How to create a perfect DAO

The emergence of DAO is inevitable, because the reduction of collaboration costs makes the marginal effect of synergy more significant.

The essence of DAO is to allow all participants to share risks and benefits, which is “Skin in the game”. Then the key to this is the need for Token to connect the bonds of interest.

Yes, any organization involving multiple parties can become a DAO, and all DAOs that create value need Tokens. How to create and manage DAO has become the biggest problem.

This article is from Future of a16z. The author is Tarun Chitra, CEO of Gauntlet, a protocol risk control platform. The article gives a detailed introduction and analysis of DAO’s incentive methods, DAO types, DAO key governance areas, and DAO governance methods. Rhythm BlockBeats translated the full text:

With the huge growth of the DeFi and NFT communities, how to govern decentralized agreements becomes extremely important. In the current and future years, one of the most serious challenges facing these communities is to understand governance, that is, how to manage collective decision-making to optimize capital and business operations.

However, governance requires a high cost of collaboration, because network participants need to truly participate in the voting for every decision. In the new type of decentralized network, these collaboration costs can be fundamentally reduced, because in these networks, participants can conduct collaborative governance through smart contracts.

These new types of networks are called DAOs (Decentralized Autonomous Organizations). In DAOs, people have consistent incentives and common interests, there is no absolute leader, there will be no single point of failure, and almost completely follow the code operation . The construction of many new agreements has begun to adopt this structure. Up to now, most of the activities are based on the open financial system, but more and more people are using it in cultural networks to purchase and trade artworks and other collectibles. From many perspectives, DAO is like a combination of investment banks, companies, and societies, which are closely linked through cryptographic commitments.

Although it is called an “autonomous organization”, in fact, DAOs are often not fully autonomous. Someone still needs to establish a decision-making framework to ensure that DAOs can be effectively governed, and financially continue to motivate participants to participate in governance, so that DAOs can Grow and grow.

Next, the founders and participants of the DAO will face many questions, such as: What decisions need to be made? What kind of financial incentives can be used? Under what conditions should DAO be formed? What are the main governance tasks required today? What tools can be used to help governance?

Before answering these questions, let us first talk about another question to briefly discuss the development path of DAO: How did DAO grow up step by step? This will enable us to understand how the decentralized structure was born and evolved in the past half month. This will also help explain why financial incentives are a key factor in the advent of the DAO governance era.

Experiments paved the way for modern DAOs

The world first heard of these Internet-native organizations in 2016. In the early stage, the most famous DAO was called “The DAO”. It is a collective investment tool designed to become a rationalist form of crowdfunding, a decentralized venture fund, and for the first time to show the world How should such a decentralized organization that runs through code manage itself? Participants provide ETH to The DAO and obtain DAO Token. These tokens represent the holder’s economic interests and voting rights in The DAO.

The dream of The DAO is to allow any participant to get rich rewards in the Ethereum ecosystem, no matter how much they contribute to the vault. A fatal smart contract vulnerability caused the funds in the DAO contract to be stolen by attackers, and the word DAO fell out of favor. This also led to the appearance of the “DAO Winter” in the 2017 bear market.

With the decline in expectations and the decline in attention, some important governance experiments in this period paved the way for the modern DAO. The first of these experiments solved the security problem, which is crucial, because if users are worried that their funds will go to naught, then no network will work, let alone development. First of all, Ethereum’s competitors such as Tezos promise to provide a more secure smart contract programming language so that developers can easily avoid the problems of The DAO. Some experimental projects have also appeared on the Ethereum network, such as Aragon, dxDAO, Kleros, and Moloch. The implementation of these DAOs has brought better programming standards and experiments with new Token distribution mechanisms to this field.

With the reduction of security issues, the biggest problem faced by early DAOs was that they were unable to find an appropriate incentive model to encourage people to participate in the governance of DAOs. And without the participation of people with expertise, the DAO will not be able to make wise decisions, and DAO governance will stall.

The rise of financial incentives

In recent years, the rise of DeFi (decentralized finance) has opened the door to more complex open financial systems and financial tools. At the same time, DeFi does not rely on banks or other traditional systems. Emerging DAOs are beginning to appear, and they use financial incentives to encourage actively participating users.

These incentives and ways to promote each other have become key factors in DAO governance, because without financial incentives, members of the network have no reason to invest time, money and energy into the network, and there is no reason to treat DAO No one cares about whether these proposals can continue to develop and achieve success.

