DAO Governance and The Future of Decentralized Institutions — VegaX Research Report
What Is a DAO?
A DAO or decentralized autonomous organization is an entity with no central authority. Decisions are made from the bottom-up, usually through a voting system, and are governed by a community organized around a specific set of rules enforced on a blockchain. DAOs are internet-native organizations that are collectively owned and managed by their members. The vast majority of DAOs have built-in treasuries that are only accessible via the approval of their members, and decisions are executed following a proposal and voting process.
Commonly, DAOs operate without traditional hierarchical oversight and can serve several purposes. Some notable DAOs include Constitution DAO which was formed in order to purchase a copy of the Constitution, BitDAO which was created by Peter Thiel with the goal of allowing anyone to participate in Web3 startup funding, LexDAO which aims to create smart contracts that are capable of carrying out legal services– the current largest DAO which is Uniswap, where users can determine the future of the financial marketplace.
How Does A DAO Work?
DAOs can feature a multitude of different structures, but this piece will outline the most widely used model. DAOs operate using smart contracts, which are essentially chunks of code that automatically execute predetermined functions once certain criteria are met. These smart contracts represent the DAO’s fundamental rules. Those with a stake in the DAO, via a token or membership signifier, get specific voting rights and can choose to influence how the organization operates by deciding on or creating new governance proposals.
The Three Steps Of A DAO Launch
- Smart Contract Creation
Smart Contract Creation
Smart contracts underwrite the functionality of seemingly every aspect of DAOs. These contracts control the governance process, funding, and treasury balancing and can execute daily upkeep in order for the DAO to operate properly. Prior to the DAO’s launch, developers must create these robust smart contracts and ensure that they function properly — once the DAO is publicly launched, the underlying smart contracts can only be altered through the public governance process. This means that the founding team must extensively test the contracts to ensure that they don’t overlook important details.
After the smart contracts have been developed and tested, the DAO must determine the best way in which to raise funds to achieve the goal or build the product that the DAO was formed to accomplish. In most cases, DAOs release tokens to the public in order to raise funds, and these tokens are used to give the community voting rights within the governance process.
Once smart contract development and funding have been completed, the DAO needs to be launched on a blockchain. From the point of deployment onward, stakeholders control the fate and future of the organization. The organization’s creators, those who wrote the smart contracts, no longer hold any more influence over the project than the stakeholders.
Why Do We Need DAOs?
DAOs are internet-native organizations that have multiple advantages over their traditional counterparts. One significant advantage of DAOs is the lack of trust needed between multiple parties. DAOs operate on smart contracts, therefore certain decisions can only be executed once necessary conditions are met in the underlying code. In traditional organizations, individuals must come to an agreement which can involve a lengthy negotiating period or may leave one side of the deal at a disadvantage. Being reliant on another individual also presents an unnecessary counterparty risk. DAOs mitigate this risk by presenting an alternative: a transparent cluster of smart contracts programmed to function in very specific ways. Trusting the code is easier to do as it’s publicly available: every decision the DAO makes after launch has to be approved by the community, which is verifiable on the blockchain.
DAOs also represent an innovative step towards full transparency and communal leadership. There is no hierarchical structure present within DAOs, yet progress and growth still occur due to stakeholder control via the native token or governance process. This lack of hierarchy levels the playing field and allows any stakeholder to put forward an insightful proposal that the entire group can consider and improve upon. Any internal disputes are then solved through the voting system where the majority rules — given the pre-written rules in the smart contract.
The main advantage of DAOs is that they offer a solution to the principal-agent dilemma. In traditional organizations, the agent or CEO may work in a way that’s not in line with the goals and objectives determined by the principal or shareholders and instead act in their own self-interest. Similarly, an agent may take an extreme risk because the principal bears the burden. For example, a trader uses extreme leverage to chase a performance bonus knowing that the organization will cover any downside.
DAOs solve this dilemma through community governance. Stakeholders are not forced to join a DAO and they have access to all of the rules and code underlying the organization in order to help them make an informed decision prior to joining. They need not rely on or trust any specific agent to act on their behalf; instead, they work as part of a group whose incentives are aligned.
DAO governance structures can take many forms but the vast majority can be illustrated through the following three examples: Ethereum Name Service DAO, Friends With Benefits DAO, and Constitution DAO.
Ethereum Name Service DAO
Ethereum Name Service DAO or ENS DAO was originally distributed via an airdrop to all holders of registered ENS domains. This airdrop gained considerable attention due to the appreciation of the ENS token price and the concentration of ENS domain holders.
