How do you program a democracy? Crypto decentralisation isn’t easy
The current struggles of the 0x Protocol (ZRX) highlight the overlooked challenges of decentralisation.
0x (ZRX) is a system designed specifically for decentralised ERC20 exchanges such as Paradex and Ethfinex. Like many other cryptocurrencies it's part currency, part open source software project and part social experiment.
That third one can be tricky. Power and wealth have a natural tendency to consolidate (the "trickle up" effect) because the more power and wealth one group has, the easier it is to accrue even more. In cryptocurrency, this can be a major problem. An imbalanced coin risks losing function and value, and in more immediate terms the actual security of decentralised ledgers is dependent on maintaining a certain balance.
Where a coin's functionality develops only by democratic vote, too much power in one bloc can also have lasting effects. For example, Bitcoin Cash and Bitcoin Gold were created mostly by accident through power struggles in the bitcoin community. The different blocs – the miners, the holders, etc – each tried to change the programming to suit their needs, but couldn't get enough support to pull it off cleanly. Arguably the remaining bitcoin core faction is left with a slightly fanatical purist bent, which is having its own long term effects.
Coins need to find a system that enables, and maintains, a suitable level of decentralisation, and not just for freedom, fairness and democracy. There are critical functional and economic reasons to find a balance that works.
Different cryptocurrencies approach this challenge in different ways. For example, Ripple foregoes decentralisation entirely, ARK uses a democratically elected council of 51 very well paid programming elders, and IOTA installed a temporary coordinator to keep it safe until it turns into an all grown up decentralised tangle network.
And the 0x protocol is currently trying out a bit of social engineering.
The 0x Protocol is being specifically designed to give both the "relayers" and the "traders" a say in the development of the system.
- Relayers – The people who run off-chain nodes to conduct decentralised exchange (DEX) transactions. Basically they carry out DEX transactions and collect fees in ZRX for their work.
- Traders – The ones who trade. The traders that buy and sell cryptocurrencies (and maybe other things someday) via the relayers. Decentralised exchanges such as Paradex would fall into this group.
Naturally only ZRX token holders can get a say in the development of the system. This ensures a reasonable vested interest and helps prevent manipulation.
The challenge is actually vesting that interest in an appropriate balance of parties and making sure it lasts. Left to its own devices in its barest form, control of the 0x protocol (in the form of ZRX holdings) would tend to migrate towards the relayers. And over time 0x would then develop to best suit the relayers rather than the traders. This kind of imbalance isn't sustainable.
The solution is to make sure traders will continue to maintain a suitable stake in the system and make their voices heard. Even if they don't necessarily want to. In the case of 0x this is done by requiring heavy traders to hold a certain amount of ZRX tokens before they can access the 0x functions, and by using ZRX as a fee token.
The good news is that this naturally ensures that traders will continue to get a vote and maintain balance in the system. The bad news is that it comes at a very literal cost. Buying the required stake isn't always cheap, and few people would willingly pay fees if they don't have to.
0x co-founder Will Warren described the problem in a Reddit post.
"We want to avoid a situation where the only people participating in governance are relayers because (1) this isn't very decentralized and (2) because relayers are running for-profit businesses and their incentives do not necessarily align with their end users."
"It is critical that decentralized governance is run by all groups of stakeholders in the 0x ecosystem; relayers and traders. By requiring traders (or at least heavy traders) to hold some amount of ZRX tokens to access 0x protocol's functionality via relayers, they will have a vested interest in ensuring 0x protocol evolves in a way that satisfies their needs."
The problem with the solution
How much tax would you pay if it was an optional donation? Decentralised governance might be an essential part of a system, but it's not a feature that most people will willingly pay for.
As an added cost it can inhibit uptake of a coin and undermine the system in a different way.
"Quite a few people have mentioned that they don't like that ZRX is used as a fee token; it can feel like an unnecessary point of friction when getting started with 0x. This is a completely valid experience and we acknowledge that it can create a mediocre on-boarding experience. Without discounting these points of feedback, we do feel that having ZRX as the fee token in 0x protocol provides the most logical incentives long term when it comes to decentralized governance. Ultimately, the community will decide how token economics work through the governance process and it will be interesting to see how this grand experiment evolves."
Paradex recently decided that it couldn't justify the cost of using ZRX, and ended up sidestepping the system that it initially planned to use.
"The gas costs associated with matching orders is quite high. Right now it costs ~$6-8 for Paradex to batch fill 2 orders and during the CryptoKitties congestion this cost was considerably higher," Warren wrote.
"Taking fees in ZRX increases these gas costs maybe ~30% and by matching orders potentially 1000s of times per day this cost adds up."
Programming a sustainable economic democracy isn't easy, and balancing it with functionality, financial viability, sheer human nature and other elements can make it all extraordinarily complicated. This is a critical yet frequently overlooked element of cryptocurrencies, and anyone who wants to throw money at a coin might want to consider the longevity of the system they're looking at.
The "grand experiment" of 0x is one example among many, and there's a lot to be learned by keeping an eye on this often overlooked element of cryptocurrency.
- Australian crypto exchange plans legal action against NAB for account closures
- Alleged IOTA fake seed generator thief arrested a year later
- VanEck-SolidX bitcoin ETF proposal temporarily withdrawn
- Cryptocurrency is down, so why are sophisticated investors buying?
- Why bitcoin is doomed by its own economics, according to BIS
Disclosure: At the time of writing the author holds ETH, IOTA, ICX, VEN, XLM