FEDS Notes Twitter Share RSS

February 09, 2024

Governance of Permissionless Blockchain Networks

Amber Seira, Jeffrey Allen, Cy Watsky, and Richard Alley1

Introduction
A permissionless blockchain network is a system of physically distributed computers
running a copy of a shared ledger and using the same software rules that enable all
network participants to "read, submit, and validate transactions" (Beck, Müller-Bloch,
and King, 2018, p. 1022). A permissionless system's accessibility stands in contrast
to that of permissioned systems, in which a central authority pre-selects validators
and potentially restricts viewing and submission rights (Krause, Natarajan, and
Gradstein, 2017; Beck, Müller-Bloch, and King, 2018).
An open question for the trajectory of blockchain-based financial services is whether
permissionless networks are suitable for hosting products and services in modern
financial and payment systems. Key issues in this area include whether
permissionless blockchain networks are compatible with financial regulatory and
auditing standards, whether they introduce novel risk management issues for
financial institutions, and how the open and decentralized nature of the networks
affects governance.
This note focuses on the last of these considerations—governance. Blockchain
scholars have explored a range of governance questions surrounding permissionless
systems, including how the networks establish rules, react to market competition,
respond to security threats, and make other strategic decisions (see, for example:
Beck, Müller-Bloch, and King, 2018; Glaser, 2017; De Filippi and Loveluck, 2016;
Lumineau, Wang, and Schilke, 2021; Pelt, Jansen, Baars, and Overbeek, 2021).
The purpose of this note is to facilitate the continued investigation of permissionless
network governance issues through three related analyses. First, the note provides a
primer on permissionless blockchain network stakeholders, focusing on developers,
nodes, and users. The primer can serve as a reference for scholars and
policymakers seeking to understand the key players in permissionless network
governance. Second, the note lays out some similarities and differences in
governance patterns between the two largest permissionless blockchain networks,
Bitcoin and Ethereum. Finally, we trace differences in models of change between the
two networks, with an emphasis on their histories of hard forks—protocol updates
that are not backwards compatible. We use the analysis to lay out a variety of
important research questions at the nexus of governance and software updates that
warrant further investigation.

