DAOs want to change the way businesses make choices altogether. Do we actually need that, though?
The last five years have seen significant advancements in the crypto space, including ICOs, DeFi, NFTs, and ultimately DAOs. The speed of human innovation since the development of the internet has been extraordinary. We live in a time that many could not have even anticipated fifty years ago.
However, humans tend to reinvent every aspect of our lives during an innovation cycle. The phone altered how people interacted with technology, the internet changed how information is shared and communicated, and most likely, cryptocurrency will revolutionize how people engage with money and products.
In the long run, we frequently triumph over the success of the few and forget about the disastrous project we encountered. Even if it is now apparent that many “inventions” couldn’t work, it doesn’t feel that way while the cycle plays out in front of our eyes.
Will the same thing occur with DAOs?
Let’s start with the basics.
DAO stands for Decentralized Autonomous Organization. In simple terms, it can be seen as a corporation without a leader where all the members (tokenholders) work together to achieve a common goal. DAOs can have employees, and revenue streams and even be recognized as a legal entity in some countries.
In my opinion, the original purpose of DAO was to avoid taxes and to conduct experiments without the constraints of regulations. Given that DAOs are decentralized by design, it is challenging for governments to understand their authority over them.
But why do we need DAOs?
Unlike Web2 businesses, Web3 businesses are thriving because of their community. Your consumers are your strongest supporters and want the venture to be successful. A strong community is rare in a conventional organization. The goal of the company’s management is to maximize wealth for shareholders; consumers do not cheer you if you raise prices.
Given the framework, involving the community in choosing how the DAO should operate and make investments seems appropriate.
That’s fantastic, what’s the problem then?
To identify the participants of a DAO, all the projects tend to issue the so-called governance token. In the beginning, many projects adopted “one token = one vote”, the goal is to democratize the project, right?
It became evident that this governance mechanism gave whales overwhelming decision power on the protocol. If only a few people could control the decision-making of a DAO, it doesn’t make much sense to have a DAO in the first place.
Few events have happened that have damaged DAOs as we know them.
A vote was held to take control of the position of the network’s largest borrowers which was very close to liquidation, threatening a consequent cascade in liquidity. The decision didn’t resonate with DeFi ethos, and given that almost all the voting power came from one wallet, the community’s outrage quickly overturned the vote.
This was a specific example where the DAO is only a cover, and the decision can be taken just by a single participant.
The Curve/Convex War was an exciting moment for DeFi. It can be described as a competition between different protocols to guarantee that their preferred liquidity pools offer the highest $CRV rewards. It is a very complex story, but, in short, Convex Finance attracted many “stablecoin” protocols to deposit Curve governance tokens to the Convex platform, which quickly ended up being the largest holder of $CRV.
Although exciting, this was a terrifying moment for many protocols. An external application such as Convex Finance that was unrelated to Curve managed to hijack its incentives and rewards, threatening the decentralization of the project.
More info about the Curve/Convex War here
Merit Circle submitted an initiative in its forum in April 2022, inviting investors to specify their contributions to the DAO. YGG responded that it was not part of the initial SAFT agreement, and in response, a community member proposed refunding the initial YGG investment in Merit Circle via MIP-13. After some back and forth, Merit Circle agreed to buy back YGG’s token allocation at a 10x valuation above the initial investment (but a 70% discount on the market price at that time). Merit Circle indicated that it was not their desire to cancel the deal with YGG, but given the proposal, they must listen to the community. The proposal jeopardized Merit Circle’s reputation and any future deals.
What would have happened if they hadn’t been able to reach an agreement? Would you consider working with Merit Circle, given what has occurred?
In April 2022, an $80m exploit happened on Fuse. A month later, a governance proposal was passed to refund the users affected by the exploit. Shortly after, Rari Capital (the core team) signaled that they had changed their opinion and a second vote passed to stop the refund process for the users. The governance decided to cast a third vote which ended up being against refunding the money.
