Anatomy of the DAO: What happens when Web3’s ownership is unexpectedly centralized

Decentralized Autonomous Organizations (DAOs) are a staple of Web3. Internet- and blockchain-based DAOs aim to provide businesses, projects, and communities with a new, democratized governance structure in which any member can vote on organizational decisions by purchasing projects.

Anatomy of the DAO: What happens when Web3's ownership is unexpectedly centralized

In a nutshell, this is how DAOs work:

  1. The DAO founder created a new cryptocurrency called a governance token;
  2. They distribute these tokens to users, supporters and other stakeholders;
  3. Each token corresponds to a certain amount of voting power within the organization. Each token also corresponds to the price on the secondary market and can be bought and sold at will.

While this process is often described as a way to decentralize power, governance token data suggest that DAO ownership is highly centralized.

Governance token holdings are centralized

By analyzing the distribution of ten major DAO governance tokens, we found that in several major DAOs, less than 1% of holders have 90% of the voting power.

Anatomy of the DAO: What happens when Web3's ownership is unexpectedly centralized

This has important implications for DAO governance. For example, if only a small percentage of the top 1% of holders work together, they can theoretically outperform the remaining 99% on any decision. This has obvious practical implications, and in terms of investor sentiment, may influence whether small holders feel they can contribute meaningfully to the proposal process.

The Impact of High Centralization on DAO Governance

For governance token holders, there are three key governance actions. Voting is easy – any holder can do it. But what about creating proposals? So what about passing it?

Based on these ten DAO proposal requirements, we found that:

  1. Users must hold 0.1% to 1% of the outstanding token supply to create proposals.
  2. Users must hold 1% to 4% to pass.

Using these ranges as lower and upper bounds, we found that between 1,000 and 10,000 of these 10 DAO holders had enough tokens to create proposals.

Anatomy of the DAO: What happens when Web3's ownership is unexpectedly centralized

There are several tradeoffs here. If too many holders can create proposals, the quality of the average proposal may drop, and the DAO may become flooded with governance spam. But if there are too few people who can do it, the community may feel that “decentralized governance” is fake.

By the time the proposal is passed single-handedly, between 1 in 10,000 and 1 in 30,000 holders have enough tokens to do so.

Over-centralized voting power in DAOs can lead to decisions that seem to contradict the principles of decentralization on which web3 is built. For example, in June 2022, the DAO that manages Solend, the Solana-based lending protocol, faced a problem: the price of Solana was falling, and if it fell further, the protocol’s largest whale users would face margin calls, which could render Solend insolvent. Paying off debt and sending Solana’s ~$20 million worth of listings could lower the asset’s price and upend the entire Solana ecosystem. The DAO is calling for a vote to control whale accounts and liquidate their positions through an over-the-counter (OTC) desk rather than the open market.

The proposal passed easily, with more than 1.1 million “Yes” votes to 30,000 “No” votes. However, more than 1 million of those votes came from a single user with a large amount of governance tokens. Without their vote, the motion would fail the 1% participation rate required for a quorum.

The decision sparked a backlash from the cryptocurrency community, with many questioning how platforms claim to be decentralized and then control users’ funds against their will. After that, Solend DAO voted down the proposal again, and whale users finally started to close their positions. While a crisis was avoided in this case, when some voters control such a large share of governance tokens, it raises questions about the ability of DAOs to act in the best interests of all participants.

How exactly are DAOs governed?

The actual governance process varies widely from DAO to DAO, and this question is best answered with examples. Let’s start with the biggest one: Uniswap.

Example: Uniswap Governance

Uniswap is a decentralized exchange (DEX), and like many DeFi protocols, it is governed by a DAO.

Anyone holding Uniswap’s governance token, UNI, is a member of the DAO. They can participate in governance by delegating voting power to their own or others’ addresses, publicizing their opinions, or submitting their own proposals. The content of these proposals varies widely: Holders recently voted on whether to fund a grant program, whether to integrate a new blockchain, and whether to lower the threshold for submitting governance proposals.

But before someone can submit a proper proposal, their idea must pass the first two stages: a climate check and a consensus check.

  1. The climate check determines whether the community has enough will to change the status quo. At the end of the two days, a majority of 25,000 UNI votes in favor wins.
  2. Consensus checks establish formal discussions around potential proposals. At the end of five days, a majority of 50,000 UNI votes in favor wins.

If both checks pass, the official governance proposal can be voted on. Then, there is a seven-day deliberation period to discuss the merits of the proposal in the governance forum. If at the end of the period there are at least 40 million votes in favor and a minority of negative votes, the proposal has passed and will be enacted after a two-day time lock.

Example: Dream DAO Governance

Not all DAOs run like Uniswap, but most run on at least similar infrastructure, using voting systems like Snapshot and chat servers like Discord. Dream DAO is no exception, although its mission and governance process are necessarily unique.