Key Stakeholders in Permissionless Blockchain Networks

We identify three broad groups of stakeholders in permissionless networks:
developers, nodes, and users. Importantly, there are distinct sub-groups within these
stakeholder categories that play different roles in permissionless network
governance.
Developers
We distinguish between two types of developers based on the software they work
on: core developers and application developers. Core developers work on the
blockchain protocol and client software. Depending on the network, there may be
one or multiple types of client software that constitute the core infrastructure.
Application developers build decentralized applications on top of blockchains. Within
core and application developer groups, there are authority structures. Between these
groups, core developers are generally more influential in governance decisions
because they steer protocol design choices. Although application developers can
exert influence on governance decisions by voicing opinions on developer calls and
in public forums, they are less directly involved in network governance than core
developers.
As discussed further in our comparison of governance patterns between Bitcoin and
Ethereum, the formality of core developer labor arrangements and compensation
varies among permissionless networks. In Ethereum, for example, core developers
are more likely to be compensated and potentially hired as contractors by the
Ethereum Foundation. In Bitcoin, core developers are more likely to be volunteers or
work for donations. Occasionally, permissionless networks offer grants or "bug
bounties" to the public for identifying code vulnerabilities.
Nodes
Fundamentally, a blockchain is a network of nodes—computers running blockchain
client software. Blockchain nodes maintain the state of the shared ledger. Stated
differently, nodes "ensure that everyone interacting with the blockchain has the same
data" (Ethereum.org, 2023a). This maintenance generally involves storing the history
of the blockchain and updating the blockchain when new transactions are processed
and when blocks are appended. Individuals and consortiums running nodes are
called operators. Node operators constitute a key permissionless network
governance stakeholder. To be effectuated on permissionless blockchains, proposed
source code changes must be accepted and implemented by node operators.
Bitcoin and Ethereum have different types of nodes that can be categorized
according to the data they store and the function they serve. A "full" node locally
stores and verifies the validity of blocks and blockchain transactions (Bitcoin.org,
2023; Ethereum.org, 2023a). An "archival" node is a full node that maintains the
entire history of the blockchain (Bitcoin.org, 2023; Ethereum.org, 2023a). Partial
nodes, such as "light" and "pruned" nodes, store only certain parts of the information
contained in each block or a limited number of blocks (Bitcoin.org, 2023;
Ethereum.org, 2023a).
Miners and validators are also types of nodes with a specific responsibility: they
append blocks to a blockchain in proof-of-work and proof-of-stake systems,
respectively (Bitcoin.org, 2023; Ethereum.org, 2023a). In proof-of-work networks,
miners compete for the right to create new blocks by working to solve
computationally intensive cryptographic puzzles (Bitcoin.org, 2023). In proof-of-stake
systems, validators are randomly selected to create new blocks, with their odds
weighted by the amount of capital they stake (Ethereum.org, 2023a). Miners and
validators are critical for well-functioning permissionless systems, since they are
responsible for checking the validity of newly proposed transactions against the rules
of the blockchain protocol. Additionally, by executing the consensus mechanism,
they help keep the networks secure.
The core client software each node runs codifies the rules of a blockchain protocol.
Nodes can run additional software depending on their function and role. The most
popular software used by Bitcoin nodes is Bitcoin Core. In the Bitcoin network, nodes
can function within the network simply by running Bitcoin Core. In Ethereum, nodes
run separate execution and consensus clients (Ethereum.org, 2023a). The most
popular execution and consensus clients on Ethereum are Go Ethereum (Geth) and
Prysm, respectively (Ethereum.org, 2023a). Nodes that perform mining and
validation functions run additional specialized software.
Users
A permissionless network user is anyone who holds digital assets related to the
blockchain. Users are important for a permissionless system's ability to achieve
network effects, wherein the value of the network increases with the number of
participants (Wall, 2018). Users can exert pressure on governance decisions through
online forums and core developer calls. As in other decentralized governance
systems, users, as well as their node counterparts, have the ability to "vote with their
feet" if they are unsatisfied with permissionless network services or strategic
direction (Ostrom, 2010, p. 644). In networks that have "on-chain" governance,
holders of native tokens may also be able to vote for or against software
development changes directly (Wall, 2018).2 Overall, though, users face collective
action problems (Olson, 1971; Ostrom, 2007) due to their dispersed nature that can
impede concentrated influence on governance decisions.

