STOP! Throwing Money At Each Other

Inflammatory claim warning: The only mechanism that can prevent a whale from influencing the outcome of voting decisions within permissionless DAOs without proper IDM (identity management)[1] is veto-like powers attributed to a subset of the token holders, usually the founders of the project in coordination with other important stakeholders.

These powers can be somewhat encoded in the smart contracts forming the base for the community members to interact. The need for these restrictions is because, in most of the current implementations, governance tokens are bought with money: FIAT or crypto, as you will, and the more money you have the more tokens you can buy meaning voting power is proportional to the investment made. Arguably undemocratic.

As a consequence, the D for decentralized in the DAO effectively becomes a C or an S for semi-decentralised depending on the particular implementation in clear contradiction to the ethos of Web3. This aspect of DAO governance, or lack of proper governance, is often overlooked, and the reason why it happens in more projects than desired is that suddenly the founders and the treasury simply vanish.

This could potentially be one of the reasons behind the failure of so many cryptocurrencies recently. Mister Vitalik Buterin seems to agree.[2] This lack of proper governance is not helping crypto enthusiasts attract new users to the space... In this sense, most ICOs are nothing but crowdfunding sales backed by blockchain, far from being a true Decentralized Autonomous Organization.[3] Still, in general, what we have right now is an improvement over most crowdfunding platforms in certain aspects... But what does it really mean the fact that less than 1% of all holders have 90% of voting power as Chainalysis reported[4], [5], and what implications does this have on the growth and potential of crypto?

An article by blockchain research group Smith + Crown explores some details about the basics of the problem we are discussing.[6]

Founders Are Always An A Privileged Position

When launching any kind of project, founders in comparison to newcomers benefit from possession of information as consequence of private meetings held with stakeholders, previous market research that might have been done, product development, etc... In traditional stock markets, this can become a problem which is typified as insider trading.[7] In cryptoeconomy this fact inevitably empowers the creators in all similitude, cough Sakamoto[8] cough; but is not perceived as something necessarily bad. What is required for the fulfillment of the ethos of Web3 in DAOs is that at the very least as time progresses and the DAO matures there are checks and guarantees that this influence tends to diminish, in the form of enforceable rules and agreements seconded in smart contracts wherever possible.

This is the reason why for any DAO to be properly called so, its governance strategy and main actors must be presented and made public in a very clear way from the very start. If you are looking at a project which has no clear strategy for governance and you are having difficulties in understanding who the founders are, how they engage with the community, and how they plan to lower the dependence of the DAO on their influence then sorry, the tokens of the project you are thinking of buying are in all likelihood, shitcoins.

An example of good governance practices is what happens with the Algorand blockchain which we suggest the reader to get acquainted with.[9] It does lack strong IDM mechanisms but in this case it poses less of a risk because blockchain communities are usually bigger than DAOs and thus harder to attack. An alternative to managing identities is the use of reputation metrics to evaluate the level of trust between members of a community. Such is the approach of Edgeware DAO.[10]

Governance in DAOs Is The Fundamental Building Block

Let's imagine a scenario where the founders of the project have no veto-like powers to begin with. Anyone is able to join the DAO and participate in its governance with equal rights in a complete permissionless way, as any DAO should be. Now let's say that the voting power is proportional to the stake someone owns, the number of tokens, and not the 1-person-1-vote rule.

For example, the question is then what is stopping a whale from buying the majority of tokens and taking control over the decisions made within the DAO? Worse still, because there is no IDM, how could that even ever be detected?

For large projects such as blockchains the likes of Ethereum this lack of IDM is not a problem per se because the market cap[11] of eth is evaluated at $195,880,240,009 which is outside of reach even for most of the worlds known richest billionaires. This represents around 14,87% of Japan's foreign exchange reserves[12] however which could still be interpreted as a threat. Of course, here I am considering any holder of eth as a member of a DAO which does not exist officially but nevertheless can be thought of as one by definition.

An attack by an institution such as a powerful country is an unlikely scenario, not worth the gamble as it could be mitigated by a hard fork once detected and considering also that the underlying randomization process specific to blockchain consensus algorithms offers a little extra protection not present in DAO voting mechanisms. A very recent example amongst many of such issues was when a whale moved out of a Solana-backed DeFi protocol when it was threatened seizure in a heated debate between members of the community.[13]

Buying tokens broadly speaking is an interesting thing to do such as those providing economic value, access to a service, or proving ownership of an asset such as what happens with NFTs. But the case we are trying to establish here is that they are not powerful enough for the governance needs of most DAOs.

