December 5, 2023

on-chain and off-chain management: pros and cons

on-chain and off-chain management: pros and cons

To understand the importance of blockchain governance and the debate surrounding it, we first need to define whatsuch blockchain management, its role and goals. Blockchain governance in the cryptocurrency space consists of two parts: the rules of the protocol (code) and the economic incentives on which the network is based.

Blockchain protocols have evolved significantlysince their inception, however, it cannot be denied that they are still at an early stage of development and there is significant room for further improvements. Every day, innovative solutions appear and are implemented in areas such as scalability, privacy, etc. Some of these solutions are extremely popular, some of them have failed. Adaptability is the key to success. 

The latest striking example of such a solutionis a recent hard fork of Monero aimed at blocking ASIC miners to avoid centralization of mining. This case shows us that a blockchain protocol must be able to adapt and improve in order to stay afloat in the long term. Such an ecosystem obviously needs a management system that will administer proposals, implement technologies, etc. Some of the major blockchain projects such as Tezos, Dfinity, Decret have already introduced on-chain governance models in which governance is an integral part of the protocol, like any other component. However, before agreeing to their proposal, it is important to first understand how the current management scheme works, as well as its pros and cons. 

The key to blockchain management is the analysis of the different classes of network participants, their individual incentives and the coordination of the interaction of subjects. 

Different classes of network members:


Miners – the basis of the network, they are the ones who helpsupport her work. Their incentives are block rewards and transfer fees. As a result, miners are more likely to favor changes that will increase the value of their existing assets and increase/maintain block rewards and transfer fees.


Developers play a very important role, starting fromprotocol ideas, ending with network support after launch. Their incentives are the potential to increase their existing assets and being known in the community/field for their contributions. 


Users, like other participants, prefer updates and developments that not only increase the value of their current assets, but also improve the functionality of the system.

Obviously, all different participants havesome common incentives, however, asymmetries in the incentives do arise, and this causes a lot of control problems. For example, users and developers can insist on changes that drastically reduce commission fees, which miners obviously will not like, which will result in the inability of the network to economically support its existence. Likewise, miners can insist on changes that will increase block rewards, but in the long run this can damage the network. It is important to study such asymmetries and find a middle ground. Let's take a look at how existing protocols such as Bitcoin and Ethereum are managed.


Bitcoin has an off-chain approach to governance.Its developers are coordinated through a mailing list, and they also maintain a Bitcoin Proposal (BIP) repository where anyone can share their ideas for improving the system. 

They have access to private funds and contributions.people who want to fund open source projects. However, there is no established reward mechanism for developers in this system. The absence of such an incentive system led people to say that the development of bitcoin does not meet their expectations, and that the direction of the entire system is formed by a relatively small group of developers.

It’s also very important for developers to understanduser response to protocol updates. The Bitcoin-talk forum has become a center for discussing cryptocurrency from the very beginning of the emergence of bitcoin. Portals such as Reddit and Twitter can also be used to gauge community opinions and reactions.


Ethereum has a similar governance system toBitcoin. Its development is sponsored and managed by the Ethereum Foundation, located in Switzerland. The developments are financed from funds raised during the ICO in 2014 and ether previously mined by the organization. It is also important to mention that the Ethereum community has survived hard forks several times and is valued for its openness and rapid adaptation to protocol updates. One of the reasons for this is the simple fact that Ethereum was born out of several failed attempts to implement the concept of smart contracts on the Bitcoin blockchain. 

Although the off-chain management modelit has existed for a long time and that it served as a means of improving and updating existing protocols; supporters of the on-chain management model believe that the absence of strong incentives for developers can significantly reduce their number, leaving only a small group of major developers. And when a centralized group of people leads the development process, the community becomes vulnerable to bribery and other influential factors.

Let's take a look at proposed and existing management protocols and ideas to compare both sides of the issue.


Tezos – is a decentralized platform forsmart contracts, like Ethereum, but with a built-in governance model and formal mathematical verification of smart contracts. Tezos takes a fundamentally different approach by creating rules that allow shareholders to approve protocol updates, which are then automatically implemented into the system. 

When a developer offers updatesprotocol, he can attach an invoice to be paid after approval and implementation of their updates. This approach provides a strong incentive to participate in the development of Tezos and further decentralized network support. Anyone can propose their idea of ​​improving the protocol and, after it is approved and tested in the test network, this idea can come true. Upon completion of the update, the participant receives payment in Tezzies for his contribution to the system. This is a huge step towards creating a reward mechanism to support the work on the protocol.


Dfinity – this is “intellectualdecentralized cloud." The company aims to become the next generation Ethereum platform by replacing the concept of “code is law” with “AI is law.” As for the governance mechanism, Dfiniti follows a similar model to Tezos, but also allows changes to be made to the ledger, subject to both parties reaching an agreement. Although this contradicts the “immutable” nature of the blockchain, participants in the system argue that problems that have appeared in the past, such as the TheDao fork, might never have happened if such a system had been in place at that time. 

Proponents of this system praise her for herthe ability to freely remove illegal materials brought in by intruders. However, some people believe that this question has a second side to the coin, asking questions like: “What material should be considered illegal, given that there are several jurisdictions”?


Decred– hybrid PoW/PoS cryptocurrency,which uses autonomous on-chain management models. Decred, unlike Tezos and Dfinity, has a fully functional main network. It also allows interested parties to make changes to the protocol and make changes to blocks, subject to bilateral consent.

Although the new management model seems incredibly useful, many people are skeptical about it. One of these people –Vitalik Buterin.The most common argument of such peopleis that the presence of such a governance model can deprive miners (and subsequently users) of the ability to contribute to the governance of the system. In the off-chain model, operators must manually update the client to match it with the new chain. This allows miners to decide which project they want to participate in. However, in an on-chain management model, updates occur automatically and do not require any intervention. Another problem with on-chain governance may be that it reflects a plutocracy. Protocol updates are resolved according to the “1 token – 1 vote”, this leads to the fact that people with a significant share of the total supply may have more rights than the rest of the network participants.

However, these problems may be related tothe fact that the blockchain space is still in its infancy, and a more developed on-chain management ecosystem can exist without problems associated with rewards and risk.

Vitalik Buterin argues that the systemoff-chain governance is guided by several factors (road map, consensus between the development team, voting of network participants, established norms), in contrast to the on-chain voting system, which is poorly suited for blockchain governance. Despite this, Naval Ravikant tweeted: “Most coins would not have been born if Bitcoin or Ethereum had future development incentives built into the protocol.” 

No matter which control systemthis or that platform is used, it will take a lot of time to fully study them and bring them to perfection. Regardless of their pros and cons, both management models should be studied in detail and implemented in a variety of projects.


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