Cover Art: Seerlight - High-Rise
The intention of the piece is to offer a thesis-driven overview of the DAO innovation landscape and consider which organizational models will prevail in such a nascent space. Any survey of the DAO landscape at present is destined to become quickly outdated. In an effort to provide a more enduring analysis, this piece focuses on the array of challenges DAOs face, the intrinsic strengths of DAOs as an organizational form, and target design principles—composability, automation, standardization, specialization, and financialization—DAOs should optimize around to ensure scalability, efficiency, and value creation for contributors.
This piece is long. My hope was to engender the greatest cross-pollination of ideas surrounding the DAO solution space so that the reader is able to connect the dots however is most meaningful to them.
“Computer software is increasingly becoming the single most important building block of our modern world, but up until now search into the area has been focused on two areas: artificial intelligence, software working purely on its own, and software tools working under human beings. The question is: is there something in the middle? If there is, the idea of software directing humans, the decentralized corporation, is exactly that.” - Vitalik Buterin
Before we get into what a DAO is, let's first talk about what decentralized organizations and autonomous organizations are. A decentralized organization (DO) is an organization in which “the activities of [the] organization, particularly those regarding planning and decision making, are distributed away from a central, authoritative location or group (Conceptual Models for DAO2DAO Relations). Democratic systems with governance privilege distributed across an assortment of participants rather than concentrated on a centralized authority is a nice mental model for decentralized organizations.
Alternatively, autonomous organizations (AO) are organizations that are independent and self-governing. Autonomy can take multiple forms. From an organizational perspective, self-sovereignty and independence from institutions are key. Alternatively, from “a human resources perspective, [autonomy] denotes a (relatively high) level of discretion granted to an employee in his or her work” (Conceptual Models for DAO2DAO Relations). Both definitions of autonomy are present in a prototypical DAO. Similar in flavor is the tendency in crypto to conflate “autonomy” and “autonomous.” In the case of DAOs, both concepts are relevant.
“DAOs contain automated components, or bots, which share similar design features with distributed systems in automatic control, such as feedback loops in sensor networks. From a political philosophy perspective, however, the salient feature of a DAO is autonomy, in the sense of self-actualization at the organizational level” (Conceptual Models for DAO2DAO Relations).
Most broadly, a DAO is defined cogently by Kei Kreutler:
“A capitalized organization in which a software protocol informs its operation, placing automation at its center and humans at its edges. For example, a software protocol could specify the conditions upon which an organization automatically distributes capital to its members. This [leads] to the idea that organizational values could be automated and executed by code." (A Prehistory of DAOs).
The distinction between an AO and DAO lies in the varying levels and prominence placed on decentralization within the organization. DAOs are distinct from decentralized organizations in that “in a DO the humans are the ones making the decisions, and a DAO is something that, in some fashion, makes decisions for itself” (DAOs, DACs, DAs, and More). While there may be “no difference between a certain set of actors making decisions directly and that set of actors controlling all of the information through which decisions are made,” this distinction will become increasingly important as process automation takes on a more meaningful stake of internal DAO activity (DAOs, DACs, DAs, and More).
The promise of DAOs lies in leveraging process automation via code to squeeze out all of the bureaucratic and economic inefficiencies that are commonplace in other organization types. It is worth noting however that DAOs consisting of humans at the edges and automation at the center is a somewhat restrictive definition of a DAO that has morphed into a broader categorization (i.e. DAOs can be large coordination vehicles with automation directing human contributors or a simple shared treasury between aligned human actors). The various DAO formations will be discussed further below.
Defined similarly by the concept’s progenitor, Vitalik Buterin, “a DAO is an entity that lives on the internet and exists autonomously, but also heavily relies on hiring individuals to perform certain tasks that the automaton itself cannot do.” (Conceptual Models for DAO2DAO Relations). The concept of a DAO invokes a confluence between human and machine that seems to be the best of both worlds, but the reality of the nascent DAO space today leaves a lot to be desired.
An archetypal DAO has the following elements:
Community initiatives to keep DAO members engaged and activate new members (e.g., working groups, community calls, onboarding sessions, IRL events, hackathons, etc.)" (Thoughts on DAO Tooling).
While many DAOs are working toward the above functionality, the reality of the space is many DAOs are no more than group chats with a shared bank account, commonly manifesting as a Discord server and a Gnosis Safe Multisig wallet (A Prehistory of DAOs). While each of the above pillars of a robust DAO is a work in progress, DAOs present the opportunity to work toward a shared mission through “representative ownership of its digital assets through a token, which often simultaneously acts as governance right and network utility” (A Prehistory of DAOs).
In spite of its infancy, the emerging DAO ecosystem has reached a remarkable scale in a few short years since its inception. As of June 12, 2022, 2223 verified DAOs are listed on DeepDAO—a DAO analytics platform—containing $8.8 billion in their treasuries across 3.6 million governance token holders. DAO treasuries listed on DeepDAO went up 40x from $400 million in January to $16 billion in December 2021.