Variations in Permissionless Blockchain Governance

The largest permissionless blockchain networks, Bitcoin and Ethereum, share many
common features, but their governance approaches are far from uniform. In
examining Bitcoin governance, De Filippi and Loveluck (2016) distinguish between
"governance by the infrastructure," which is "achieved via the Bitcoin protocol" itself
and "governance of the infrastructure," which is "managed by the community of
developers and other stakeholders" (p. 1). The former mechanism, protocol-based
governance, enforces the rules of the blockchain. But the protocol does not make
design choices, fix bugs, and pursue strategic changes. Indeed, despite their
decentralized premise, permissionless networks still need centralized structures to
govern blockchain software development.
Regarding protocol-based governance, there are meaningful differences between
the proof-of-work and proof-of-stake consensus mechanisms underlying Bitcoin and
Ethereum, including the incentive structures designed to shape miner and validator
behavior. However, the mechanisms play similar governance roles on the respective
blockchains. They enforce economic outcomes and govern what constitutes valid
transactions. Network conflicts involving overlapping block validations are generally
resolved via rule-based or tiebreaker logic. Economic disputes are largely preempted
by the protocols. As such, there are no formal dispute resolution mechanisms for
economic actors.
Differences in governance of the permissionless network infrastructures is more
complex. Both Bitcoin and Ethereum are open source software (OSS) projects with
off-chain governance. Off-chain governance refers to a system in which "protocol
change decisions happen through an informal process of social discussion, which, if
approved, would be implemented in code" (Ethereum.org, 2023b). The two networks
borrow consensus building and feedback solicitation approaches from other well-
known computing projects. Specifically, they leverage improvement proposal and
request for comments (RFC) frameworks, adapted from the Python programming
language and the Internet Engineering Task Force, respectively (Python Core Team,
2018; Internet Engineering Task Force, 2023; De Filippi and Loveluck, 2016). In both
networks, software update suggestions start out as improvement proposals before
moving onto the next phase as RFCs.
In Bitcoin and Ethereum, as in most OSS projects, anyone can typically review
source code, recommend bug fixes, and propose other enhancements. OSS
proponents argue that this continuous peer review process leads to better outcomes
than can be achieved in closed-source, proprietary software development models
(Raymond, 1999). Additionally, anyone can generally copy and modify OSS code,
though different OSS licenses spell out expectations for doing so (Weber, 2004).
While the ability to review and copy OSS code is quite permissive, making source
code modifications and accepting improvement proposals is almost always
restricted, and considerable variation exists in approaches for controlling
permissions. Two extremes that have developed in OSS projects are the
"democratic-organic structure" (De Laat, 2007, p. 170), which tends to be
meritocratic and maintain highly formalized rules and procedures, and the more
autocratic "benevolent dictator" (Weber, 2004, p. 90) model, in which the power to
make changes is concentrated in the hands of one or a small group of developers.
Historically, Bitcoin has tended toward the more consolidated authority structure. The
power to make source code modifications was originally concentrated in the hands of
Bitcoin's founder, Satoshi Nakamoto, before a small core development team took
over project maintenance in 2010, a structure that remains in place today. It has
been reported that the Bitcoin Core software is primarily maintained by five key
developers (Kiernan, 2023). Bitcoin core developers often operate under
pseudonyms and work on a volunteer basis, though they can be compensated
through donation channels, some of which are formalized.
It is less straightforward to locate Ethereum on the continuum of OSS governance
models, and we observe that the network's governance approach is evolving.
Several key differences between Ethereum and Bitcoin are clear though. Compared
to Bitcoin, Ethereum's leadership is more visible, the network is larger and more
diverse, the developer model is more conventional, and the network relies more on
its foundation for coordination. When it comes to leadership, the network's co-
founder and key figurehead, Vitalik Buterin, is public facing and has advocated
building "fair and inclusive institutions" that are "credibly neutral" (Buterin, 2020).
Regarding size, Ethereum has the largest core developer pool among blockchain
projects by a considerable margin (Electric Capital, 2023). Further, core developers
are generally known, and their work is usually compensated. The Ethereum
Foundation also plays a central role in hiring development contractors, though other
independent contributors and employees of private companies contribute to
Ethereum development as well. Notwithstanding these observations, more research
is needed to understand Ethereum's evolving governance approach.

