DAO, short for Decentralized Autonomous Organizations, is a novel way of organizing human enterprises, providing more freedom for members, reducing organizational barriers, allowing the flow of contributors to come and go, with maximum focus on community and value creation.
Most DAOs start small and attract members and contributors as they tackle challenges and solve problems. As this article will explain, the rate of growth is controlled by network effects.
Network effects start out weak, but can be a powerful force in growth and decline, as new users join or leave simply because others they know are doing the same.
We’ll describe in detail what network effects are, and hint at how they apply to DAOs, before focusing on the practical impact. While more traditional organizations like corporations or NGOs can also be considered networks, DAOs allow members to join or leave with little or no friction. A deep understanding of growth and decline dynamics is invaluable to founders, pod leaders, and contributors. We hope this article will be of some help.
1. Network effects control the growth and decline of DAOs
2. Governance should always pay attention to network saturation and culture
3. Dunbar’s number means size matters, larger groups split into smaller parts
4. As the DAO scales, only a shared purpose or initiative will keep the team cohesive
Introduction to Network Effects
Theodore N. Vail, president of AT&T, was the first to mention the term “network effect” in Bell’s 1908 annual report. He used it to argue that Bell had a natural monopoly and that consumers would ultimately benefit from the consolidation of telephone switches in the company’s hands. Fast forward to the 1980s and Ethernet inventor Robert Metcalfe captured the idea, describing how the value of a communication network is proportional to the square of its number of users.
A two-user network has only one possible connection, while a three-user network has three, one of four already has six, and so on. The utility of the number of connections and thus the size of the network is proportional to the number of nodes squared. In this article, we will use nodes and users interchangeably, although in practice a node can represent multiple users, or a user can operate multiple nodes.
Illustration of network effects, source: applico.inc
Social networks like Facebook are prime examples of network effects. With each new user added, the likelihood of finding known friends on the network increases, as does the cost of switching to another network with fewer users. If the competing network is “sticky”, the market becomes “winner-take-all”, which means:
01. Users gain more utility from network effects than from conversion
02. It is costly for users to be active on more platforms
03. User switching costs are high
Users can easily remain active on multiple DAOs, which weakens the network effect. In similar types of DAOs (e.g., DeFi DAOs like Sushi), switching is not expensive, unless users already have strong social relationships with members of one DAO who are not members of another DAO.
Crypto’s focus on interoperability has the effect of intentionally reducing switching costs, so the network is less sticky and more fungible.
Demand-side economies of scale and critical mass
Demand-side economies of scale and critical mass Economies of scale generally describe how the price of producing a good decreases as the scale of production increases. Producing one in a million laptops is far cheaper than making a one-off by hand by a gifted hardware engineer. When costs are reduced, more people can afford the product, increasing demand, which is known as supply-side economies of scale.
On the other hand, network effects are economies of scale on the demand side. As more users flock to a network, its value increases, and more users are willing to pay higher prices.
“In other words, as the number of corporate buyers or sellers increases, so does the willingness to pay of buyers,” said Harvard Business School professor Bharat Anand.
The point at which the utility of a new entrant equals the price paid is called the critical mass. Strong network effects can be observed from this point, and the network can often grow without advertising, relying solely on word of mouth and momentum. “Once you gain significant market share, you can usually sit back and let network effects take over,” Anand said. “In effect, your existing buyers and sellers are your sales force that attracts more buyers. You tend to There are very few things to do.”
Facebook CEO Mark Zuckerberg had an intuitive grasp of these dynamics from the very beginning. He shrunk the initial market size to only allow users with Harvard email addresses to sign up, giving the product a uniquely elite appeal. After Harvard’s market was saturated, he opened up the product to students at Yale and Stanford. The product was and is still free to users and thus reaches critical mass faster than paid products.
Mike Novogratz, CEO of Galaxy Digital, made a similar comparison: “One of the great things about the Ethereum narrative is that it values the Ethereum network, like we did with Facebook, the more network effects you get…so you look at DeFi [Decentralized Finance] and stablecoins… that alone brings more visibility and network effects to Ethereum.”
