Governance Structure for Blockchain Networks

Developing a Governance Structure for Blockchain Networks

A well-structured governance is crucial for a successful business, driving excellence in performance and culture. Governance concerns rules of engagement for the greater good and fairness within a system, encompassing rules and decision-making processes. Exceptions to rules are inherent, making coordinated decision-making a core aspect of governance. Consensus mechanisms enforce governance through equitable participation, often using economic incentives in trust systems. In some instances, reputation systems combined with consensus ensure integrity in participation.

Whether self-governing or semi-autonomous, the governance of a blockchain business network defines a comprehensive set of rules agreed upon by participants to ensure trust, transparency, control, and coordination throughout the network's lifecycle—from design and development to testing, deployment, and operation. Governance affects interactions across the blockchain network.

Governance Across a Blockchain-Based Business Network

In permissioned networks, governance is a design imperative and must be flexible enough to adapt to ecosystem and membership changes and shifts in the business model. Technology must support the dynamic nature of the governance structure, allowing for the least disruptive path to collective decision-making among network participants. Governance is integral to a sustainable network, posing collective challenges on both process and political fronts. Governance models range from self-governing networks to consortium-defined, semi-autonomous structures. Finding the right governance model to support the agenda of blockchain-based business networks presents both opportunities and challenges. Governance presents an interesting paradox in the blockchain context.

Consider a self-governed, censorship-resistant blockchain value network with a governance structure defined by control points and economic incentives to balance network-based coordination and decisions on transaction finality. Consensus algorithms in decentralized networks offer a distributed governance structure where input (transaction initiation) comes from various stakeholders (asset owners, assigned/delegated ownership, or delegated authority). This input involves a transaction undergoing decentralized processing, with the output being a decision on transaction finality. The governance structure is based on economic incentives driven by consensus.

Governance is defined as the body (centralized or decentralized) responsible for making binding decisions by establishing laws or rules. Blockchain's genesis relied on technology-based systemic governance, featuring incentives and coordination mechanisms, as seen in permissionless, crypto-asset-based networks like Bitcoin and Litecoin. However, this systemic governance poses challenges for enterprise business networks using blockchain technology.

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In the enterprise world, which is largely regulated and relies upon permissioned blockchain models, the checks-and-balances system is complicated by transactions between competing entities. These transactions often involve regulated data and fiduciary responsibilities, which cannot account for tangible or systemically generated incentives (crypto assets) or have network-wide mechanisms of coordination due to privacy and confidentiality issues. The focus for enterprises should be on understanding the technology and reimagining ecosystems, business networks, regulatory compliance, confidentiality, privacy, and business models that impact industry networks. The governance structure is an interesting challenge and emerging discipline in this environment.

In the enterprise blockchain world, the options range from full decentralization and quasi-decentralization to fully centralized blockchain networks, with the specific choice hinging on the governance structure. The governance structure and landscape determine the interaction models, means of growth (centralized or decentralized), technology design, and overall business operations of the enterprise blockchain network.

Differences Between Permissionless and Permissioned Blockchain Networks

A blockchain-powered business network as a digital transaction platform can facilitate the co-creation of new value and synergies. It is a managed platform operated with a defined service level agreement (SLA) and a robust governance structure that attracts new participants and sustains the confidence and business benefits of its founders and existing participants. It has a close-knit dependency on the business models and governance structure that oversee various facets of blockchain network operations. A well-thought-out governance structure for blockchain networks provides an important avenue for business continuity, funding and sourcing models, and overall growth, which is driven by the economic and financial structure of the business network and powered by the tenets of blockchain technology.

Systemic governance that relies solely on incentives and network coordination is inadequate for highly structured and regulated industries and their use cases. A governance structure and landscape that uses known and proven existing practices is needed.

The resulting model is modular and facilitates progression, yet also provides a layer that separates the competency concerns of the various participants. This framework aims to define a simplified governance framework that draws inspiration from the core tenets of blockchain design and incorporates a governance model that encompasses principles of game theory, incentives, penalties, flexibility, delegation, and network mechanisms of coordination. This framework uses blockchain technology to trust networks and flattens the distinction between the miner and the user. At the same time, it enforces rules of engagement that encourage technology upgrades and security updates and penalize noncompliant systems and nodes, including similar business network rules of engagement. The incentive mechanism is intended to ensure continued participation and resulting business benefits and growth for members of blockchain-powered business networks. This business governance model governs participation in business networks and an equitable cost structure that is fairly spread out among network members based on participant activity.