ENS DAO uses a three-layer approach to control governance:
- The discourse of proposals
- Off-chain voting used by delegates
- Voting on the blockchain
The majority of proposals begin in the ENS forum or the discord channel and are later put up for an off-chain vote by delegates within the ENS discord. The DAO’s Constitution was the first proposal to be voted on and this Constitution served to control the suggested decisions and provide parameters for all future proposals.
There are three types of proposals that can be launched in this DAO:
- Social Proposals: Modifications that do not need on-chain activity
- Executable Proposals: Smart contract execution through the DAO’s wallets
- Constitution Amendment: Proposed modifications to the DAO Constitution
Each proposal requires a vote in order to pass and follows through with the three steps of governance displayed above. The ENS governance process is complicated and relatively slow. For the proposals to move on to on-chain voting only a quorum of 1% is required. This is a low threshold and implies that only a few delegates can truly move proposals ahead.
Friends With Benefits DAO
Friends With Benefits DAO or FWB DAO is comprised of Web3 pioneers including artists, innovators, researchers, and theorists. The FWB token serves as a portal to the FWB DAO, connecting token holders to like-minded individuals working towards a common goal.
The Friends With Benefits DAO approach has developed from simple governance by consensus model to a multi-group based model using Discord to communicate proposals, papers to formalize them, and Snapshot to vote on the various proposals. The recommendations that receive the most votes will be put into action by the assigned team.
FWB has established an upvote paradigm in which community members can offer and upvote proposals that are of interest to them. This strategy aids in the curation of such proposals, both in terms of content and timeliness.
Following that, a proposal team drafts organize, and cleans the ideas in preparation for community evaluation and vote. This makes the proposals’ format and substance more consistent.
The project was started by a core group of individuals who noticed that the United States Constitution was going to be auctioned and wanted to prove the effectiveness of fractionalized ownership via purchasing it with a DAO. There was a lot of discussion regarding the funding required to purchase the Constitution and how to efficiently disperse capital during the bidding process but nothing was put up for a vote.
The DAO came very close to achieving its goal. The artifact was sold for $43.2 million. While the DAO was able to gather almost $47 million in Ether, Sotheby’s ultimately limited the DAO’s bid to $43 million to account for taxes and the costs of protecting, insuring, and moving the Constitution. The DAO gave full refunds to everybody who donated after the auction. Those who refused refunds kept the PEOPLE governance tokens they had received in exchange for their donation.
The Future Of DAO Governance
While there is currently a multitude of successful DAOs operating globally under different governance structures, it is obvious that Vitalik’s (ethereum founder) vision of DAOs was different. DAOs were conceived as purely encoded, on-chain entities with immutable properties of decentralization. Most DAOs today — structured as multi-signature wallets of delegates implementing the will of off-chain votes — don’t meet the original definition. Instead, Jacob Horne at Zora and Spencer Graham have proposed a new form of governance for DAOs that will turn them into hyperstructures.
DAOs as Hyperstructures
Hyperstructures, coined by Jacob Horne at Zora, are protocols that can run for free and forever, without maintenance, interruption, or intermediaries.
Hyperstructures are a platonic ideal for DAOs — unstoppable, free, valuable, permissionless protocols that can serve as infrastructure for a wide range of use-cases and applications. This is essentially how DAOs were originally conceived, but not how the term is commonly used today.
This difference between the current DAOs and hyperstructures is more than a technicality. As Spencer Graham has argued via the anticapture framework, decentralized execution capabilities are a good strategy for limiting the exploitation of common pool resources. Furthermore, having organizations that are designed to run autonomously (i.e. without centralized leadership) is the only way to ensure that a hyperstructure will continue to operate indefinitely. Although current DAOs may not look centralized from the untrained eye — they vote on every decision, smart contracts underlie all actions, and a strict governance process that every member can participate in — the presence of a multi-signature wallet that requires the core teams approval to execute a proposal evidence a clear vector of centralization.
While there are few examples of truly functional hyperstructures, bitcoin provides a benchmark for decentralization and autonomy. You can make the case that the original DAO was bitcoin. If you’re a real DAO purist, you could even make the case that bitcoin is the only DAO. Additional examples of emerging hyperstructures include other blockchains like Ethereum, decentralized exchanges like Uniswap and Sushiswap, and auction protocols like Zora.
Most human organizations, like companies, get less efficient as they grow. What enables these hyperstructures to survive indefinitely without centralized leadership is that they get better with scale. Geoffrey West has looked across natural and human systems at structures that can achieve superlinear scaling, where they get better as they get bigger instead of getting worse. While nature builds ecosystems like this naturally, humans have built very few examples of things that will last indefinitely and get better with scale. The only human structures that have this property are emergent systems like economies and cities.
A shift towards truly decentralized DAOs that function as efficient hyperstructures represents the future of coexistence on the blockchain.
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