An important lesson for DAO founders is to reduce the addressable market at the beginning and focus on a specific niche in order to reach critical mass. If the audience is too small, growth is limited from the start, and if the audience is too large, gaining traction becomes difficult and expensive. The ideal audience for a DAO is large enough that it is reasonable to assume that there are enough contributors and enough problems can be found to solve. But not so big that even an active 100-member DAO can easily be overlooked.
Direct and indirect network effects
Social networks and instant messengers are prime examples of direct network effects. Every new user adds value to the network. However, platforms like eBay are different. Each new seller adds no value to the seller, if anything, and the increased competition increases price pressure. But additional sellers add value to buyers, who now have a wider variety of items to choose from or see lower prices. Attract more buyers who add value to sellers, which in turn attracts more sellers. These are indirect network effects.
Many DAOs that sell services face indirect network effects. It doesn’t make sense that new members add capacity, but there are no takers. For DAO clients, increased capacity means more services or faster turnaround times, which can lead to the need for more new members. In a way, DAOs are ultimately scalable organizations because there is no formal hiring or firing process involved. Contributors flock to DAOs where they can provide meaningful input and leave when bored. They often go through some sort of startup process and perform small tasks to prove their abilities. Afterwards, they take on larger and larger tasks and acquire more and more rights and responsibilities from other members and are codified into the contracts that govern the inner workings of the DAO.
Negative network effects – saturation, notification overload and anger
So far we have only discussed positive network effects, virtuous growth cycles that help the network attract more and more users. But where there is light there must be shadows.
Network effects are equally effective when users leave. Metcalfe’s law states that the value of a network is proportional to the square of the number of nodes. A DAO of 100 users would have a scale value of 10,000. If one user leaves, the ratio drops to only 9,801, and there is a 2% loss for just one user leaving. As the network loses value and other users have no reason to stay, a chain of losses can begin.
We’ve seen this starting to happen with Facebook and even DAOs like Friends With Benefits. The toxic debate surrounding Brantly.eth still being the primary representative of ENS also threatens the negative network effects of the ENS-DAO.
The most common cause of negative network effects is saturation, the point at which network capacity is exceeded. In the example of a telephone switch, when the switch can handle as many users as possible, try to make a call, and then the next user who answers the call receives a busy signal. A poor user experience can lead to user frustration and slow growth, or worse, users leave.
In peer-to-peer systems, capacity typically scales with users. BitTorrent is a prime example. The more people sharing files, the more bandwidth the system has. But this is not the case with cryptocurrencies, where transactions must be verified by a majority of miners or validators in the network. Ethereum users are well aware of network saturation, as most see transaction fees spike during NFT launches or coveted airdrops. Other cryptocurrencies have made up for this and started a layer 1 movement, most notably Solana and Terra. Networks like Arbitrum and Optimism build faster, cheaper layers on top of Ethereum, aptly called Layer 2 networks.
Bitcoin and Ethereum scale through the second layer blockchain. Avalanche through subnets.
For DAOs, there is saturation in Discord chats, making it difficult to keep track of conversations when too many people flood the timeline. Persistent anger and a harmful communication culture can also lead to more sensitive users leaving. This changes the makeup of the user base. With less aggressive users leaving moderate to toxic communicators getting worse and eventually dooming the DAO. The trickle of users leaving will sooner or later lead to churn.
Dunbar’s number and the power of myth
Growth is wonderful, and it’s fun to brag about five-figure Discord memberships, but what so many people actually do in the DAO. Chat rooms are so full of messages that it’s impossible to catch up and have a decent conversation. Determining what to do, what tasks to do, can become so difficult that new members quit first, become passive, and leave after a while.
DAO governance needs to know how to deploy new members so that growth translates into traction and new members become valuable contributors. Two important points to note are the size of the group and the clarity of its purpose. As it turns out, Robert Dunbar does a good job of establishing the maximum size of a group that can still easily maintain a sense of belonging and cohesion.
Dunbar is a British anthropologist who studies primate group size. He found that the average human is unable to maintain more than 150 meaningful relationships, and that the primary mechanism of group cohesion is gossip.
