HashKey Cui Chen: Discuss DAO governance goals, methods and potential problems

The DAO model seems to be superior to the mainstream top-down governance model, but not all DAOs can go on the right track. It also has problems such as decision failure, free-riding, supervision and safety.

Written by: Cui Chen, working at HashKey Capital Research
Audit: Zou Chuanwei, Chief Economist of Wanxiang Blockchain

The concept of distributed autonomy is much earlier than blockchain technology, and it is reflected in nature. Ants, which have a history of tens of millions of years, are passed on in this way. The ant colony does not have a leadership center. Each worker ants makes decisions through information exchange with each other, and completes decisions such as foraging and moving. In this mode, the group will not be unable to operate due to the departure of the manager. Unlike the popular top-down management method, distributed autonomy allows all members to participate in and be responsible for project governance. Distributed autonomy developed rapidly after the birth of the blockchain, which stems from the fact that smart contracts can openly and uniformly execute governance rules on the blockchain, and the blockchain network creates a trustless environment and appropriate economic incentives. The DAO (Distributed Autonomous Organization) model seems to be superior to the current mainstream top-down governance model organized by leadership, but not all DAOs can successfully get the organization on track and fully mobilize the enthusiasm of participants. DAO’s goals, governance methods, and existing problems are what this article will discuss.

The meaning and goals of DAO

DAO (Decentralized Autonomous Organization) The concept of distributed autonomous organization originated from the DAC (Decentralized Autonomous Corporation), which aims to subvert the traditional enterprise structure and allow enterprises to operate transparently and flatly. DAO includes more than enterprises, and any decentralized form of autonomous organization can be classified as DAO. The realization of decentralization stems from the equal relationship and trustlessness between the members of the organization, and it is believed that other members will not make decisions that damage the system. Autonomy requires rules to be constrained, and members must agree on the content of the rules and strictly abide by them. To achieve these conditions and realize the DAO function, blockchain technology is indispensable.

First of all, smart contracts can ensure that the rules in the DAO are transparently disclosed to everyone, cannot be tampered with, and can only be implemented in accordance with the designed rules. Secondly, the blockchain is an open network without permission, everyone can join and exit freely, and the status of participants in the network is equal. Finally, the tokens issued in the blockchain can take economic measures so that participants will not do evil in the system in order to maximize their benefits. In general, DAO uses tokens to ensure that personal interests are consistent with the overall interests of the project, and the entire rules run in smart contracts to ensure transparent and decentralized execution.

Before the birth of DAO, the concept of distributed autonomy had been circulated for a long time, and it was initially reflected in nature. For example, the ant colony does not have an orderly leader to manage the ants, but through the exchange of information between each ant, the entire colony continues to inherit and develop. The goal of DAO is the same, to maintain the operation and evolution of the organization through the autonomous operation of the community. The advantages of DAO are obvious. Members can increase their activity in the project by participating in governance, and all can fairly enjoy the benefits of the project. More importantly, it avoids possible problems caused by centralized management, such as decision-makers. Accidental departure and bureaucracy. This form of organization has also attracted the attention of regulators. On July 1, 2021, the State of Wyoming formally implemented the DAO Act. Since then, the legal status of DAO in the state has been recognized. The DAO Act treats DAO as a limited liability company, which needs to comply with the Wyoming State Limited Liability Company Act. In DAO governance, it is necessary to clarify the relationship between members and the rights and responsibilities of members, the implementation of DAO activities, and the procedures for changing smart contracts. The DAO Act allows algorithmic governance and manual governance to coexist and classifies smart contracts as organizational documents. Among the organizational documents including the articles of association and operating agreements, smart contracts have the highest priority.

As can be seen from the above description, DAO cannot be an independent project, but as a decision-making center in a complete project. Decision-making is achieved through non-centralized member autonomy. In order to facilitate this governance process, smart contracts are indispensable. The concept of DAO has been proposed for several years, but how to make the most of DAO in the project is still being explored.

DAO governance

Advantages of DAO applied to governance

As mentioned above, the realization of DAO is related to the underlying technology of blockchain, and blockchain projects are also inseparable from the participation of DAO. In order to pursue decentralization, blockchain projects including on-chain applications and public chain protocols have allowed DAO to act as a decision-making center. DAO governance is more decentralized and closer to the goal of a decentralized agreement through the resolution of the whole people. Using the DAO way of governance, the founding team can exit after completing the set goals, and the project will self-improve.

