Rethinking Decentralization 

Decentralization gave Web3 its original sense of purpose.

In the last cycle, it was not only a philosophical commitment but also a practical shield: in the United States and other major markets, being “sufficiently decentralized” once helped projects avoid both punitive taxation and the risk of being treated as a regulated security issuer.

That landscape has changed.

Since IRS Notice 2014-21 and follow-on guidance clarified that virtual currency is taxed as property, and with the SEC now focusing on how tokens are marketed rather than on a vague “sufficiently decentralized” test,² the automatic legal or tax penalty for operating a centralized software company has largely disappeared.

Foundations that once feared catastrophic treatment for holding core IP can now incorporate, pay taxes, and engage regulators without incurring extraordinary liabilities.

The New Question for Layer-1 Leaders

If the old “stick” for decentralization has weakened, why pursue it?

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Today there are really three strategic reasons to be decentralized:

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1. Security: a broad validator set makes it hard to compromise the network or censor transactions.
   
   
2. Limiting legal liability: distributing control can still reduce exposure of any single entity, even if the legal requirement is softer.
   
   
3. Philosophical ideal: the conviction that an open, user-owned network is the right way to build public infrastructure.
   
   

These motives are legitimate.

But over the past cycle we have also seen that decentralization pursued to its theoretical extreme can turn from strength into liability.

Decision cycles lengthen, accountability blurs and a small group of whales can quietly dominate outcomes.

The very trust decentralization set out to build begins to erode.

The question for L1 boards is no longer “How decentralized must we be?” but:

“Which of these motives actually justifies our decentralization, and how far should we go before the costs outweigh the benefits?”

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Lessons from the Last Cycle

Polygon 2.0: From Ideal to Institutional Readiness

In October 2023 Polygon Labs proposed PIP-29 to create a 13-member Protocol Council charged with system-level upgrades.

Two paths were built in: a regular upgrade track requiring seven signatures with a ten-day timelock, and an emergency track requiring ten signatures and no timelock.

The change coincided with Polygon’s “2.0” architecture, which merged its PoS chain with the zkEVM ecosystem while signing enterprise partnerships with brands like Nike and Reddit.

Critical upgrades across multiple chains demanded a governance model that could act at institutional speed.

Polygon kept decentralization as a security feature, but introduced professional oversight to avoid the bottleneck of pure token-holder voting.

ENS DAO: Guarding Against Hidden Centralization

ENS launched its DAO in 2021 to place control in token-holder hands.

Soon after, analysis showed the top 1 % of holders controlled roughly 62 % of voting power (Gini coefficient ~0.89).

To counter this concentration, ENS created an eight-member Security Council with a limited veto mandate and a sunset clause.

The DAO preserved its philosophical commitment to user ownership while adding the institutional safeguards needed for credibility.

Bitcoin’s Blocksize War: Philosophy Without Process

Between 2015 and 2017 the Bitcoin community fought over whether to increase block size to allow more transactions.

With no formal mechanism to break the deadlock, debate stretched for years and ultimately split the chain when Bitcoin Cash forked off in 2017.

It remains a cautionary example of how full decentralization, without well-designed governance, can paralyze progress and fracture a network, proof that philosophy alone cannot guarantee operational success.

Strategic Takeaways for L1 Executives

• Identify your primary motive for decentralization.
  – If it is security, design governance for resilience and rapid emergency response.
  – If it is limiting legal liability, focus on transparent, well-documented decision rights that satisfy regulators.
  – If it is the philosophical ideal, show how broad participation will remain meaningful as the network scales.
  
  
• Recognise that complete decentralization can become a bottleneck.
  Without tiered decision processes and clear escalation paths, upgrades stall, emergency fixes lag, and investor confidence fades.
  
  
• Decide what kind of organisation you want to be.
  With the old tax and regulatory pressures diminished, you are free to operate as a streamlined software company where decentralization is primarily a technical safeguard, or as a retail-funded public network where governance is itself the product.
  
  

Signal your strategy.
Institutional capital and enterprise partners now evaluate governance alongside technology. Whether you lean toward efficiency or toward utopian community ownership, articulate it and back it with visible governance processes.

Decision Lens for Boards and Foundations

When your foundation or board next reviews governance, start with a single question:

Which of the three motives, security, liability management, or philosophical mission, justifies our decentralization today, and how do we prevent that decentralization from becoming the very bottleneck that slows us down?

Your answer will dictate the need for emergency powers, the role of legal entities, the level of token-holder influence, and, ultimately, how your network competes for capital and developer trust in the next market cycle.

Moving Forward

The decentralization ideal gave Web3 its early identity, but both the external incentives and the internal costs have changed. 

Governance is now a deliberate strategic design choice. 

Chains that can clearly state their reason for decentralization, and ensure that their governance model delivers both resilience and operational speed, will be the ones that win developer trust, attract institutional capital and define the next phase of Web3 adoption.

STORM Partners works with leading Layer-1 protocols to design governance models that satisfy regulators, protect security, and preserve the community trust that decentralization was meant to build.

Whether your next step is to incorporate a legal wrapper, draft a MiCA-compliant white paper, or re-architect on-chain voting to avoid hidden centralization, our legal and strategy teams can guide you through the trade-offs.

If your board is beginning the conversation this article outlines, we invite you to speak with us about how to align your governance with the next phase of Web3 adoption.

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² IRS Notice 2014-21 established that virtual currency is treated as property for tax purposes; subsequent guidance and the 2021 Infrastructure Investment and Jobs Act introduced standard reporting obligations without creating special punitive treatment.

Since 2021, SEC enforcement actions have focused on how tokens are offered and sold rather than on a “sufficiently decentralized” test.

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