The three primary building blocks of a blockchain business network are:

1. Technology infrastructure governance

2. Network membership governance

3. Business network governance

Technology Infrastructure Governance

Technology infrastructure governance focuses on IT infrastructures, performance, cost structures, technology, and business risks. It includes collaborative tools, processes, and methodologies intended to ensure organizational alignment of the business strategy with the technology infrastructure and services. The goal is to support, adapt, and complement the blockchain business network’s objectives. In a blockchain network, these tasks can be challenging because the governance framework should focus on specifying an accountability framework to encourage necessary behavior.

The functioning of the IT infrastructure that enables deployment and operation is defined as the foundational layer of the blockchain network. Many best practices frameworks, such as Information Technology Infrastructure Library (ITIL) and Governance, Risk, and Compliance (GRC), have laid a strong foundation for blockchain networks to build upon and create a blockchain-specific technology governance structure. Any technical design should accommodate the flexibility of various participants when it comes to choices related to technology and infrastructure. Blockchain networks will generally aim for certain levels of decentralization or quasi-decentralization. In turn, IT governance should accommodate a model that supports distributed flexibility and distributed control.

Technology governance–related tasks include:

1. Devise a decentralized IT management structure.

2. Devise a model for distributed (and decentralized) maintenance, including software and hardware updates, upgrades, and path management.

3. Devise a framework that uses industry standards, such as COBIT, ITIL, ISO, CMMI, and FAIR, that are driven by the consortium, joint venture, or other business model.

4. Establish industry-specific governance, risk, and compliance (GRC) tools.

5. Perform consortium resource optimization, which includes choices related to technology procurement, supplier–vendor relations, SLA management, skills, and talent management.

6. Perform technology adoption and risk assessment, which requires keeping up with technology evolution and economic deployment models, including deployment and operational risks.

7. Devise a network deployment strategy. This task is not as simple as an application upgrade. Include a model that can encourage and enforce continual technology and security updates and upgrades.

8. Set up network support services, which are business networks. The governance model should include network support services, IT SLA enforcement, and membership services.

9. Perform consortium risk optimization, which includes operational support services (OSSs) and business support services (BSSs), IT infrastructure continuity services and planning, and technology alignment to legal and regulatory requirements, among other factors.

The IT governance model should encourage technology upgrades and security and penalize noncompliant systems and nodes, so as to create an incentive mechanism to ensure continuous participation.

Network Membership Governance

The model of network governance in a blockchain network reflects the fact that the network is organic and composed of ecosystem players with varied business interests. It is an interactive ecosystem with common business objectives instead of a bureaucratic structure with a centralized business entity. This model imposes extraordinary challenges on network members to maintain the balance of smooth business operation and the enforcement of engagement rules within the operating framework. In many consortium-led business structures, network governance might involve a select set of autonomous entities that are engaged in creating value, services, and digital goods, and it might use smart contracts and the blockchain as a marketplace mechanism to coordinate and safeguard the exchange of value. Therefore, the business model plays a critical role in increasing the efficiency of the operating model and reducing agency problems due to defined rules of engagement associated with both rewards and penalties. These business governance models govern participation in business networks and create an equitable cost structure that is fairly distributed among members based on participant activity. Their structure enables autonomous and like-minded business entities to engage in business transactions, contracts, and value creation.

To ensure smooth operation of the blockchain, the governance structure should include rules of engagement and social contracts that promote fair behavior and reputation systems to enforce it.

Blockchain network membership governance–related activities include:

1. Membership onboarding and offboarding:

   The permissioning structure and key management can include a model that has the following qualities:

   a. Vote-driven but centrally managed
   b. Has a federated structure in which members invite other business entities to join the network
   c. Has a delegated structure that includes services providers that can delegate to other members

2. An equitable and fair cost structure.

3. Consortium-wide data ownership structure for business entities joining and leaving the network.

4. Compliance assurance services for industry-specific regulatory oversight provisioning, which includes a model to act as a delegate to generate regulatory compliance, adherence, and reporting.