Explanation of Dunbar’s number, source: Wikimedia
Dunbar’s number is an important breakthrough point for DAOs. As the number of members increases, the sense of cohesion and “being in the same boat” disappears, and divisive groups form. These divided groups often define themselves as different and better than other subgroups of the same organization, leading to infighting, worsening communication, lost productivity, and dissatisfaction.
One way to maintain common purpose and group cohesion in larger groups is by defining a strong sense of shared identity, with a clear and reaffirmed purpose, or even a collective myth. The Christian and Catholic Churches could briefly unite a fragmented medieval Europe in the crusades against “infidels”.
Peter the Hermit preaches about the First Crusade. Source: public domain
In enlightened modern social mythology, storytelling is often used to define a common goal and unite members of an organization of more than 150 members. It is recommended that DAO governance keep an eye on the pulse of group dynamics and split large organizations into Pods and SubDAOs to keep members engaged.
Shared values and purpose are difficult to reiterate often enough to maintain a sense of belonging. DAO members committed to community engagement often feel they are repeating the same message and are sickening, when in fact the audience changes each time. Governance must reaffirm the need to maintain the spirit of the DAO and support community participation.
The practical impact of network effects on DAO governance
In previous chapters, we have briefly covered the ways in which DAOs can use network effects, and we will expand on this in this chapter. Specifically, what governance teams need to understand to successfully bootstrap a decentralized organization.
Cultivate a DAO
When the DAO was launched, the focus of governance was growth. When DAOs aren’t born out of successful products, like NFT launches (BAYC and Loot come to mind), DAOs start out with members who want to build something of value and expect to solve specific problems.
At this point, reaching critical mass and finding a team of members to facilitate the DAO is critical. Treasuries rarely allow for generous ad spending or journalism budgets. All successful DAOs start with a strong desire to solve a specific problem or form the community they want to build. Critical mass is reached earlier in smaller markets, as significant market share requires less effort. Another approach is to address a problem that has attracted a lot of attention. ConsitutionDAO is a perfect example of the latter. Buying a physical copy of the constitution is such an amazing feat that many people get on board and the DAO can scale quickly. But these are exceptions.
For a more common example, imagine a DAO that brews beer, let’s call it beerDAO. Rather than wanting to compete with international brands like Anheuser Busch, beerDAO could instead focus on creating content and selling starter kits for homebrew beer or making world-class local craft beers if a ready-to-drink product is required. Small markets allow DAOs to reach a critical mass of members in less time.
If members do not continue to recommend new members, governance must find out what is going on. If answers aren’t available in conversations with members, a thoughtful experimentation can at least make DAOs more interesting. Unexpected breakthroughs are also more likely if founders keep iterating.
Governance needs to watch for signs of network effects:
1. Do existing members keep bringing in new members?
2. Do members talk about being part of the DAO without being prompted?
3. Is there an active ongoing conversation in the forum? What was the tone of the conversation?
4. Are friendships and connections formed?
These dynamics cannot be forced, but are a sign of community formation. If members do not continue to recommend new members, governance must find out what is going on. Is the purpose of a DAO unclear, or unattractive? Is the task not enticing enough, or the reward not satisfying enough? Isn’t the DAO’s culture appealing? If answers aren’t available in conversations with members, a thoughtful experimentation can at least make DAOs more interesting. Unexpected breakthroughs are also more likely if founders keep iterating.
Keep DAO members engaged
Governance wants to ensure that new members grow into engagement, valuable contributors and stick around. If new members show boredom and dissatisfaction, this will affect the overall dynamics of the DAO and may lead to user departures and negative network effects.