When the DAO conducts governance, participants must be conducive to the common goals of the project, otherwise it is difficult to reach consensus on governance opinions, which requires binding personal interests with the overall interests of the project. Take the mortgage lending project MakerDAO as an example, users use Ethereum to over-collateralize the stablecoin DAI. If the mortgage rate behind DAI is insufficient, the system will liquidate the mortgaged assets, and the governor needs to determine the mortgage rate and stability fee and other parameters. The token MKR is used for MakerDAO’s governance and payment of stability fees and other functions. When the user repays the debt, the MKR used to pay the stability fee interest will be destroyed, and the value of the network is directly tied to the MKR price. Therefore, as the number of network users increases, the price of MKR will rise, and those who hold MKR and participate in governance will make cautious decisions even without a central leader.

Members of DAO governance

The DAO should be a governance organization with full participation. For the proposals sent out, the opinions will be voted in the form of a referendum. The tokens voted by users are counted in units of quantity. This simple and direct governance method is adopted by many decentralized projects. For example, in neuron governance in Dfinity, anyone can create neurons to directly participate in governance voting.

Another common governance participant is a committee or organization. They are elected by individuals to replace individuals for governance. In the early stages of the project, in order to guide the formation of correct long-term goals and frameworks, committees are often used for governance and given greater powers. For example, in Polkadot, the rules put forward by the governance committee are easier to pass. EOS has always adopted the method of delegated governance. Users vote for nodes, and then nodes manage tokens to vote. If the user does not agree with the behavior of the node, the vote can be cancelled.

In addition to determining project parameter changes and long-term goals, governance content has a large part of technology upgrades. However, most ordinary users do not understand the content involving technology or other professional knowledge, and cannot learn in a short time. In order to improve governance efficiency and delegate specific matters to specific people, DAO has also developed into a different structure.

yearn.finance is a revenue aggregation platform, and autonomous communities are more active in DeFi projects. The holder of the token YFI decides what the platform owns. During the development process, the DAO of year.finance evolved into version 2.0. The governance system is organized into different parts to exercise specific powers, which is called the form of Multi-DAO. The specific structure is shown in the figure below. The groups participating in governance are composed of YFI holders, yTeams and Multisig.

Coin World-HashKey Cui Chen: Discuss DAO governance goals, methods and potential problemsFigure 1: Yearn.finance’s Multi-DAO governance framework

YFI holders delegate power to different management teams, and they have the power to approve yTeams and change Multisig members. Some key issues involved, such as casting and destroying YFI, using treasury funds, etc., are also determined by YFI holders. yTeams is divided into multiple parts, such as yBrain responsible for strategy management, yPeople responsible for team management, and yBudget responsible for budgeting. Multisig is responsible for execution on the chain, and they also have the right to veto the decision, but it will not be used under normal circumstances. Decentralizing the decision-making in yearn.finance to different teams can prevent everyone from needing to make decisions and reduce the complexity of decision-making in the DAO organization. In addition, in the DAO of yearn.finance, you can choose to delegate voting, give voting rights to other users, and follow others’ voting results.

DAO governance

According to the definition of DAO, the rules are written into the smart contract, and the governance of DAO should be completely completed on the chain. However, the voting process requires multiple discussions, especially when it involves parameter changes, and the deployment of smart contracts and voting require costs, so the current general approach is a combination of on-chain and off-chain for DAO governance. Before initiating an on-chain vote, it is necessary to initiate a poll and discussion in an offline forum, and initiate an on-chain vote based on the results of the poll. Let’s take MakerDAO as an example to illustrate the way of DAO governance.

DAO governance in MakerDAO is divided into two parts: off-chain and on-chain. Off-chain discussions are conducted through forums, which generally precede on-chain governance and are used to discuss and evaluate community issues. If you need to measure community opinions or reach a consensus on something, you can initiate a poll in the forum. If these issues are supported by the majority of people in the forum, you can vote on the chain, and the result of the vote will be written. There are two types of on-chain voting, governance polls and executive voting. The proposals in the governance polls are mainly used to judge the intention of MKR holders for some decisions. The content of the implementation vote is mainly to change the current state of the agreement, the latter is more inclined to the implementation level and more important. Anyone can initiate on-chain voting, but there is no convenient UI entry related to it, and can only be implemented directly by interacting with smart contracts, which raises the threshold for initiating on-chain proposals.

