On DAOs, their efficiency and path forward


Originally published by Evgeny Gaevoy on CfC St. Moritz on June 15, 2022.

Decentralized Autonomous Organizations (DAOs) became a dominant governing primitive in web3 over the last three years. Having witnessed them surviving and evolving throughout the last cycle, it’s interesting to examine whether they lived up to hype or became another “wrong turn” in the seemingly endless cycle of crypto rediscovering ways to organize and incentivize things. By virtue of us being both active users and long-term investors in web3 space, Wintermute found itself continuously engaging with various governance models.

The current lack of clear ‘best practices’ amongst DAOs and their governance systems has led protocols down a range of paths from horizontal adoption – replicating popular existing protocols, to improvisation – believing their community knows best. As a result, crypto has ended up with multiple pseudo-governance protocols like Uniswap which illuminate the facade of a democratic process yet exhibit voter apathy due to asymmetrical power amongst token holders. These protocols are ultimately governed the same way a start-up would work, with complexity increasing as the number of employees grows, and it is not particularly interesting to dive into these in much detail. On the other extreme, some protocols have taken and applied the meaning of ‘ownership economy’ to literally all decision making, introducing an anarchist/free-for-all governance system that controls every inch of functionality/operation. While each governance system has its own perks, the common intrinsic trade-off between speed and decentralization remains systemic, creating an ecosystem of operationally inefficient and/or intransparent protocols.

The Root Cause of Inefficient DAOs

Crypto’s fast paced nature emphasizes the importance of adaptation in the success of a protocol. Losing your first mover advantage or competitive edge to a nimbler protocol unconstrained by time locks and voting windows is not in the best interest of token holders. Yet ironically, it’s these very token holders that ideally want a say in such changes.

A realistic timeline for a change to occur can easily reach a month or two: 1-2 weeks for contributor/team consensus, 1-2 weeks to write and review a proposal, 1-2 weeks for governance voting depending on the executable, and a couple of days for implementation. However, this example implicitly assumes there is a well-oiled, sufficiently educated and aligned team on the other side to promote improvements, as well as enough participation from token holders to grant such a change.

In reality this is hardly the case. Why? For 4 main reasons:

1. Participation – A democratic governance system is susceptible to voter apathy, free-riding, social & financial costs, and complexity, decaying voter participation and inhibiting advancements

2. Alignment – Without sufficient incentives a classical principal-agent problem arises between contributors/team and token holders. Introducing inefficient resource allocation and a lack of drive towards protocol and token value maximization

3. Human Capital – Uninformed or inexperienced decision makers whether that be the community or team members lead to inefficient outcomes

4. Decentralization of Power – Hierarchy erosion limits speed and autonomy in exchange for public ownership

Reducing these issues alongside smaller cosmetic ones i.e., lack of transparency, accountability, direction, and principles, is something actively being worked on by DAOs. For example, Maker DAO takes a representative democracy approach to governance, utilizing Delegates and Core Units:

  • Delegates are community whitelisted people or groups of people who contribute to Maker DAO and receive enhanced voting power from MKR delegations. Effectively concentrating the votes of many individuals into the hands of one person. This reduces the lack of voting participation and increases operation efficiency

  • Core Units are groups of contributors with budgets and mandates that work to achieve long term objectives under one or more operational domains.

Maker DAO ensures Core Units and Delegates are sufficiently compensated and aligned, appropriately selected, and easily held accountable through periodic elections to reduce a large portion of inefficiencies mentioned above. Yet its level of decentralization still restricts its autonomy and speed in certain situations and begs the question if it is truly necessary?

DCGS – A potential solution?

The idea of Decentralized Corporate Governance Structures (DCGS) aims to maximize DAO efficiency through traditional corporate governance structures similar to a two-tiered board system, yet with an additional coordinator (i.e., CEO). A decentralized two-tiered board and coordinator system consists of a:

1. Coordinator – An individual who is responsible for the overall vision, goals and oversight of the protocol and business unit board

2. Business Unit Board – Groups of business units that run the day-to-day operations of the protocol and are composed of contributors/teams (like Maker’s Core Units)

3. Community Board – Token holders who have the ability to hire and fire the coordinator and members of business units through yearly elections.

Such a system eliminates a large majority of issues associated with current governance systems:

1. Executive decision making is retained within the power of the coordinator and business unit board, in contrast to seeking the community’s approval through a governance vote

2. Yearly coordinator and business unit board elections reduce voter apathy, social & financial costs, and complexity. The significance of these votes and their impact on the success of a protocol increase the opportunity cost of not voting, while yearly elections limit the principal-agent problem, forcing the coordinator and business unit board to work harder and maximize value (or else they be fired)

However, this system heavily relies on a central figure to ensure there is a clear direction, long term goal and to coordinate operations effectively. Furthermore, people may argue that the limited decentralization of power goes against the ethos of true decentralization and what a DAO stands for. While this point is valid, this structure is simply a trade-off between decentralization and speed that already exists amongst current protocols.

DAOs and their governance systems are in an adaptive cycle, exhibiting signs of growth and change under new collections of conditions, beliefs, and ideas. While they’re still yet to find a set of best practices, I believe that experimentation with DCGS can provide a clear improvement to many of the highlighted issues, hopefully finding the right balance between proper governance and operational efficiency.