Corrupt Governance? What We Know About Recent EOS Scandal | Crypto

This week, EOS found itself in hot water after allegations arose that a major part of its blockchain governnance, led by Chinese crypto exchange Hubobi may be involved in a corruption scheme. EOS’ parent company and Huobi have issued public statements since these allegations, but refrained from admitting or denying the charges.

What is EOS?

EOS.io is a blockchain-powered smart contracts protocol for the development, hosting, and execution of decentralized applications (dApps). It aims to operate in a way similar to the web-based applications and retains similar structural principles, which makes it comparable to Google’s Play Store or Apple’s App Store.

EOS.io is supported by the native cryptocurrency EOS, currently the fifth largest crypto by total market cap. Those tokens could be staked for using network resources either for personal use or leased out for developers use — as per the project’s whitepaper, dApp developers can build their product on the top of the EOS.io protocol and make use of the servers, bandwidth and computational power of EOS itself, as those resources are distributed equally among EOS cryptocurrency holders. Hence, EOS.io attempts to represent a decentralized alternative to cloud hosting services.

The EOS.io platform was launched in June 2018 as open-source software. Its first test nets and the original whitepaper emerged earlier in 2017. The platform was developed by block.one, a startup registered in the Cayman Islands and lead by Daniel Larimer and Brendan Blumer.

EOS holds the absolute record in terms of funds raised during initial coin offerings (ICOs): it has managed to gather around $4.1 billion worth of investments, or about 7.12 million Ethereum, after fundraising for nearly a year. Its predecessor, messenger Telegram, has raised less than half this much – $1.7 billion.

Who are ‘block producers’?

EOS employs a consensus model called Delegated Proof-of-Stake (DPOS). That means that its investors are rewarded with voting power and decide who gets to mine the EOS blockchain.

Indeed, the EOS network is constantly governed by a total of 21 block producers (BPs). Those are decentralized bodies who, well, produce the blocks of EOS blockchain — just like miners do within the Bitcoin’s (BTC) blockchain. In reward, BPs earn EOS tokens produced by inflation. The total inflation of EOS tokens is reportedly 5 percent, only 1 percent of which goes to BPs.

Whilst BPs have the option to keep the tokens, they are also encouraged to reinvest them “to create better infrastructure growth, better community and financial support, along with better education on the EOS network and EOS dApps”, as blockchain analyst and tool builder Ben Sigman explains in a Medium post.

What does ‘mutual voting’ mean? Nuances of blockchain governance

BPs are elected through the voting system since June 2018, when the mainnet went online. EOS’s total supply is set at 1,000,000,000 (1 billion), and the EOS main platform was fully activated, or handed over to the community, when 15 percent of total circulating supply had voted. That occured on June 14, when 21 EOS block producers primarily from the US, China, and South America came ahead in the voting race. The voting process with EOS is constant — that means that the top 21 is fluid and BP candidates who earn enough votes can replace the BPs in power any minute.

The supposedly democratic voting system soon showed its flaws: for instance, cryptocurrency exchange Bitfinex secured its position as a block producer allegedly due to the votes of just few EOS holders, one of which accounted for 27 percent of all votes for Bitfinex, as community members pointed out on Reddit.

‘Mutual voting’, in turn, would imply a process when block producers are voting for each other in order to remain in power and keep their passive income – according to some estimations, top three EOS BPs earn around 1000 EOS per day. That process violates Article IV of the current EOS Constitution titled “No Vote Buying”, which states the following:

“No Member shall offer nor accept anything of value in exchange for a vote of any type, nor shall any Member unduly influence the vote of another.”

Moreover, the EOS voting system seems to be designed for casual users who vote with their private wallets, whilst investors who have their EOS tokens on exchanges’ wallets appear to be stripped off of their voting rights — instead, they are passed over to the exchanges who hold their tokens. While Bitfinex has attempted to introduce a scheme that would allow its customers holding EOS to participate in the voting, other exchanges have remained inactive on the matter.

This problem was recently discussed by members of Chinese EOS Community, who argued whether exchanges should be allowed to vote with customer funds. As per the meeting notes posted in English, “general consensus was mixed between yes and no, but favored yes with the caveat that all voter participation must be increased [… and] exchanges should be expected to provide greater transparency to their voting selection process”.

The allegations: geopolitical conspiracy

The allegations were originally raised by Eosone, a non-profit supervisor of BPs and builder of EOS ecosystem who regularly reports on BPs’ activities. On September 26, Eosone posted what it claims was an Excel spreadsheet of the large Chinese cryptocurrency exchange Huobi, currently the fifth largest exchange by reported volume globally per Coinmarketcap, that was allegedly leaked by its former employee Shi Feifei.