There are currently several types of incentive measures, and the key events that form these measures, which can better help builders understand the following questions: How did DAOs get to this point? When do you need DAOs? Why are incentives important to DAOs? And strategies to effectively govern DAOs.

Growth incentives

June 2020 is a crucial development node. The core developers of Compound (an on-chain lending agreement) delegated their rights and transferred the operation and ownership of their network to the community. Unlike the previous DAO, the Compound Governance DAO gives community members control over the agreement and reserve assets, which are generated by charging borrowers and lenders for revenue. These cash flows were the highest among all on-chain protocol revenues at the time.

Compound proposed a novel Token distribution model, which aims to stimulate the capital growth of the chain protocol and provide users with a more suitable loan price. In this model, users who provide liquidity for the agreement or create a loan relationship through the agreement will continue to receive the native Token (COMP) from Compound as a reward. This allows every user of Compound to become a direct stakeholder, which allows many users to become active contributors and voters in the community.

These financial incentives play a vital role in controlling key parameters such as margin requirements and interest rates. Compound’s Token distribution method makes us seem to see the realization of the dream of decentralization, that is, the control of protocols (and cash flow). Since the compound agreement has billions of dollars in assets and pledged assets that need to be governed, a new type of community-native DAO has emerged. Participants have clear reasons to use their time, assets, and votes in the governance of the online community. Because only the growth and development of online communities are related to their personal interests.

Income farming

With the development of governance token distribution methods, in addition to investors and development teams, users in the agreement can also get tokens, which also makes many new solutions possible. The first is agreement incentives like “income farming.” Income farming is when users get rewards for providing liquidity for the agreement through borrowing, pledge or other forms. These rewards are actually Tokens representing the ownership of the agreement itself. Those who are rewarded can accumulate these tokens representing the ownership of the agreement, wait for the value of the agreement to rise, or immediately sell them on the open market, and then perform various compound interest operations. Let’s imagine. If every time you make a deposit, the bank will give you a small portion of the stock, you are more likely to deposit, because it is good for you and the bank.

For example, Compound users can earn governance tokens by locking their assets in the agreement (using them as collateral assets and lending through the agreement). In this way, Compound can use COMP (Compound’s native Token) to incentivize growth, create a user base, incentivize users to vote and contribute to the protocol community, because the revenue can attract more users.

Once developers realize that they can attract funds to the new DeFi primitives through revenue farming, competition between DeFi protocols will occur through DAO Token like DeFi Sunmer in 2020. The launch of Yearn Finance (YFI), DeFi’s revenue aggregator, is a catalyst for DeFi growth in the summer of 2020. Its “fair issuance (where all tokens are distributed to fund providers, and project developers do not have tokens)” transfers the narrative from venture-funded projects to community-funded projects. Once YFI goes online and achieves rapid growth, many competitors will start to “clone” and “counterfeit” products, and promise to make improvements, but more importantly, launch a new DAO governance Token.

YFI demonstrated to the public that “just the promise of governance” can make the network bootstrapping. Fair sales model and the use of native token distribution to attract potential users have become common practices.

Retrospective airdrop

New agreements are usually established based on these models to further motivate users. Airdrop is a typical case. Sometimes Tokens are sent directly to users’ wallets to spread awareness, establish ownership, or retroactively reward early users. For example, Uniswap, a decentralized trading protocol, once issued UNI Token, and this Token is retrospectively awarded to everyone who has used the Uniswap protocol. This airdrop allowed some early users to obtain UNI worth tens of millions of dollars.

More importantly, airdrops and Token issuance have become an effective capital protection weapon, and soon this has also become a necessary way for the new DeFi agreement to seek market share.

The increase in Token issuance has also led to a change in governance power – early users did not know that their participation would bring governance power, and they began to own important parts of the network, which in turn promoted further decentralization.

Retrospective airdrops have become a tool to expand Token issuance and active user governance participation.

Cultural DAO and Game Guild

The development of the aforementioned financial incentives has promoted the exponential growth of DeFi agreements in the past year. However, other types of DAOs with different cultures, incentive models, and governance structures are also emerging. Recently, we have seen the rise of DAOs. The Token distribution model they use has nothing to do with use or participation, which is different from DeFi’s DAO.

This is the Collector DAO, composed of people who decide to collectively buy art or other digital objects. PleasrDAO is an example. This DAO was originally established to purchase video works created by pplpleasr (Emily Yang) to celebrate the release of Uniswap V3. This video is regarded as an iconic artwork that captures the spirit of DeFi in 2020. The video was cast as NFT and auctioned, and the proceeds will be donated to charity. This auction and the collective temperament surrounding the artwork have led some long-term DeFi developers and entrepreneurs to create a DAO to purchase this artwork.