Different types of voting methods and statistical rules are also different. Off-chain voting is carried out in units of accounts, using the statistical method of one account for one vote. On-chain voting is written into the smart contract, and votes are counted in units of MKR. In the MakerDAO forum, the reputation system of the user account will indirectly affect voting. Each account of the forum has a corresponding badge label and level, which is comprehensively judged based on the number of active days, the number of likes, the number of reports and other factors. Users of different levels have different management permissions in the forums, such as having labels such as manager and active, which is very similar to the operating mode of Internet forums. Since on-chain voting will be discussed through forums, the identity of accounts off-chain will also affect the results of on-chain voting. For example, higher-level users supporting a certain point of view in the forum will cause more attention. The MakerDAO Foundation has a large number of MKRs, but does not participate in governance voting.

Other DAO governance methods that use a combination of on-chain and off-chain are similar to MakerDAO. Proposals need to be discussed in forums or other social media before final voting on the chain. For example, yearn.finance votes on the chain to pass the proposal, which needs to meet the two conditions on the chain and off the chain. The forums under the first chain have been published and discussed for more than three days and more than 25% of the polls in the forum agree, and the second chain votes It takes more than half of the votes for 5 consecutive days. Community proposals in Polkadot also need to be ranked first in the off-chain community voting before they can be voted on-chain.

The content and enthusiasm of DAO governance

In theory, all items in the project must be decided and managed through DAO. Different parts of the DAO governance method are responsible for different content. The three types of voting content in MakerDAO are shown in the following table, and they are in a progressive relationship. .

Coin World-HashKey Cui Chen: Discuss DAO governance goals, methods and potential problemsTable 1: Classification and content of voting

The governance content in other decentralized applications will also be related to the application type. The content of the decision in yearn.finance includes adding machine gun pool tokens, adjusting YFI distribution parameters, adding airdrops, etc. The governance content of the public chain protocol includes the technical upgrade of the network and the modification of public chain parameters, such as adding the number of governors, and changing the rules for issuing tokens. The combination of on-chain and off-chain governance is based on the off-chain statistics of community opinions, and binding voting is initiated on-chain.

In the history of MakerDAO’s development, there have been several major challenges, such as large-scale liquidation triggered by a collapse of collateral and insolvency, etc., and the price of DAI deviated from the benchmark value. These problems have been adjusted through the MakerDAO governance system. The circulation of DAI has been increasing and has been maintained at around 1 US dollar for a long time, which proves that the governance method of DAO is vigorous. As a stable currency issuance platform for mortgage lending, maintaining the price of DAI and expanding the scope of use of DAI is the ultimate goal of governance. This is related to the value of MKR. People involved in governance will not make any profit for economic purposes because they hold MKR. The decision to compromise the system.

The voting enthusiasm of different projects is also different, which may be related to the content of governance and the way the tokens are distributed. Yearn.finance’s token YFI is distributed through mobile new mining, and adopts the token distribution method of Fair Launch. In the early stage, there is no central organization or team to participate, and the management awareness of currency holders will be stronger, and the governance will be very active. And as a revenue aggregation platform, every decision made by users is related to how much revenue they get, and governance has direct positive feedback results. Relatively speaking, the governance enthusiasm on the public chain will be worse. This stems from the fact that most people do not understand the content of technological upgrades, are not interested in voting, and the results after participating in the voting are not very profitable. In addition, token lockup will increase the opportunity cost of voters, which is also the reason for the enthusiasm of voting.

Problems and Improvements in DAO Governance

According to the performance of the DAO in the past, there are currently five problems in governance through the DAO.

The correctness of DAO governance

Whether group decision-making is better than centralized decision-making, that is, whether the project can choose the right direction through DAO governance is a difficult question to judge. Decentralized governance can centralize group wisdom, but centralized leaders will also have more clues in task allocation. For different development stages of different projects, different routes may be suitable. For example, Synthetix encountered problems in DAO governance, and the founder who had already withdrawn from the decision-making process had to return to continue to lead. Kain, the founder of Synthetix, gave the decision-making power to the Spartan Committee (8 people, used to decide the protocol parameters and mechanisms), and did not serve on the committee. However, after the transfer of power without a core leader, many new problems appeared and no one was responsible outside the DAO management authority, which affected the development of Synthetix. In order to solve this problem, after the core participants withdrew, they should generally remain in the DAO to guide decision-making or expand the scale of governance.

