Governing the Un-Governable: Enterprise Blockchain Ecosystems

Developing an idea into a successful business requires a solid team, a clear vision, a roadmap, financing, and clients, among other things. Although having a vision of where you want to be in 10 years is important, you cannot start at the end, and it's crucial to focus on the basics when you start. While building and developing your business, you may realize that some things could be done differently, more efficiently, or that you need a change of direction. It's a natural part of the process, and you should keep your end goal in mind.

However, applying this concept can be challenging in unfamiliar areas or industries, such as blockchain and decentralized ecosystems. A well-thought-out governance system is the foundation and compass of any successful ecosystem, including blockchain. Effective governance in a blockchain ecosystem requires diverse phases to orchestrate the complex system of actors and technologies. Understanding the unique phases of development that a blockchain ecosystem undergoes is essential for building or joining an existing one. Knowing in what stage of maturity you are operating helps in determining what activities (that belong to certain behavioural drivers) to prioritize, and therefore the further development and growth of the ecosystem.

In this article, we explain how the different stages, layers, and behavioural drivers of a blockchain ecosystem relate to each other and evolve as the ecosystem matures. A functioning governance system that guides through the different stages of development would be extremely valuable, especially in the blockchain ecosystem.

Blockchain governance can be considered to be particularly challenging. It is highly dynamic and entails both coded and non-coded governance aspects. In a recent comparative case study of three large blockchain ecosystems [1], namely Energy Web Foundation (EWF), Vechain (VCT), and Corda Network Foundation (CNF), researchers discovered that blockchain ecosystems go through at least three, but perhaps more distinct stages toward any level of maturity. Each stage is characterized by an intricate relationship between off-chain and on-chain governance mechanisms, and before moving from one stage to the next, there are a few preconditions that must be met. Figure 1 shows that each stage has (at least) one prominent behavioural driver with its corresponding activities which should be prioritized. It also shows that picking the correct one(s) will have a great influence on the ecosystem’s long-term success and viability. Furthermore, it must be noted that this prominent behavioural driver changes throughout the stages and therefore also the priority of activities. Figure 2 provides an example of how these drivers could be prioritized in for example stage 2. However, once again this prioritization changes throughout the stages. Each behavioural driver contains different activities that change as the ecosystem evolves through the stages.

Another point of attention surrounds the notion that entering the blockchain space requires new ways of collaboration. Traditionally speaking a contract is signed between two different organizations, but what should you do when there is no formal organization to sign a contract or letter of engagement? This requires new ways of thinking and re-interpreting your risks, and figuring out how to translate your needs and wants into goals for the ecosystem. Furthermore, it is necessary to establish what kind or role you want to play within the ecosystem, but to do this one needs to have a complete overview and understanding of the ecosystem, the underlying risks, and technology.

Stage 1 - Developing the Initial Idea and Creating a Consortium
This stage consists of all the activities, that take place, before the blockchain is functional, in which the initial team typically consists of innovators that believe in the benefit of the technology and the project itself. The mission is defined, a Proof of Concept has been drafted and a white paper has been written to raise broad awareness about the project and acquire the required financial resources. In this stage, the most important behavioural driver appears to be accessibility; making the envisioned blockchain ecosystem accessible for a (relatively small) group of participants. It all starts with a minimum viable ecosystem, in which 3-5 consortium participants partake in a collaboration agreement to invest their resources, such as time, money and expertise, and make the initial ecosystem viable. At this stage, the membership of the initial consortium is very selective and it should provide incentives for joining the ecosystem with a long-term objective to create strong network effects. Once the board structure and the off-chain governance rules have been set, the ecosystem starts bringing in software developers. Finally, to close off stage 1 and move on to the next stage, three preconditions have to be fulfilled:

1. The founding members must agree upon the initial governance rules and formalize them accordingly in the white paper;
2. The founding members must provide sufficient capital to ensure the viability of the blockchain in the short term; and
3. A Proof of Concept must be developed and made publicly available.
   