Variations in Hard Fork Patterns: An Opportunity for Future Research

An important and understudied question in permissionless blockchain governance is
how variations in governance approaches affect patterns of change, particularly
within the context of hard forks. In blockchain networks, a hard fork is a "change to a
blockchain implementation that is not backwards compatible. Non-updated nodes
cannot continue to transact with updated nodes" (Yaga and others, 2018, p. 29-30).
Hard forks entail an update-or-leave dynamic that often drives core developers to
build consensus prior to their deployment. The backwards-incompatibility inherent in
hard forks means that node operators are faced with a decision: either they update
to stay with the network, or they get kicked out. But if the proposed change is
contentious and enough nodes elect to forgo the update, the legacy network, rather
than the updated network, could be considered the main network.
Bitcoin and Ethereum have both experienced hard forks. However, hard forks on
Bitcoin have not generally been used to implement updates or changes to the
protocol design. Instead, updates are implemented in a backwards-compatible
manner. Historical instances of hard forks on Bitcoin have created separate
blockchains with a different native cryptocurrency. These "altcoins," including Bitcoin
Cash, Litecoin, Bitcoin Gold, and Bitcoin Diamond, have had varying degrees of
success. The lack of substantive hard forks on Bitcoin that modify the main network
protocol raises at least two questions for future research. First, to what extent do
Bitcoin's governance mechanisms deter collective action on the Bitcoin network and
impede substantive change to the core Bitcoin protocol? Second, does the relative
stability of the core Bitcoin protocol lead to better network outcomes?
The Ethereum network, on the other hand, has pursued significant, coordinated
changes to the main network via hard forks. Early in its history, the majority of
Ethereum nodes accepted a hard fork in response to a major security incident, the
hack of a large decentralized autonomous organization, The DAO. A distinct minority
set of nodes refused to accept the fork and continue to maintain a separate
blockchain, Ethereum Classic, which operates under the proof-of-work consensus
mechanism. The most notable Ethereum hard fork was the Beacon Chain, where the
proof-of-stake consensus mechanism was developed and tested, and, subsequently,
The Merge, which transformed the core Ethereum consensus mechanism from
proof-of-work to proof-of-stake. Another substantive and coordinated change to the
network was Ethereum Improvement Proposal 1559, which modified how gas fees
are calculated.
The relative frequency of substantive hard forks on Ethereum, as compared to
Bitcoin, raises several questions that warrant further interrogation. First, is
Ethereum's governance framework the primary enabling factor behind these
substantive modifications to the main network? Second, is there a relationship
between the diversity of applications and services hosted on a blockchain and hard
forking propensity? Finally, does the flexibility to pursue major changes to core
permissionless blockchain protocols, as opposed to protocol stability, lead to better
economic outcomes?

Conclusion
The nature and effectiveness of permissionless blockchain network governance are
important areas of inquiry for scholars and policymakers seeking to understand the
potential role of permissionless networks in the digital economy. This note provides a
primer on key stakeholders in permissionless systems, focusing on developers,
nodes, and users. Further, it compares governance approaches between the largest
permissionless systems, Bitcoin and Ethereum, and highlights variations in hard fork
patterns between these systems. In doing so, we call on scholars and policymakers
to further explore the interaction of permissionless network governance and models
of change.