The advancement of PleasrDAO is to have a unique mechanism to fragment NFT, which makes it possible for collective ownership of a single artwork. This portrays the DAO as an art museum (just like MoMA), and all works in the museum can be collectively owned by funders.

In the fall of 2020, another culturally significant collector DAO FingerprintsDAO appeared. Unlike PleasrDAO, FingerprintsDAO focuses on creating collections of generative art and on-chain art. NFT-based generative art is unique because the artwork will change every time the ownership changes-for example, the artwork $HASH (Proof of Beauty) every time the artwork is transferred, the basic metadata will be based on the block The chain status changes randomly. FingerprintsDAO has collected these collections and has the largest collection of Autoglyphs, Bitchcoins and 0xDEAFBEEF.

FingerprintsDAO and PleasrDAO use governance tokens to manage the treasury, perform asset sales (including fragmented revenue), and perform asset management. Holders of DAO Token have the right to vote on these issues, and the results of these votes are directly executed by on-chain algorithms using DeFi protocols (such as Fractional or Uniswap).

Since collector DAO’s Token distribution and use or participation are not related, and the financial incentives are different from the usual DeFi DAO, this may cause the early organizers of the DAO to assume increasing obligations to maintain the effective operation of the DAO, and the DAO Complex dynamic relationships between members. This consistency challenge is specific to cultural DAOs, and builders in this field should use different types of governance strategies to keep DAOs running efficiently.

One way is for the collector DAO to hire full-time engineers and product managers, using governance tokens for direct incentives (while ensuring the decentralized governance and operation of the DAO). By ensuring that those who work for the DAO can obtain a larger and larger share of the assets of the DAO, a stable balance can be created between the early holders of the Token and those engaged in the daily management of the DAO.

The last type of DAO is the game guild. This DAO has its own culture, incentive model and governance structure. This is the DAO version of the game guild (a team of players). These decentralized collectives own game items and/or collections, and share usage rights and sales proceeds.

Unlike traditional player guilds, the “Play to Earn” mechanism in games such as Axie Infinity encourages cooperation strategies and revenue sharing among participants. These mechanisms make them more like DeFi DAOs. Participating in the network can be rewarded, and it also improves the prospects of the network. But at this point, the governance of the network is less connected with pure financial indicators, and more connected with game performance and social indicators. many. These DAOs are worthy of attention, because as they develop, they may find new mechanisms to increase their degree of decentralization in ways that other DAOs have not used before.

We need DAO now

At present, the general growth of DAO and the great success of some highly innovative DAOs are declaring to people the fact that the realization of development and the improvement of network participation require the help of DAO. When market sentiment is high, it is not difficult for us to infer that all organizations, communities, and projects need DAO to join, just like Crypto, which emerged with the IC0 boom in 2017.

Of course, this is not entirely accurate. Only when the governance burden related to curation, security, and risk declines faster than the coordination cost that is automatically generated by letting members participate in voting for each decision, DAO can maximize its role. This is why the protocol builder must evaluate the true goals of the organization when deciding whether to form a DAO.

The common governance areas for all DAOs are:

Collective asset ownership and management. DAO’s treasury and balance sheet should be consistent with the functions of a decentralized enterprise, while considering the distribution of assets, liabilities, liquidity, income, and financial resources. Asset risk management. Need to monitor market volatility, prices and other market conditions in real time. Asset curation. From art collections to loan collateral, all DAO assets can benefit in the process of achieving curatorial goals.

Only when the community has clear requirements for these three governance areas, people should form a DAO.

It is worth noting that although DAO only participates in some activities, it also needs to provide all three functions. This is because, assuming that a cultural DAO owns an asset and can profit from it, even if the DAO completely ignores risk management (focusing only on asset curation) before, it will also sell the asset Inevitably face risks and challenges.

One of the most typical examples of this type of incident is the sale of $DOGToken by PleasrDAO for $225 million, which represents part of the ownership of the original Dogecoin Enigma NFT. Prior to this, PleasrDAO only focused on asset curation and ignored risk management. Since the team needs to issue tokens on Sushi’s Miso platform, they must learn the distribution mechanisms and economic principles of different tokens, especially when the splittable NFT market has just started. The team must also establish a community development fund to ensure that community members actually feel the ownership of this NFT.