Members who join but don’t participate are not necessarily a bad thing. Sometimes new members want to get a seat before they feel confident enough to sign up for a mission or engage in a conversation. Lurkers represent potential waiting for the DAO governance to activate. Polls or active participation can reveal specific reasons lurking. If there is a pattern, it becomes obvious how to activate these members.
have to be aware of is:
1. Is the number of active participants growing, stagnant or declining?
2. How is the entry experience structured? Is it engaging and easy to understand?
3. Are closed groups formed who are in charge of tasks and are not friendly to newcomers?
4. Are chats filled with messages and conversations becoming incomprehensible?
Dunbar’s number is an important concept to keep in mind when considering engagement. Without structure, too much engagement can undermine any chance for meaningful conversation and relationship building, as anyone who has participated in an airdropped Telegram group can attest.
If a DAO is growing and the chat is starting to flood with messages, governance should consider opening a channel of specific interest in Discord, or even launching a Sub-DAO that focuses on a subset of the broader mission. This is a good question, but must be addressed . If the conversation is swept away by a flood of other user posts, less confident members will leave, and some of them may become star contributors if they can find room to blossom.
#general, #off-topic and #introduction chats generally cannot be broken down into smaller sub-chats. But pinned messages or Discord bots can ensure new users quickly find the subgroups most relevant to them. These can then be managed to keep small, comfortable places where meaningful conversations can take place and work gets done.
DAO culture, mythology and the art of storytelling
Maintaining a common goal is easy when DAOs are small and the communication channels between members are direct. As more members joined, the interpretation of the organization’s purpose began to diverge, eroding the influence of the entire enterprise.
This is especially true for large, distributed organizations where there is little formal onboarding and it is difficult to ask members to attend meetings. Regular community calls are invaluable, but a call with 12,000 attendees means few questions are answered and only a few opinions are heard.
Without a strong sense of purpose and active community building, DAOs tend to become chaotic at first and then quickly become boring as members simply give up trying to participate.
Since DAOs rarely offer regular salaries, community and friendship are key. Governance must ensure that this can be easily achieved. Buddy systems, newcomer events in small groups, and drop-in-the-wall channels are some of the ways members can get to know each other better and foster meaningful relationships. Ultimately, it will be relationships that bind members together and provide the most value. A DAO’s cohesion determines its staying power in a competitive environment.
Gaming guilds are a good example where a common goal and a well-defined mission are shared. A shared passion means new members have common talking points that help build connections.
DAO governance should pay attention to the following situations:
1. The common purpose and story of the DAO is often reiterated and mentioned.
2. The mission of the DAO is regularly refined and well understood.
3. There is a common ground and shared values to build on.
4. A higher purpose and mission can be identified.
It might seem like an exaggeration to call the DAO’s shared purpose or shared story a place in the myth of the World Organization, but we think it fits the bill. In the long run, tedious, everyday stories don’t have the necessary appeal and power to motivate members. The power of myths lies precisely in their ambiguity, which helps it fit into a wider context than a rigorous essay.
Take Apple, for example: By telling their brand stories over the decades, users trust Apple to make the best products for successful ideas and to be at the forefront of innovation. They are more willing to forgive occasional mistakes, such as a malfunctioning keyboard, because they believe “Apple is good.” That’s what organizational mythology can do. A certain attitude and aura are associated with an organization, and this vague notion is self-fulfilling, as long as the core message does not directly contradict the behavior of the organization.
Governance should be defined as early as possible:
- What common values should the DAO stand for.
- Is there a founding story worth telling.
- Is there a higher mission worth striving for.
- How this identity is maintained through storytelling, and how it is refreshed and realized.
DAO governance should pay attention to whether these values emerge from within the organization and leverage them. Community engagement should relentlessly reaffirm the stories that define the purpose of a DAO because stories connect human communities in ways that are more enduring than rational goals.
All organizations are networks. DAOs just allow people to join and leave faster. The power of DAOs is that the barriers to entry are extremely low. But so are the barriers to leaving.
Network effects are at the heart of growing and maintaining a vibrant, distributed organization that delivers great work. DAO governance needs to ensure they understand these dynamics and set appropriate incentives.
We would like to end this article with the words of American author and entrepreneur Keith Ferrazzi:
“The currency of the real network is not greed, but generosity.”
May generosity and a higher sense of purpose inform your decisions.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/daos-dunbars-number-and-network-effects-and-what-to-watch-out-for-in-governance/
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