Does This Mean That Token Based Voting is a Completely Wrong and Unuseful Approach?

Outside of the blockchain infrastructure realm itself, if we are looking only at the DAO aspect of it in particular, in the current state of affairs the answer is that token-based voting provides no clear safe mechanism for decision-making unless token owners are ready to recognize that what they are participating in is not really decentralized for the reasons we alluded to. In a regulated market, things might be different. Voting with money may actually be the best approach in certain areas of the economy and regulation need not necessarily mean centralization as long as the rules by which certain financial operations occur, crypto finance in our case, are previously agreed upon amongst the majority of which future token holders are a part of. Having this regulation in place could allow mechanisms for conflict resolution.

The immediate solution and the easiest way out to the problems we shared here is to bring digital identity to the DAO space or to regulate the crypto market... not in the sense of crypto as money but regulating the way DAOs operate, interact with each other and take actions in the real world... Little mention is made of DAOs in the latest attempt of EU officials to regulate the space.[14] To the best of our knowledge, the most comprehensive and serious attempt at regulation was proposed by the COALA working group which we strongly suggest you get acquainted with if you are a developer yourself.[15]

Moving from a completely anonymous to a pseudonimous Web3 environment (which would still preserve privacy, by the way), is the only way for 1-person-1-vote, or remote e-voting as in the literature, to be feasible. Not all ideas in old systems are bad and obsolete! Just as the laws of gravity proposed by sir Isaac Newton are still taught for educational and practical purposes even though relativistic equations are better at describing the physical reality, maybe IDM and regulation in legacy computer and economic sciences are important aspects that should be still taken into account in the new Web3 frontier.

The endgame is thus to make proper use of digital identity and cryptography, whose details we will investigate in separate articles in upcoming months.

References:

[1] Identity management entry on Wikipedia, https://en.wikipedia.org/wiki/Identity_management

[2] "Governance is more than token voting" by Vitalik Buterin, repost from authors blog at CoinYuppie, 2021, https://coinyuppie.com/vitalik-governance-is-more-than-token-voting/

[3] Decentralized autonomous organization entry on Wikipedia, https://en.wikipedia.org/wiki/Decentralized_autonomous_organization

[4] "Dissecting the DAO: Web3 Ownership is Surprisingly Concentrated" by Chainalysis, 2022, https://blog.chainalysis.com/reports/web3-daos-2022/

[5] "1% of DAO Members Controlling 90% Voting Power: Chainalysis" by Jay Zhuang, CryptoPotato, 2022, https://cryptopotato.com/1-of-dao-members-controlling-90-voting-power-chainalysis/

[6] "Distributed Governance: Beyond Token-based Voting" by Smith + Crown, 2019, https://smithandcrown.com/research/distributed-governance-beyond-token-based-voting/

[7] Insider trading entry in Wikipedia, https://en.wikipedia.org/wiki/Insider_trading

[8] "Who Is Satoshi Nakamoto?" by Adam Hayes published on Investopedia, 2022, https://www.investopedia.com/terms/s/satoshi-nakamoto.asp

[9] "Decentralizing Algorand Governance" on Algorand's portal, 2021, https://algorand.foundation/governance/proposal

[10] Edgeware DAO, https://edgewa.re/

[11] Ethereum price and market cap at CoinMarketCap, http://coinmarketcap.com/currencies/ethereum/

[12] List of countries by foreign-exchange reserves entry in Wikipedia, https://en.wikipedia.org/wiki/List_of_countries_by_foreign-exchange_reserves

[13] "Solend Whale Moves $25M to Another Platform Despite Canceled Plans to Seize Their Wallet" by Jay Zhuang, CryptoPotato, 2022, https://cryptopotato.com/solend-whale-moves-25m-to-another-platform-despite-canceled-plans-to-seize-their-wallet/

[14] "An Overview of MiCA: Markets in Crypto Assets Regulation" publication by LimeLegal, 2021, https://lime.legal/an-overview-of-mica-markets-in-crypto-assets-regulation/

[15] "Model Law for Decentralized Autonomous Organizations (DAOs)", Coalition of Automated Legal Applications, 2021. https://coala.global/, https://www.lextechinstitute.ch/wp-content/uploads/2021/06/DAO-Model-Law.pdf