We should realize from this that DAO needs to add new collective skills and governance processes according to changes in its activities, and to discover its own problems in time.

Three key governance areas

For those developing DAOs, one day their communities will require it to have a governance structure with all three key requirements. Below, I will give a detailed introduction to them respectively, so that the builders and protocol developers can clearly and clearly formulate the development focus, so as to establish a successful DAO.

Collective asset management

All DAOs have a part of initial capital, including governance tokens held by DAO smart contracts and assets used to purchase governance tokens. For example, if a DAO initially minted 1,000 governance tokens and sold 500 governance tokens to the founding members at a price of 100 ETH, then the initial capital of the DAO would be the remaining 500 governance tokens plus 100 ETH . However, as DAOs continue to grow in terms of users and accumulated cash flow (such as Compound), the community needs to manage their capital like corporate capital, because the best model of corporate governance is also applicable to DAOs. But in this way, privacy is difficult to guarantee.

Risk Management

Since DAO’s assets are usually risky assets, it is particularly important to manage its currency risk to protect the source of funds for future business. Some DeFi and NFT DAO’s vaults have hundreds of millions or even billions of dollars in assets. These assets are used to fund development and audits, provide insurance protection for the underlying agreements, and spend on user growth and acquisitions. In order to achieve these goals, the DAO needs to effectively manage its treasury to achieve specific indicators or KPIs, such as “Can we survive a 95% drop in asset prices?” or “If we rely on the assets we hold to obtain X % Interest, can I still buy a high-priced NFT?”

There is a recent example to illustrate this situation: Aave is a decentralized money market protocol. When its network participants used xSushi as collateral in the protocol last week, they discovered that the protocol still has potential loopholes due to prophecies. There was an incorrect quotation on the machine (CREAM Finance lost USD 130 million due to hacking). Gauntlet conducted a simulation of risk assessment and found that under current market conditions, potential attackers could not manipulate currency prices. However, in order to prevent this from happening, Gauntlet made a suggestion in Aave governance. He suggested prohibiting certain types of borrowing to reduce risk. This suggestion was also unanimously approved by the participants. (Aave’s DAO is a Gauntlet customer)

How to create a perfect DAO

There are three key governance factors at play here-a community that balances payments and can detect potential risks in a timely manner, a model to assess the nature of risks, and a governance process set up to make necessary adjustments (especially In terms of security).

Asset curation

Asset curation is generally carried out in the NFT collection DAO, such as PleasrDAO. These DAOs also naturally play the role of art and cultural curators, and the DAO governance token is used to vote on the increase or decrease of curatorial assets. However, DAOs on DeFi often face such a problem, although some mechanisms like Uniswap allow people to add assets at will, allowing people to use them to create a trading pool, but most other mechanisms with leverage do not allow people to add assets. this way. Especially for lending agreements like Aave and Compound, they need to use governance methods to determine the increase or decrease of assets. This is because these mechanisms must be considered for the security of the agreement, and they must carefully determine the corresponding parameters of each asset, including the margin ratio, interest rate curve and insurance costs.

Let’s use a simple example to illustrate what might go wrong. Suppose we minted a new type of asset-TarunCoin, and I control the entire supply of the coin. Suppose I create a loan pool at this time, so that I can borrow TarunCoin by mortgage. If I can peg TarunCoin to the U.S. dollar (for example, through the Uniswap fund pool, and I am the only liquidity provider in it), then I can greatly increase the market value of TarunCoin (for example, reach 100 million U.S. dollars), and then I will It is possible to borrow USD 100 million by collateralizing TarunCoin. However, since TarunCoin has almost no liquidity, loan defaults are inevitable, and those borrowers will suffer losses as a result.

This example shows that asset quality measured by Token distribution, liquidity, difficulty in price manipulation, and historical trading volume is very important for those DeFi DAOs that use leverage. Most of these DAOs use governance tokens as implicit or explicit insurance funds to be able to repay borrowers in the event of adverse events. Therefore, it is important for them to be cautious in selecting assets and formulate reasonable parameters for them. As the field continues to evolve, insurance products will help improve and reduce the governance interventions required for asset curation in DeFi.

