So much has changed in the last year due in large part to a seemingly unpredictable sequence of epic market failures. Despite this, we’re still here trying to predict the unpredictable. As the dust settles from a cascade of collapses including FTX, Terra, 3AC, and many others, the direction crypto must take to become viable is now clearer. 

We find ourselves in a strange position. We built protocols that actually work under immense market pressure, showing some of the promise of decentralized systems. However, that pressure came from deeply irresponsible market manipulation and behavior. How do we make sense of the fallout, and do better.

Blockchain Regulation: it’s coming

First, this space is about to get regulated. The Digital Commodities Consumer Protection Act (DCCPA) looms in the wake of FTX’s demise and Sam Bankman Fried’s increasingly radioactive support of the bill. The DCCPA aims to give the CFTC primary jurisdiction over crypto exchanges. This would establish the commission as the authority on spot, margined and leveraged digital commodity trades. 

The bill, however, does not outline processes for classifying assets as commodities and securities. This is relevant because the Securities and Exchange Commission (SEC), which under Gary Gensler has increasingly strived for more oversight, currently qualifies most crypto, aside from Bitcoin, as a security. 

In Europe the new Markets in Crypto Assets Regulation (MiCA) aims to regulate dollar-pegged stablecoins, controlling transaction count and volume limits which, according to Reuters, are already exceeded by the three largest stablecoins, Binance USD, USD Coin & Tether. Stablecoin volume has increased dramatically over the last several years and a cap or ban could hinder the crypto ecosystem overall. Crypto regulation and the conversations around asset classifications, regulatory purview, and stablecoin usage will be defining battlegrounds in 2023. 

Decentralization: yes it matters

Increasing regulatory pressure will force crypto projects to re-focus on achieving actual decentralization; not just to avoid legal consequences but also to empower more equitable and effective on-chain governance. Although there is no official guidance from the SEC, commissioner Hester Pierce’s Safe Harbor Proposal has served as a guiding light for those interested. The proposal suggests networks must achieve sufficient decentralization within three years, meaning networks should not be controlled by a single individual or group of individuals. 

Tokens must also be used to exchange value pertaining to the network. The token should be sold for facilitating access to, participation on, or development of the network. Essentially, if it’s a decentralized network, validators/investors/teams cannot control majority stake. If the network has a token, then the token needs to be used for something actually intrinsic to network operations–it can’t just be a fundraising vehicle.

On-Chain Governance

We’ve touched on a number of external forces impacting networks but what about internal forces? On-chain governance is rapidly evolving. Usage of proof of stake (PoS) consensus has grown over the last several years in part due to a dramatic reduction in power consumption, and also because of increased flexibility to affect significant changes to network parameters. With voting power relative to stake, stake concentrated in the hands of a few entities can present unique and potentially insurmountable challenges to achieving sufficient decentralization.

The Cosmos ecosystem is a particularly fascinating testing ground for on-chain governance. From the controversial Juno Prop 16 which resulted in on-chain confiscation of user funds, to the equally controversial Cosmos Prop 82 which put forward an entirely new paradigm for Cosmos Hub utility and ATOM value capture, the Cosmos ecosystem has been trailblazing governance processes and implementation. 

What’s at Stake?

One of the main issues we’re seeing now is the disproportionate concentration of stake. In Cosmos for instance, the top 5 out of 150 Juno validators control 25% of the network. The top 5 out of 175 Cosmos validators control 25% as well. The top 5 out of 100 Akash validators control 37%. 

In Ethereum, according to Nansen, there are 5 entities that control 64% of staked Ether. Although only 11% of circulating ETH is staked, among 426,000 validators, three major cryptocurrency exchanges account for 30% of the total staked ETH, with Lido DAO accounting for 31%. 

If the top 4-5 Validators control 1/4 of the stake and, at times more, of a network, is the network really decentralized? If an exchange like Binance or Huobi can buy up large volumes of tokens, enter the top validator slots, and through governance, make substantive changes to the network for their own benefit, is that network truly decentralized? There are valid arguments on both sides. 

There’s an argument that these networks are permissionless and any entity can engage in governance by purchasing tokens and staking them, so in theory, they are decentralized. In practice, power is often concentrated in the hands of a few entities with a majority of the tokens. 

The current Cosmos governance landscape is also fascinating because many pivotal governance mechanisms and network changes are being deliberated simultaneously. Should there be a constitution? Should there be larger deposit requirements for proposals? Should ATOM issuance be changed to fund network growth initiatives–completely repurposing the network in the process? Cosmos will continue to innovate on-chain governance. As Cosmos gains more visibility, developers will adapt components of Cosmos governance for their purposes. 

Novel Solutions to Crypto’s Most Existential Problems

As we look ahead to 2023, Laconic is well positioned to address these issues. Laconic Network leverages Cosmos technology and is run by an LLC that is designed to comply with the laws within its jurisdiction and to allow each member to comply with the laws within their jurisdiction. Geographic distribution of member validators strengthens the network's resilience to nation specific sanctions. 

Additionally each member validator is given one vote and all votes are equally weighted. This eliminates uneven distribution of voting power typically seen in delegated proof of stake networks. Laconic Network also makes it clear that Laconic Network Token (LNT) is treated as a loyalty point and for prepayment of services, and is not a security or currency. 

For more on the Laconic Network Governance model and how it addresses the fundamental issues around asset classification, token usage, PoS networks and regulation, you can check out “A New Governance Model for the New Web.” 

Crypto isn’t going anywhere, but we will need to build safer and more decentralized systems, and work within a more aggressive regulatory environment.