The supposedly leaked document includes four tables with titles “node mutual voting table” and “node income statement” among them. Eosone implied that chief EOS BPs, including Huobi, which is bthe fourth largest BP in current producer ranking, according to EOS Titan data, were involved in mutual voting along with pay-offs.

According to the explanation of Twitter user and EOS investor Maple Leaf Capital, who summarized the document’s findings in English, Huobi voted for 20 other BPs, and 16 of them voted back for Huobi. Moreover, Huobi allegedly voted for three other BPs in exchange for significant paybacks:

“Huobi votes for eosiosg11111, cochainworld, and eospaceioeos in exchange for 170, 150, and 50 percent of the returns respectively…”

Maple Leaf Capital also argued that such agreements could “increasingly compromise the integrity of the network,” noting that at least 12 of 21 major BPs were controlled by Chinese entities:

“This file documents the collusion, mutual voting, and pay-offs that occur amongst the Chinese BP community.”

Thus, Maple Leaf Capital essentially accused a number of Chinese companies of forming a cartel to collude together, adding:

“I view such action with utter disgust, and there is a reason why our Mapleleafcap proxy only votes for a very selective [sic] group of Chinese BPs.”

Furthermore, the Twitter user linked the alleged mutual voting with the recent promotion of Huobi Pool Token (HPT,) which shared tokens with users in exchange for locking their EOS on Huobi. The Chinese crypto exchange might then capitalize those votes, Maple Leaf concluded.

EOS response: neither confirmed nor denied

On October 1, Block.one’s CEO Brendan Blumer published a statement addressing EOS public blockchain governance problem. In it, he neither confirmed nor denied the allegations, stating his company is “aware of some unverified claims regarding irregular block producer voting, and the subsequent denials of those claims”.

Without specifying which “denials” of allegations he referred to, Blumer stated that EOS will continue to “ensure a free and democratic election process and […] vote with other holders to reinforce the integrity of this process”:

“We continue working on our potential involvement with the goal of empowering the intent of the greater community through a transparent process that incorporates community feedback.”

Huobi response: investigation is required

On October 2, Huobi responded to the accusations. In a brief statement, the exchange said an investigation into the allegations was “still ongoing”:

“Based on the initial investigation, there were no financial contracts involved between Huobi and any third party… The investigation is still on-going [sic] and therefore, we seek your patience and co-operation [sic] in this matter.”

Previously, on September 26, Danny Wu, Senior Manager at Huobi Pool, defended against the allegations on Telegram, claiming that the document in question was faked by their former employee.

Community backlash and Vitalik’s “I told you so” 

Expectedly, the alleged Huobi spreadsheet provoked a major backlash in the EOS community and beyond.

EOS Alliance, an non-profit organization formed by EOS community members and block producers with the role to “facilitate the dialogue within community”, has released a statement on the situation:

“Dan Larimer’s Delegated Proof of Stake (DPOS) was designed with the requirement that 15 of 21 independent votes are required to operate the network securely. If, as some alleged recently, some current Block Producers are coordinating together, this might call into question the transactional reliability of the EOS blockchain data for all users and the attractiveness of EOS as a platform for dApps.”

Additionally, EOS Alliance stressed that “there are geopolitical considerations, given that Chinese corporations and investors are potentially being demonized, and the consequences in China might be more dire for the individuals involved than they would be in other countries”.

The community’s reaction on EOS’s official Reddit channel seems mixed. “I don’t find that surprising giving the governance model of EOS.”, wrote user bhiitc. “If you optimize your system under the assumption that most players aren’t malicious and thus reduce the number of nodes for more transactions per seconds, such an outcome like this was likely”.

Ethereum co-founder Vitalik Buterin commented on the aforementioned thread started by Maple Leaf Capital, arguing the vote-trading was “completely predictable”:

“Interesting! I mean, it was completely predictable and I did predict it,  but I did not expect it to happen so thoroughly and so soon!”

Buterin also criticized the very system of EOS nodes:

“As a followup, *this* is why I do not believe in coinholder-voted on-chain treasuries. Any chain where coinholder-voted on-chain issuance is used to supposedly fund public goods can easily collapse into this kind of ‘I vote for your crappy project, you vote for mine’ equilibrium.”

Interestingly, the Ethereum co-founder has criticized the EOS voting system before. In August 2017, Buterin clashed with EOS’ Daniel Larimer after he responded to an Ethereum Reddit thread post claiming that EOS was superior to Ethereum in terms of number of transactions and flexibility.

In his comment, Buterin mentioned that EOS’s reliance on voting, among other features, is problematic, and the scenarios where “exchanges would vote on users’ behalf, with users not really caring how exchanges vote with their money” were “likely to happen”.