References
Beck, Roman, Christoph Müller-Bloch, and John Leslie King (2018). "Governance in
the Blockchain Economy: A Framework and Research Agenda." Journal of the
association for information systems 19, no. 10:
1, https://doi.org/10.17705/1jais.00518.
Bitcoin.org (2023). "Bitcoin Developer: Developer Guides," accessed October
11, https://developer.bitcoin.org/devguide/index.html.
Buterin, Vitalik (2020). "Credible Neutrality As A Guiding Principle," Nakamoto,
https://nakamoto.com/credible-neutrality/.
De Filippi, Primavera, and Benjamin Loveluck (2016). "The invisible politics of
bitcoin: governance crisis of a decentralized infrastructure." Internet policy review 5,
no. 4, https://doi.org/10.14763/2016.3.427.
De Laat, Paul B. (2007). "Governance of open source software: state of the art",
Journal of Management & Governance 11(2), pp. 165-
177, https://doi.org/10.1007/s10997-007-9022-9.
Electric Capital (2023). "Developer Report," accessed October 13,
https://www.developerreport.com/.
Ethereum.org (2023a). "Ethereum Development Documentation," accessed October
11, https://ethereum.org/en/developers/docs/.
Ethereum.org (2023b). "Introduction to Ethereum Governance," accessed October
11, https://ethereum.org/en/governance/.
Glaser, Florian (2017). "Pervasive decentralisation of digital infrastructures: a
framework for blockchain enabled system and use case analysis." Proceedings of
the 50th Hawaii International Conference on System
Sciences. https://aisel.aisnet.org/cgi/viewcontent.cgi?article=1204&context=hicss-50.
Internet Engineering Task Force (2023).
"RFCs," https://www.ietf.org/standards/rfcs/ (accessed May 2023).
Kiernan, Paul (2023). "Bitcoin's Future Depends on a Handful of Mysterious Coders,"
The Wall Street Journal, February 16, https://www.wsj.com/articles/bitcoin-core-
maintainers-crypto-7b93804.
Krause, Solvej, Harish Natarajan, and Helen Luskin Gradstein. (2017). "Distributed
ledger technology (DLT) and blockchain." World Bank Group: Washington, DC,
USA. https://openknowledge.worldbank.org/server/api/core/bitstreams/5166f335-
35db-57d7-9c7e-110f7d018f79/content.
Lumineau, Fabrice, Wenqian Wang, and Oliver Schilke (2021). "Blockchain
governance—A new way of organizing collaborations?." Organization Science 32,
no. 2: 500-521, https://doi.org/10.1287/orsc.2020.1379.
Olson, Mancur (1971). The Logic of Collective Action: Public Goods and the Theory
of Groups. Harvard Economic Studies: 124. Harvard University Press.
Ostrom Elinor (2010), "Beyond Markets and States: Polycentric Governance of
Complex Economic Systems." American Economic Review, Vol. 100, No. 3: 641-
672, https://www.jstor.org/stable/27871226.
Ostrom, Elinor (2007). "Collective Action Theory," in C. Boix and S. Stokes (eds),
Oxford Handbook of Comparative Politics (Oxford: Oxford University Press).
Pelt, Rowan van, Slinger Jansen, Djuri Baars, and Sietse Overbeek (2021). "Defining
blockchain governance: a framework for analysis and comparison." Information
Systems Management 38, no. 1: 21-
41, https://doi.org/10.1080/10580530.2020.1720046.
Python Core Team (2018). "PEP 13 – Python Language
Governance," https://peps.python.org/pep-0013/#the-core-team.
Raymond, Eric S. (1999). "The Cathedral and the Bazaar." Knowledge, Technology
& Policy 12, no. 3: 23-49, https://doi.org/10.1007/s12130-999-1026-0.
Wall, Larry D. (2018). Blockchain Challenges and Governance. Center for Financial
Innovation and Stability. Federal Reserve Bank of
Atlanta. https://www.atlantafed.org/cenfis/publications/notesfromthevault/07-
blockchain-challenges-and-governance-2018-07-30#_edn14.
Weber, Steven (2004). The Success of Open Source. Harvard University Press,
2004.
Yaga, Dylan, Peter Mell, Nik Roby, and Karen Scarfone (2018). "Blockchain
Technology Overview." U.S. Department of Commerce: National Institute of
Standards and Technology, Internal Report
8202, https://doi.org/10.6028/NIST.IR.8202.

1. The views expressed in this paper are solely those of the authors and should not
be interpreted as reflecting the views of the Board of Governors or the Federal
Reserve System. The authors would like to thank David Mills, Sonja Danburg, Jillian
Mascelli, and Sarah Wright of the Federal Reserve Board for their review. Return to
text
2. "On-chain" refers to activity that happens on the blockchain network where the
data is appended as a record of the blockchain. "Off-chain" refers to activity that
occurs outside the blockchain and it is not formally recorded on the network. Return
to text
Please cite this note as:
Seira, Amber, Jeffrey Allen, Cy Watsky, and Richard Alley (2024). "Governance of
Permissionless Blockchain Networks," FEDS Notes. Washington: Board of
Governors of the Federal Reserve System, February 09, 2024,
https://doi.org/10.17016/2380-7172.3443.
Disclaimer: FEDS Notes are articles in which Board staff offer their own views and
present analysis on a range of topics in economics and finance. These articles are
shorter and less technically oriented than FEDS Working Papers and IFDP papers.
Last Update: February 09, 2024