Free-rider problem of governance

In actual governance, only a small number of people will participate in voting, but everyone can enjoy the benefits of governance. This is a free-riding problem in the DAO system. Not only that, but those who participate in governance will be constrained and lost due to locked-in tokens. The free-riding problem is a social and psychological problem, and there is no solution. By rewarding participants, governance behaviors can be encouraged, such as issuing token rewards to participants who vote for locked positions.

Degree of decentralization of governance

The goal of DAO governance is to achieve the greatest degree of decentralization and delegate management power to all participants. But in DAO governance, it is impossible to adopt a completely on-chain approach. The content of the proposal will inevitably be discussed in forums or social media. Former leaders or community KOLs will inevitably affect the community votes, and their proposals will receive more attention And support, which will affect the degree of decentralization of the community.

The rules of on-chain governance are written into smart contracts, but they cannot prevent off-chain influence. Especially when the voting rate is low, the voting results are easily affected by the off-chain center. These centers are often the people who have the most tokens. If the project is affected by centralization, then they are the ones who suffer the most. Through the mutual restriction of multiple centers, the centralization trend can also be limited.

DAO security

Since on-chain governance requires smart contracts, the security of smart contracts will affect DAOs. If there are loopholes in the smart contract, it will affect the use of DAO and even cause heavy losses. The DAO is the first platform on Ethereum as a DAO application, and it is a financing platform. The user deposits Ether into the smart contract in exchange for DAO tokens, and these crowdfunded Ethereum is used to fund other projects that require financing. The holder of DAO tokens decides the distribution of investment and obtains a return on investment. However, the The DAO project was attacked by hackers before it went live, stealing 3.6 million Ether that had been raised through a loophole in the smart contract. The DAO’s reputation was damaged and normal governance was not carried out.

DAO’s regulatory risks

As mentioned above, when conducting DAO governance, it is necessary to issue tokens and use tokens to vote. The price of tokens is related to the value of the system, and economic benefits are bound to the governor to prevent the governor from doing evil. And the issuance of tokens may trigger regulatory issues. The US Securities and Exchange Commission issued an investigation report on The DAO incident in July 2017, stating that DAO tokens belong to the definition of securities in the securities law. If the issuance of tokens is not exempted from the issuance of securities and is judged to be a security attribute by the regulator, this will cause a major blow to the entire project.

Thinking and summary

The ideal DAO governance scenario is that the project can still run completely independently without centralized leadership. Currently, DAO is widely used in decentralized applications and the governance part of the public chain. Users make decisions by holding tokens and voting. The result of the decision affects the overall value of the project, that is, the value of the token, economically prompting users to make decisions that do not damage the system. In some projects, increasing the token lock-up time in governance can increase the voting weight, and DAO voters are always tied to the long-term interests of the system.

Under normal circumstances, DAO governance is divided into two methods: voting by all members and proxy voting. These proxy agents will be selected by voting, and users can change their votes at any time. If multiple committees are set up in the DAO, they will also form a restrictive relationship. DAO governance is generally a combination of on-chain and off-chain. Proposals can be fully discussed off-chain, and public opinion surveys can be initiated off-chain, users’ intentions can be investigated in advance, and then on-chain voting can be initiated. In some projects, on-chain proposals also have strict restrictions on the pass rate of polls. For example, only polls that exceed a certain approval rate can initiate on-chain voting. Under normal circumstances, the contract will be automatically updated after the voting on the chain is passed, which also reflects the advantages of DAO. If the content of the public chain voted needs to be manually updated, it is likely to fork if the two sides are evenly matched.

There are several problems in the DAO organization, such as decision failure, free-riding, centralization influence, supervision and security issues. Except for the final security issues that require professionals to strengthen the review of the code, other issues can be improved by expanding the voting scale. The increase in the number of governors can increase the fault tolerance of the system, and the expansion of the scale of decentralization can also reduce the possibility of tokens being recognized as securities attributes.

In addition to playing a role in blockchain applications, DAO can also be used in more scenarios. The design of DAO needs to meet several conditions:

  1. The interests of the governor are consistent with the long-term interests of the project;
  2. The users involved in governance are sufficiently dispersed;
  3. All members have the final decision right, even when the governance committee exists;
  4. Everyone has a unified consensus on governance rules.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/hashkey-cui-chen-discuss-dao-governance-goals-methods-and-potential-problems/
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