Why is Good Governance so Hard?
In both corporations and Web3, we talk a lot about governance. Particularly how governance will help prevent failures and enable evolution + improvements. In the wake of the FTX collapse, many are comparing it to corporate scandals like Enron. History seems to be repeating itself. These events highlight that good governance is hard to implement in practice.
Today we unpack and shed some light on these topics.
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One of the promises of Web3 is that with user-owned networks, you also enable community-led governance.
The logic goes, the founding team would launch the project and seed the foundations of good governance. Over time, they would march toward decentralizing the project and enable community-based governance systems. If the users who own the network also decide the key decisions of the network, then the stakeholders get what they want out of the network.
This makes a lot of sense in theory, but many projects have not achieved the unicorn of good governance.
Outside of Web3, most governance structures are top-down systems. In corporations, governance is set by the board of directors and management. There are also laws in place to protect shareholders with good governance. It’s an established system with rules in place.
Web3 imagines a world where there is bottoms-up governance. The various stakeholders (users, core team members, contributors, investors, etc.) play a key role in deciding the direction of the project. This includes:
Proposing ideas to change and evolve the project
How to use funds in the treasury to pursue initiatives
Voting on leadership changes and acting as a check and balance
Because Web3 is experimenting with bottoms-up models, it wants a governance model that is more community-led. Ideally anyone who has a vested interest in the project can participate in governance.
It’s supposed to be for the people by the people. Of course, easier said than done.
Ingredients for Good Governance
At heart, governance is a coordination problem.
Good governance boils down to two key areas:
Systems and processes for governance:
Do we have systems to capture votes?
Did we define how proposals are made?
Do we know who can and should participate?
Anything else that relates to the “how” of governance
Participation in governance:
Do people know how to participate?
Are the participants qualified to participate?
Do (enough) people have the means to participate?
Do the participants care enough (motivated) to participate?
It looks something like this on a 2x2 matrix:
Obviously if you have both, you are in the unicorn bucket of governance.
If you have one or the other:
(Upper Left) Systems and processes are in place, but stakeholders aren’t empowered to participate. Governance is merely a “check the box” exercise.
(Bottom Right) Stakeholders actually care about governance and want to participate, but there aren’t good systems and processes in place. It’ll probably be fine because where there is a will, there is a way.
Most systems seem to fall in the upper left where a governance system technically exists, but there isn’t a lot of participation.
Culture of Good Governance
A culture of good governance promotes strong participation, seeks out what’s broken and evolves its processes and systems. Ideally participation is also incentivized intrinsically and extrinsically [See a16z article exploring this]. Lastly, a culture of good governance should also limit the impacts of bad actors in a system.
Participation rates are notoriously low in many systems because there isn’t a strong culture that promotes participation (i.e. governance ends up being a “check the box” exercise).
In corporate governance, many shareholders vote by proxy (allowing another firm to vote on their behalf). This has led to a few firms and a few people in those firms voting on some of the major decisions.
In Web3 governance, there is usually a small subset of people in a community that care about governance enough or have the means to participate. The few end up deciding for the many and influence the project’s direction.
And it’s not just simply participating in governance, it’s creating a culture where people can and want to do the right thing. Any system can and likely has bad actors that want to hinder and prevent widespread participation because it’s beneficial for the bad actors to do so.
All of this makes good governance systems hard to implement in practice.
Allegory of the Cave
Lack of good governance paves the way for failures and collapses. Let’s unpack through Plato’s Allegory of the cave.
Plato describes a group of people who have lived chained to the wall of a cave all their lives, facing a blank wall. The people watch shadows projected on the wall from objects passing in front of a fire behind them and give names to these shadows. The shadows are the prisoners' reality, but are not accurate representations of the real world. The shadows represent the fragment of reality that we can normally perceive through our senses, while the objects under the sun represent the true forms of objects that we can only perceive through reason…
The philosopher is like a prisoner who is freed from the cave and comes to understand that the shadows on the wall are actually not the direct source of the images seen. A philosopher aims to understand and perceive the higher levels of reality. However, the other inmates of the cave do not even desire to leave their prison, for they know no better life…
…Plato continues, saying that the freed prisoner would think that the world outside the cave was superior to the world he experienced in the cave and attempt to share this with the prisoners remaining in the cave, attempting to bring them onto the journey he had just endured…
The returning prisoner (philosopher), whose eyes have become accustomed to the sunlight, would be blind when he re-enters the cave, just as he was when he was first exposed to the sun… The prisoners, according to Plato, would infer from the returning man's blindness that the journey out of the cave had harmed him, and that they should not undertake a similar journey. Plato concludes that the prisoners, if they were able, would therefore reach out and kill anyone who attempted to drag them out of the cave…
In short, in an environment where there is a strong desire and systems to keep the status quo, it becomes almost impossible to change it. [See: Why is Change so Hard?]
Some compare the recent FTX collapse to Enron.
The Enron scandal brought to light the fact that existing governance systems that were meant to prevent failure did not work. In the wake of Enron and related scandals, regulators enacted the Sarbanes-Oxley Act, which put more strenuous requirements for stakeholders (management, accountants, board members) to do right by their stakeholders or face penalties.
While this was a step in the right direction, Enron did have governance systems in place. There was a board of directors with plenty of qualified individuals who could have caught all the accounting gimmicks the company was doing. See here for the Enron board of directors list at the time of the scandal. Notice there was a senior accounting professor from one of the world’s top business schools and former regulatory chair of CFTC on the board of directors.
When something goes wrong, it’s hard for one individual to sound the alarm bells when everyone else wants to keep the status quo.
The one individual sounding the alarm bell is trying to change other people’s reality and tell them their reality is false. This is almost an impossible task!
The failure was not one of capability, but rather one of motivation. No one was motivated (incentivized, felt safe, etc.) enough to call out the inconvenient truth.
Governance is Hard
All this begs the question: how much governance does a system need? Perhaps people’s involvement in governance should be take a back seat and software / protocol-led governance should take front and center. These are ideas we will explore in a future essay.
For now, we go back to can versus will: whether you can participate in a governance system is different than if you will.
While the many can, it seems the few will. Perhaps, the history of the world is decided by the few who will, for better or worse, often behind closed doors.
Capability and motivation are not the same.
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