as defined below), and a16z voted against Wormhole during the actual proposal period. Wormhole ultimately won in the end, with ~66% of votes favoring the proposal (Figure 3).
Figure 3: Deploy Uniswap V3 to BNB Chain Using Wormhole Bridge Vote Breakdown
Source: tally.xyz, 2/10/2023
Although a16z ultimately lost the vote, the venture capital firm controlled more than 64 million of the 85 million total votes cast, representing a significant percentage of the total voting power. In fact, if a16z had retained all 64 million votes for themselves, they could have potentially won the vote. However, the firm had delegated 40 million of their voting tokens to third parties such as universities and other entities in an attempt to increase decentralization in the protocol they had invested in early (Figure 4). Some delegates ended up voting against LayerZero, resulting in potentially lost value for the bridge and one of Silicon Valley’s largest venture capital firms.
Figure 4: A16z’s initial delegate network
Source: a16z, as of 8/26/2021, delegates subject to change
Through a transparent process, we have a glimpse into various governance battles between key players, each with their own incentives. From these events, we observe a protocol like Uniswap exhibiting greater degrees of decentralized decision-making, defying the prevailing “governance theater” narrative.
As protocols grow and diversify into new ventures, we can expect a growing number of competing factions owing to the growing number of stakeholders. With more stakeholder diversity, the possibility of a more effective governing body arises, one that can resist arbitrary changes yet remain receptive to necessary modifications that could benefit the majority of stakeholders.
Ultimately, the value of governance votes relies on their ability to bring about change. As more changes to protocols are made and implemented through decentralized methods, it’s reasonable that the value of governance votes will potentially increase in the future. As the stakes grow, questions like these will become more important:
- Is it possible to objectively measure the decentralization of a given project?
- Is it possible to estimate the implied value of a token solely based on its governance power?
- How does token concentration affect a protocol’s decentralization?
- Is there necessarily a tradeoff between community governance and providing upside to founders and investors?
- How does vote delegation turn out in practice? How will behaviors evolve if token votes are demonstrated to have real value?
We are looking forward to watching the answers unfold as decentralized applications continue to evolve.
1. Formerly known as the Binance Smart Chain, it was rebranded into the BNB (Build and Build) chain in February 2022
2. As of 2/9/2023
3. As of 2/9/2023