The Governance of DAO Infrastructure
April 29th, 2021

Originally published on Boardroom's Substack on August 25th, 2020

This week we’re featuring a guest post from Felix Machart, a summary of his longer report on “The State of Blockchain Governance” drafted alongside Jascha Samadi. This is a timely article delving into the intricacies of stakeholder governance as many of the prominent DeFi and cryptocurrency teams experiment with novel ownership models.

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DAO communities so far have been experimenting with various systems to govern the infrastructure, from informal to formal processes, from loosely coupled off-chain to tightly coupled on-chain systems. There is no doubt that voting plays an important role in gauging community sentiment and to condense individual preferences into a picture that reflects the aggregate. The main questions are, 1) which stakeholders are entitled to vote (to the largest extent token-holders in permissionless systems, as “1-person-1-vote” has so far been either reliant on centralized KYC or not sybil resistant) and 2) how tightly coupled is the result of the vote with a protocol change.

Stakeholder lock-in as a measure of interest alignment & legitimacy of governance rights

Agency theory commands that the providers of specialized inputs should be in charge of governance, which has traditionally been providers of physical capital/investors, as they are locked-in with their investments (sunk costs — inputs are not useful otherwise or it is costly to make them so). In the knowledge age and digital sphere it is increasingly specialized knowledge, data, and the use of standards, but also capital that is being invested, staked, or locked-up for extended amounts of time to contribute to network security and value creation that represents those specialized inputs or sunk costs. Thus, systems taking into account broader stakeholder groups are highly desirable.

Stakeholder representation vs. scalability of decision making

There are large differences in participation rates in voting, due to differences in community size and composition and differences in voting systems as well as quorum requirements. Direct democratic approaches suffer from low participation as decision-making involves cognitive costs, so some amount of representation by councils, boards, and/or through liquid democracy might be necessary in many cases in order to enable effective decision making (e.g. voting power delegation in Compound). Liquid democracy structures are blending the best of representative and direct democracy, allowing anyone to directly vote on an issue if she feels to be well informed or there is a strong opinion, as well as allowing for delegating one’s voice to a representative (like a liquid management board or protocol politicians). Thus, voters who are rationally ignorant might have enough incentive to at least delegate, while the cognitive load of deciding on a matter is outsourced to the delegate (which increases turnout). Voters who are motivated to decide for themselves can still do so, which increases decentralized input.

There have been votes that were able to be influenced by large individual voters, which becomes easier as there is low participation. Adaptive quorum biasing, introduced by Polkadot is an interesting approach to autonomously protect against low turn-out votes having a result that does not reflect the whole. Making an elected board decide like in Nexus Mutual and let them be overridden by a sufficient threshold of voters is also a pragmatic way of leaving uncontroversial and day-to-day decisions to agents that focus on the matter while keeping the option of decentralized direct decision-making. One could argue Nexus Mutual does not represent a true DAO as it has elements of centralization and lacks true autonomy and permissionless-ness (limiting the influence of individual voters to 5% by KYC). However, also other projects show centralized and permissioned aspects, highlighting the fact that decentralization is multi-faceted as well as a spectrum and not absolute.

Finally, token/vote distribution (incl. the level of participation and decentralization of full-nodes in layer 1 DAOs such as Ethereum) is the most crucial factor in determining the extent to which power is decentralized and communities ought to target and select long-term, mission-aligned and knowledgeable members and investors (time-locking for voting can be a feasible proxy for long-term alignment).

Ultimately, governance is about social consensus

In the end, social consensus is what defines a crypto network. The option to fork is the most crucial instrument of last resort to force decision-makers to take stakeholders into account, while effective governance gathers maximum stakeholder voice in order to avoid exit.

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