As has been widely reported, in the last few months ICOs have raised significantly more money for blockchain startups than has come from traditional venture investors. This can be seen as a sign of the long discussed unbundling of venture capital. The idea is that while VCs bundle capital, advice, governance and possibly services (e.g., help with recruiting), technology may make it possible to separate out these different functions. Today I want to focus on “governance” which is the least understood, and I believe most difficult to accomplish, of these functions.

What is governance? The word, like “government,” comes from the Greek word for “to steer.” It stands for the decision making bodies and processes that steer a company, a protocol, or a country. 

Why is governance needed? Because we (a) cannot in advance specify the right course of action for all possible contingencies and (b) for many of those contingencies there is not a single, obviously optimal action to take. That’s often the case because actions will impact different constituents differently. The role of governance, of steering, is to help choose an action at those moments.

What are examples of governance issues? In companies, these include events such as fundraising, considering an M&A offer, replacing a CEO. The need for governance in a company tends to be relatively limited because the CEO has a lot of discretionary power. In contrast, protocols completely describe the activities of participants and so almost any change to the protocol turns into a governance issue. 

People have written about governance once a protocol is up and running, including different mechanisms for triggering (or avoiding) forks. But the issue I want to focus on instead is the question of governance post ICO and pre-protocol launch. How should the allocation of funds be steered?

For a lot of projects the answer appears to be that funds can be spent on whatever the founding team deems appropriate without any additional governance mechanism. This is akin to a company without a board or a board that’s controlled by the CEO. Other projects have set up foundations that control some of the ICO proceeds with an independent board as a governance mechanism.

Governance will turn out to be important here because there are so many allocation decisions to be made (several projects have raised north of $100 million). And those decisions not only don’t have obviously right answers but also come with the potential for self dealing, starting with determining salaries for team members. 

Now VCs role in governance of companies is not perfect either. There are lots of potential conflicts of interest. For instance, investor board members may want to accept (or reject) an M&A offer that management wants to reject (or accept) because their economics are quite different. And there are of course plenty of examples of VCs not exercising their governance role.

Nonetheless, the right answer is probably not doing away with governance altogether. I recommend to all the projects that have raised money through ICOs to put some kind of governance structure in place before spending a lot of the funds. It will be important for that mechanism to not just include investor and founder interests, but to also reflect community members, the people who are ultimately supposed to benefit from the protocol.