How to operate a DAO

Then, a natural follow-up question is: “How should our community actually accomplish these three tasks? Our community only cares about X.” As the DAO matures, there will be a growing company and protocol ecosystem. Aims to closely assist the selection of assets and parameters through automated analysis and monitoring, and reduce the burden on members of the DAO. There are also strategies to reduce the complexity of DAO and allocate resources more efficiently. Here are some steps that DAO can take:

Make good use of governance tools

First of all, there are now many quantitative tools that have appeared in the market. They allow the community to visualize the risks in the DAO (and possibly related agreements) and form a function in conjunction with the market environment. For example, let DAO members understand what proposals such as lowering the collateral/margin standard or raising interest rates mean for the agreement. This improves the overall transparency of the risks in the DAO’s vault and allows the community to update the components in the vault to meet specific KPIs.

For example, the billions of dollars in assets held in the loan agreement Aave and Compound can effectively serve as insurance support for the loan agreement. For example, if a large price shock occurs, causing a large number of loan defaults and causing the lender to suffer losses in the agreement, these DAOs can use the treasury to compensate (for example, the DAI liquidation event in the Compound agreement ).

Adjusting parameters such as margin requirements in the agreement will help reduce the possibility that DAO will have to spend treasury funds in emergencies. Below is a real-time dashboard to monitor the risks of different Aave markets. (Information disclosure: I am the founder and CEO of Gauntlet, an application that provides these services). The tools used to quantify risk include simulation tools that combine algorithmic trading and artificial intelligence (such as AlphaGo).

How to create a perfect DAO

How to create a perfect DAO

The goal of these tools and services is to allow the community to expand to a larger and more diverse population. Due to the composability of smart contracts, protocols become more and more complicated, and for each new member, governance becomes more and more difficult. This in turn makes it more difficult for new members to participate in the DAO in a meaningful way.

By explaining to users the complex behavior hidden in the DAO in a simple form, visualization is the key to helping new members “get in the car”. For example, tools can allow all members to understand what they are voting on, without the need to understand potentially complex technologies. Then, each DAO’s tool or service can show the health of the DAO from a technical, financial, and community perspective in the form of an easy-to-understand dashboard.

In the DeFi field, DAOs mainly deal with financial and technical risks, so their Token holders will use tools to assess these risks. They can also help proxy voters (such as transferring voting rights to other voters) to evaluate their proxy’s performance in improving the agreement.

Divide DAO into smaller “subgroups”

Another thing that can help the DAO to expand its membership is to divide the DAO into smaller subgroups, which will operate independently and focus on different specific tasks (development, marketing, etc.). The first successfully grouped project is Yearn Finance. Yearn’s rapid growth and continuous product iteration forced it to divide the team into different groups to complete different tasks such as front-end UX, core protocol development, and marketing. Early participants such as tracheopteryx, zemm, and zakku created Coordinape to help contributors collaborate. This product allows the DAO to smoothly manage the pay of anonymous contributors, regardless of their location.

How to create a perfect DAO

Another more decentralized way is to use DAO smart contracts to group a DAO into multiple teams. As a result, different subgroups (called sub-DAOs or pods) can call specific functions in the DAO smart contract. The Orca protocol has established tools to automate this process so that those without development experience can easily create pods. This protocol allows you to create permission groups that can manage specific functions in DAO. This also allows different subgroups in the community to independently operate different tasks.

How to create a perfect DAO


The last thing to note about DAO governance: Once a DAO has a large enough community and assets, the most important thing is that it needs to hire people who can devote all their energy to maintenance, community communication, and management of the DAO. However, DAO must be careful not to recruit those who are very active in the community just for the increase in Token price. Therefore, we need to recruit all kinds of employees in a decentralized manner.

If DAO cannot successfully hire full-time developers, community managers and other staff, it will be very difficult when the DAO vault runs out of money or needs help. The once popular DeFi protocol failed because DAO assets were exhausted, and no DAOde members believed that they had enough motivation to ensure the operation of the protocol (for example, through protocol improvements or asset redistribution operations).

PleasrDAO has a committee (similar to the company’s board of directors) that can help the DAO indicate the long-term direction. The core contributors will be responsible for the DAO’s initiation, funding issues, and the smooth completion of the curation. In this way, DAOs can usually learn from the operation methods of traditional companies.

These online decentralized and asset-holding collaborative organizations are usually regarded as typical cases of the “Wild West”. However, many of the problems and solutions in traditional systems can also be used in DAO, because they all require human cooperation. These schemes have been tempered and tempered, so they may still be applicable in the new field of DAO. By learning DAO’s past development history, it may be able to help people build future online organizations more effectively. 

Posted by:CoinYuppie,Reprinted with attribution to:
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