5. A dispute resolution charter for the network.

6. Coordination and direction of the technology infrastructure and management.

7. Business network and SLA management for the blockchain business

8. Network support services: Business networks. The governance model should include network support services, business network SLA enforcement, and membership services.

9. Network-specific risk optimization: A business support services structure that includes business continuity services and planning, network alignment to legal and regulatory requirements, and other items.

Business Network Governance

Business networks that are powered by blockchain need a governance model that is industry- and use case–specific. Also, these networks must account for various facets of the industry itself, as well as its evolution—including the change in overall governance structure. Blockchain is an important form of multi-organizational governance. Its core objective is to increase operational efficiency and reduce hurdles imposed by the agency (centralized business entity). The efficiency is enhanced by distributed data, asset- and value-related decision making, and decentralized problem solving through trust systems and consensus.

The term shared governance is often used to describe a business activity that collectively represents an industry to the various external ecosystems, such as adjunct business networks, and governmental and regulatory entities. This collective representation has advantages such as sharing of the business process costs and the market benefits conferred by arbitrage, brokerage, and attracting new ecosystem players.

One key goal of business network governance is to manage the growth of the network while maintaining the SLA and core business objectives. The governance structure includes a wider understanding of network functions, with these collective functions by various participants then leading to network outcomes. As blockchain networks evolve and grow and as new participants are added or removed, the dynamics of the network change, and both bilateral and multilateral relationships may emerge.

Co-creation is a concept that brings different parties together (e.g., a company and a group of customers) to jointly produce a mutually valued outcome. Co-creation gathers a unique blend of ideas from direct customers or viewers (who are not the direct users of the product), which then leads to a plethora of new ideas for the organizations that represent the consortium. Ideally, business network governance imperatives will seek to balance the growth and cultivate the synergies between the ecosystems so as to transform the business network by adopting new business models.

Business network governance–related tenets include the following items:

• Communication and notification: Network-related charter and communication.

• Synthesis of transaction costs and economies of scale: Common and shared services management, such as know your customer (KYC), audits, reporting, network operations, IT infrastructure, and flattened business processes.

• Business SLAs: Quality assurance, performance, and network security.

• Favorable exchange conditions: Integrity of digital assets, asset specificity, supply and demand uncertainty, and product and business network evolution.

• Collective representation: Enforcement of industry-specific compliance legal and regulatory frameworks.

• Structural embeddedness: Adherence to industry-specific requirements for trusted movement of assets and value in the network.

• Federated governance framework: Framework, charter, and stewards of technology and network membership governance frameworks.

• Business structure: Formulation of appropriate business models, legal charters, and rules of engagement for network business operations.

Development of Governance Structure

Development of governance structure is a challenging and emerging discipline in the enterprise blockchain world, where the debate around the spectrum of options—which range from full decentralization and quasi-decentralization to fully centralized blockchain networks—hinges on the governance structure selected. The governance structure and landscape determine the interaction models, growth (centralized or decentralized), technology design, and overall business operation of enterprise blockchain networks. The platform that facilitates co-creation and new synergies must be effectively managed, operate under the aegis of defined SLAs, and have a robust governance structure that attracts new participants and sustains the confidence and business benefits of its founders and existing participants. There is a close-knit dependency between business models and governance structures that govern various facets of blockchain network operations. A well-crafted governance model will ensure balance and smooth interactions between various entities that compete with some network participants and that cooperate and co-create with some other network participants. Although blockchain networks are decentralized by nature, the governance structure is fundamentally driven by the type of the business model (including business participants, outcomes, and incentives) that you are considering for your blockchain business network.

Potential models include a joint venture, consortium, NewCo, business ecosystem, founder-led network (build, own, and operate), or founding consortium–led network (build, own, operate, and transfer). In addition, governance models can be self-governed or semi-autonomous, managed off-chain or on-chain. Off-chain means that governance rules and policies are managed outside the blockchain; that is, after they are reviewed and approved, they are implemented on blockchain. On-chain means that governance policies and rules are managed by using smart contracts and consensus algorithms within the blockchain.