   

Stage 2 – Translating the Proof of Concept into the Technical Infrastructure
Here, the focus is on creating and testing the operational blockchain beyond the Proof of Concept, in which access is restricted to the founding members and key contributors. As there are no third-party applications yet, the infrastructure work focuses on the protocol and the network layers. In this stage, the most important behavioural drivers appear to be accountability and conflict resolution, in which the main challenge lies in designing algorithms that mimic the agreed-upon off-chain governance rules as closely as possible. Accordingly, this is also where a more progressive shift tends to appear from off-chain to on-chain governance. Given the closed nature of the ecosystem at this stage, it is built upon consensus mechanisms such as Proof of Authority, instead of Proof of Work or Proof of Stake. Although restricting the creation of blocks to validators whose identities are known will ultimately limit the level of decentralization, it does provide increased levels of security, regulatory transparency, and increased capacity. At the end of this stage, the blockchain should be ready to accommodate new stakeholders that can build applications on top of the network layer. To be successful in this transition, and ultimately move to the next stage, three preconditions have to be fulfilled:

1. The incentive structure must attract new members to the ecosystem while providing profit for the founding members;
2. The economic rules of the blockchain have to be clearly defined; and
3. The governance board of the blockchain needs to restructure accordingly to provide the new members with decision-making power.
    

Stage 3 – Opening the Blockchain to External Partners
The ecosystem demonstrates its utility in this stage by expanding its value-sharing protocol. The main objective is to extend the range of applications offered on the network, as these applications ensure the (financial) viability of the ecosystem. In this stage, the most important behavioural drivers appear to be incentive mechanisms, which are needed to motivate the participation and action of the application builders. The implementation of incentives can vary across different ecosystems. In most cases, incentives are provided by creating a token economy, in which the participants are provided with crypto-assets. However, in other cases, the use of tokens is optional and thus not a necessity. In that case, the lack of on-chain incentives can be compensated by off-chain opportunities, such as being offered a seat on the board. The distribution of tokens and granting access to new members does imply a progressive decentralization of the blockchain, and at this stage, it should aim to become an (open) permissioned chain. Meaning, all users can read all transactions, but only some have the right to write and commit. This level of decentralization can cause changes in the on-chain consensus protocol. Ultimately, once the application layer has finally been set up, the blockchain ecosystem could (in principle) run itself. However, it is suggested that an off-chain governance structure would be useful to further guide the development of the ecosystem.

A significant hurdle for permissioned blockchains is establishing adequate legitimacy to attract, and retain, a sufficiently large number of participants and application developers to the ecosystem. Existing members may also be hesitant to accept changes to the governance structure, particularly if those changes decrease their influence or incentive. To avert scenarios where (e.g., founding) members obstruct the (natural) evolution of the blockchain ecosystem, the early governance rules outlined in the white paper (established in Stage 1) should include well-defined “rules for changing the rules”.

Now, the likelihood of creating a successful blockchain ecosystem largely depends on network effects. To enhance these effects, the founders should prioritize community-building initiatives during Stage 1, even if the technical infrastructure is not in place yet. However, it is also advisable to limit the number of participants during this (fragile) early stage. To address this dilemma, it is crucial to establish clear and transparent rules of and for participation early on. Such rules can reinforce the self-selection mechanism, and attract new stakeholders that can add value to the ecosystem while discouraging those who do not fit in. Additionally, traditional contracts and liability mechanisms can also establish a heightened level of accountability.

Encountering some degree of conflict among ecosystem members, as well as initial technical problems with the blockchain, is nearly inevitable. Despite this, conflict resolution mechanisms are often overlooked in the initial design of the blockchain and are established after disputes have already arisen. It is therefore important to install a (preliminary) conflict resolution in Stage 1, which then can be developed into a programmable (on-chain) solution in Stage 2. While it is a possibility to fork a blockchain, doing so at such an early stage is not recommended, as it can cause fragmentation and hurt the ecosystem’s credibility, which will only make it harder to attract new members, especially corporate entities.

Final Remarks
Blockchain ecosystems tend to change frequently, especially in the early stages. These changes should be viewed as part of natural evolution, especially considering the different needs of the ecosystem and the number of participants at each stage. As new stakeholders join the ecosystem, on-chain governance becomes more prominent over time, and while the challenges of different blockchain ecosystems are common, the solutions differ substantially. There is no one-size-fits-all approach, but understanding the different stages of blockchain ecosystem developments and the associated behavioural drivers of governance will pave the way for organizations to navigate this landscape and create a sustainable ecosystem that benefits all the participants. Deloitte can help you maneuver the space accordingly, may it be through providing governance support to blockchain ecosystems or may it be helping our clients re-interpret the risks of their first steps in the ecosystem. If you are eager to learn more about this topic or have any other (governance) questions, please reach out to the contacts attached to this article.