Confusing? Below is an excellent visualization of the story.
There are many other stories about DAO, from hacks to mismanagement of treasury funds, but hopefully, I think I conveyed the idea. Overall, DAOs governance creates a massive amount of chaos, making decisions difficult, and even when they are made, it takes a long time to coordinate to get things done (assuming no one changes their mind).
There are five points we should reconsider when setting up a DAO.
Whether trying to buy an NBA team, build a fantastic DeFi project, or create an IP, make sure the DAO’s vision is set in stone. A DAO is no different than a company; it needs a plan to reach specific goals by determining steps along the way.
To avoid securities regulation, many projects seek to become “decentralized” as soon as possible. The primary goal should always be creating a product that people need and, if necessary, decentralizing along the process.
Who can make a proposal? On what? What will it affect?
Community governance should be limited to a few topics. When everyone can propose and vote on anything, a company/DAO will quickly lose its vision.
A DAO should limit the proposals and their scope, find specialists and professionals on a specific topic, and listen to them. The community will always have a place to express their voice, even without on-chain governance.
Democracy might be the “best” form of in-real-life government, but it might not be the most efficient way online. Making a country a nice place to live and aligning people’s interests reduces the chance of “governance failure” (citizen fleeing) and progressively makes a country prosperous.
Nevertheless, even if a firm needs its “citizens” to thrive, giving everyone a voice may slow the rate of innovation, and competitors will grow much quicker, attracting your citizens to move to them. The barrier to moving from one company to another is very low compared to moving to a different country.
Tokens are a quantifiable method of determining a project’s commitment. Despite that, the stake does not represent a person’s contribution to the DAO.
There is currently no alternative; perhaps, Soulbound Tokens will provide an alternative to this mechanism.
The purpose of a DAO has always been to empower its community and consider suggestions from its members. Very small DAOs could, theoretically, work as purely decentralized companies, where each individual or small group focuses on specific aspects and organizes itself without needing a leader.
Given that the governance of a project becomes a liability over time and does not bring any practical benefit, a DAO should consider operating in the same way companies have been working until now until there isn’t a better governance mechanism.
The main difference between a DAO and a company will be that your community will, in part, replace your Marketing and R&D Team and have direct access to a pool of talent that can demonstrate to align with your company/DAO’s vision.
In the end, if the DAO’s intention is real, it could be open-minded even without such organization and on-chain governance.
*but you can raise extra money if you are a DAO*
By following this approach, there are certain industries or specific brands where the consumers’ switching cost is too high or even impossible, making an appealing case for DAO (with the differences explained before) to be considered.
Sports fans love their team; they travel thousands of kilometers to follow and support their idols, and spend lots of money on clubs, and, for some people, devotion to the team is even stronger than any religion. Companies such as Socios and Binance have started tackling the sports industry by collaborating with existing sports teams. Fan Token can be used to make decisions for your team and unlock enhanced experiences to “be more than a fan”.
Gamers have always been vocal about what they like and don’t. To various degrees, a game’s community can determine the project’s longevity, their opinion should be valued, and DAO could be a way to collaborate in making the game they want to play.
Spoiler alert: of the 69% that hate NFTs, only 12% said they fully understood what they are. Link to the article here
In general, a brand with a strong IP that relies on a large community should consider setting up a DAO (or find a better way to listen to them).
While it is a fascinating concept that clearly provides a different way of operating a firm, DAOs may be a stretching of the innovation cycle in which we attempt to build the new wheel, this time designed square since it is simpler to park, but forgetting that the purpose was to travel more easily.
I am confident that some DAOs will succeed, and especially with the upcoming Soulbound Tokens, I might change my mind in the future. But, until DAOs figure out a better approach for dealing with governance, I don’t think they’re the most efficient framework for getting things done.
Listening to what the community cares about might be easier than it seems.
This article was originally published by Marco Lucchesini on Hackernoon.
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