SCTrustNet

The SCTrustNet network is intended to bring end-to-end visibility, trust, transparency, and transformation to a consortium-led business model of an enterprise supply chain network, which consists of various participants including suppliers, buyers, banks, shipping carriers, freight forwarders, and regulators (custom and port authorities). The transformational business outcomes are expected to reduce cost, complexity, and latency across supply chain transactions and network.

The SCTrustNet governance structure is organized into three primary areas: business network, network membership, and technology infrastructure.

Business Network Governance

The supply chain business-specific legal and financial policies and rules are governed and managed by the business network governance structure. They include the following items:

• A unified charter includes the overall network’s business outcomes, participants’ contributions (costs, resources, and ecosystem), and their incentives (visibility, control, efficiency, and monetary rewards) in SCTrustNet.

• The agreed business model is a consortium-led ecosystem with a set of founding members (three suppliers, three buyers, two banks, and a shipping line carrier) and nonfounding members (freight forwarders and custom and port authorities). Founding members can order and endorse the transaction for validation and commitment. Nonfounding members can only endorse transactions.

• Business contracts (purchase orders, bills of lading, letters of credit, bank guarantees, commercial invoices, and others) between buyers, suppliers, banks, and carriers are managed by using smart contracts.

• SLAs for shared services, such as reporting, auditing, tracking, and tracing of assets, including penalties in quality of service, are coded on-chain.

• Cross-border trader and payments regulations and compliance policies are agreed to between buyers and suppliers and added to smart contracts for transaction and fulfillment agility.

• Business operations and security principles to ensure participants’ and their data’s privacy, integrity, and performance are part of the digital supply chain network.

• Risk identification and mitigation policies are included in SCTrustNet.

Network Membership Governance

Network membership governance drives the overall membership management and governance of the network participants, network services, and related activities. It includes the following items:

• Established rules for each type of participant, the authority to invite entities to join the network, and onboarding and offboarding of new suppliers, buyers, freight forwarders, banks, carriers, and custom and port authorities

• Access and operations rights to data and transactions (purchase orders, invoices, bills of lading, and letters of credit) in the blockchain

• Membership and network participation fee structures for each type of participant and their roles

• Management of decentralized and shared network services, including track and trace, purchase order processing, and transportation

• Penalties for not delivering services and quality and neglecting the charter of SCTrustNet

• Communication policies to share the correct information with the correct participants at the correct time in the supply chain for trust and transparency

Network Infrastructure Governance

The infrastructure governance for SCTrustNet includes all the rules and regulations of the following items:

• Blockchain technology (i.e., Corda, Ethereum, and Hyperledger Fabric) assessment, selection, and deployment (public and private cloud)

• Setting up blockchain nodes (a system with a copy of the distributed ledger and connected in the network)

• Project management, test, and deployment of chaincodes (decentralized applications) for network services

• Security and access of nodes and shared services chaincodes

• Autonomous execution of incentives and penalties for infrastructure service and quality assurance, and risk management

• SCTrustNet infrastructure operations (server, storage, and network)

• Change, upgrade, and release management of the technology

• High availability, disaster recovery, and business continuity management

• Capacity, scalability, and performance management policies

• Incidence management, logging, and monitoring

Chapter Summary

Blockchain-based application networks are more than a technical project implementation. The technical aspects of the blockchain, if they are well designed by using the correct skills, can be realized with a high certainty of success. To achieve this success, we need to carry out a series of business-driven activities that ensure the correct focus, enterprise resources, acumen, and organizational energy are channeled with executive commitment. Selecting the correct use case is necessary to understand the appropriate business models and define the correct governance structure. This choice puts the focus on enterprise commitment and industry-wide influence as a means to attract other ecosystem players, which then commit to the common vision and goals of the blockchain network. The use case and resulting business economics drive the investment agenda, which enables the enterprise or consortium to focus on business models that lead to equitable and sustainable deployment and a governance structure that meets the industry-specific requirements.

Blockchain projects encompass creative strategic thinking and solve complex technology problems, which means that the correct use case must have a tight linkage between the business models and the technology blueprint. The governance model integrates a business model with the correct amount of coordination, thereby ensuring that all participants adhere to a common set of objectives, fair and equitable use of network resources, and rules of engagement.