Dream DAO is an impact-driven DAO created by 501 (c)(3) charity Civics Unplugged to provide training, funding, and community to the diverse global Gen Zers who need to use Web3 to improve humanity. Their governance process is run by holders of SkywalkerZ – this NFT acts both as a governance token and as a fundraising incentive for anyone interested in donating to the program. For every SkywalkerZ NFT purchased by a donor, a new SkywalkerZ is reserved for future Gen Zers to join as voting members to gain power in the DAO without paying. Buyers of NFTs can apply to join the DAO and become voting members, or they can leave it to their sponsored Gen Z students — either way, the NFT is theirs.

By removing financial barriers to participating in the DAO governance process, Dream DAO empowers its target audience – future Gen Z leaders – to influence decisions, immerse themselves in Web3, and actively leverage blockchain technology.

Where are DAOs most common and well-funded?

DAO spans the entire length of web3. They manage:

  • Uniswap ($ UNI) Japanese Sushi ($ SUSHI) etc. DeFi sushi.
  • Social clubs such as Friends With Benefits ($FWB) and Bored Ape Yacht Club ($APE).
  • Funded projects such as Gitcoin ($GTC) and Seed Club ($CLUB).
  • Gaming guilds such as Good Games Guild ($GGG) and Yield Guild Games ($YGG).
  • NFT generators like Nouns (1 NFT = 1 vote).
  • Venture capital funds such as MetaCartel and Orange DAO.
  • Charities like Big Green DAO and DreamDAO (1 SkywalkerZ = 1 vote).
  • Virtual worlds like Decentraland ($MANA) and Sandbox ($SAND).
  • and many more.

But in terms of raw numbers and size of funds, DeFi-related DAOs have a huge lead. The DeFi category accounts for 83% of all DAO treasury value held and 33% of all DAOs.

Anatomy of the DAO: What happens when Web3's ownership is unexpectedly centralized

There are also a large number of DAOs focused on venture capital, infrastructure, and NFTs, which shows the attractiveness of DAOs to investors, developers, and artists. However, their on-chain treasury is relatively small.

To be fair, the lines between these categories are blurred. Gaming DAOs typically work with NFTs, venture DAOs typically fund DeFi, and infrastructure DAOs support all of the above categories.

Money management: What assets does the DAO hold?

While DAOs vary in type and size, most of their on-chain treasuries hold similar cryptocurrencies. The most commonly held cryptocurrency is the stablecoin USDC, with over half of the 197 DAOs we analyzed holding USDC balances.

Anatomy of the DAO: What happens when Web3's ownership is unexpectedly centralized

However, stablecoins rarely account for the majority of on-chain treasury value. On average, 85% of the DAO’s on-chain vaults are stored in a single asset, while only 23% of the assets in the DAOs we studied are stablecoins.

Anatomy of the DAO: What happens when Web3's ownership is unexpectedly centralized

These on-chain treasuries are roughly as volatile as Bitcoin. By assuming the DAO’s current holdings are their historical portfolio for the past year, we find that:

  • DAOs with assets over $1 million have an average annualized volatility of 82%, compared to 69% for Bitcoin.
  • The average DAO with assets over $1 million saw the biggest drop of 51% over the past year, compared to Bitcoin’s 72% drop.

The value of the DAO treasury is also closely related to Bitcoin price movements. 38% of the on-chain DAO treasury has a correlation between 0.5 and 1.00 to Bitcoin.

Anatomy of the DAO: What happens when Web3's ownership is unexpectedly centralized

One of the most interesting areas of DAO money management that has yet to take off is mergers and acquisitions (M&A). M&A makes sense for DAOs because it allows them to move into adjacent areas without having to develop internal tools. As the DAO model matures, we suspect mergers and acquisitions will become more common.

To date, DAOs have also been fairly limited in the types of tools they use and hold. For example, to date, few DAOs have used loans or credit, possibly due to their uncertain legal status. As DAOs mature, we may see more standardized regulations, governance policies, and reporting practices.

Who contributed to the DAO?

While we do not collect demographic data about DAO participants, we can learn something about DAO contributors using blockchain data.

Anatomy of the DAO: What happens when Web3's ownership is unexpectedly centralized

Token Smart Contract = project specific ERC-20 or layer 1 token contract

As one might expect, DAO participants are power users of cryptocurrency services. Only 17.9% of the DAO treasury funds came from centralized services, and the remaining 82.1% came from decentralized services. This suggests that most DAO contributors are also involved in DeFi platforms and may self-custody their cryptocurrencies.

The future of DAOs

As DAOs gain momentum, cottage industries of tooling services and advocacy groups have emerged to help them grow and govern. Superdao simplifies DAO creation; Snapshot simplifies governance; and Coin Center advocates for the industry on Capitol Hill. As they continue to expand, it will be interesting to see what they can accomplish, what they will become, and how far they will achieve their goal of decentralizing Internet ownership. With the proliferation of DAOs today, we will have many opportunities to see.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/anatomy-of-the-dao-what-happens-when-web3s-ownership-is-unexpectedly-centralized/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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