Equally astonishing are the numbers on participation. “Participants in DAOs went up 130x, from 13k in January to 1.6 million by December 2021.” These numbers indicate the undeniable staying power of this new org structure and suggest that DAOs have empowered contributors with unprecedented ownership of their communities.
This is a new organization type that is clearly financially distinct from traditional firms through the augmentation of a concept called liberation capital.
Back in the 1950s, Arthur Rock conceived of the private limited partnership that would align incentives between company success and upper management/junior employees via stock options. Rock’s novel innovation at Fairchild Semiconductor was offering an ownership stake to researchers willing to experiment and incorporate. A scientist turned founder at the time remarked that “[w]e were blown away…. Arthur pointed out to us that we could start our own company. It was completely foreign to us” (Behind the Power Law).
This eventually evolved into the widely-known equity culture that is commonplace in the world of early-stage startup culture (Why DAOs are the new firms). This model of “liberation capital” is the key innovation whereby a firm’s key contributors are incentivized beyond just salary.
If we continue along this firm-to-employee incentive alignment spectrum, DAOs are at the most incentive-aligned end. Instead of stock options for important company contributors, “DAOs extend this economic logic to every worker… DAO workers are paid in native tokens (equity). DAOs, therefore, empower workers with the best of both worlds: flexibility and stakeholdership. This gives them an even further vested interest in seeing the DAO organization grow” (Why DAOs are the new firms).
Alternatively, DAOs also compensate their contributors with USDC, ETH, or other treasury assets, not unlike the salary-plus-stock-option model that is commonplace in firms with an employee stock option pool. The primary takeaway from this evolution in compensation medium is the higher level of incentive alignment DAOs are able to achieve to motivate the entire community to strive toward a shared mission.
DAO history has been written about fairly extensively. To avoid reinventing the wheel, check out these pieces chronicling the origin of DAOs:
To preface this section, it is important to note that we will be flagging areas that DAOs should be thinking about critically as they mature. Later in the piece, we will explore some design principles DAOs should be mindful of to scale without loss of direction or coordination.
Existing DAO challenges can be broken into three buckets:
In these early days, there is a wide chasm between the promise of DAOs and the realities of day-to-day life in a DAO. In early March 2022, Dane Lund published an insightful piece on this distinction, evaluating the governance status of four prominent DAOs—“RaidGuild, a design and development collective for Web3 products; HoneyDAO, a decentralized venture capital collective; VitaDAO, a collective of longevity scientists and enthusiast; and, LexDAO, a collective of lawyer-engineers” (DAO Governance Primer: Flat DAOs). He uncovered concerning trends in each DAO when looking at discord engagement, governance proposal distribution, and user voting volume. Below is a graphical representation of the data he pulled:
The figures in each data cut demonstrate the vast inequality amongst DAO members' various contributions, following a power law distribution. For the Discord voting data, the observed contribution fall-off reveals that the top participants are the most active commenters by a large margin with nominal participation outside of a few core leaders. This data reveals that “the top commenter made an average of 6.8 times more comments than the tenth most frequent commenter” (DAO Governance Primer: Flat DAOs). This is, in part, a consequence of the novelty of this organization type whereby knowledgeable contributors are hard to come by, but, all the same, these trends highlight a serious issue of the same voices persisting and alone driving the DAOs progress.
In a similar vein, the steep proposal drop-off beyond the top handful of proposers suggests that the lion's share of governance proposals are submitted by a small group of active participants. It is important to note that “proposal initiation does not have a strong correlation with the success of the proposal, nor are those who initiate the most proposals necessarily the most frequent in the Discord,” which might preserve hope that DAO contribution between tasks (governance proposals, Discord activity, etc.) may have distinct highly-active contributors (DAO Governance Primer: Flat DAOs).
Finally, the decay in governance votes is not as pronounced as the other two data cuts, which may suggest that voting is more accessible and, therefore, more engaging among the suite of DAO contributor activities. However, there is still a clear centralized brain trust driving internal democratic processes. The decay may suggest that “thought leaders within the collective have a significant incentive to vote in a manner that preserves their elevated status” and point to a large amount of voter apathy across the four DAOs (DAO Governance Primer: Flat DAOs).
In summary, this data summarizing Discord activity, governance proposal generation, and governance voting participation is revealing that the namesake decentralization in these sample DAOs is not as robust as one would hope. The following quote from Dane offers some of the negative implications of concentrated high-value contributions in DAOs:
“It would be difficult for a new DAO member to know how to navigate the respective hierarchies or how to become ‘more equal than other DAO members’—and for long term mission direction—hierarchies in DAO collectives emerge, but not in an orderly manner, which could frustrate coordination over the long term, as DAO members aim to align with the idea of a flat organization but have no compass for how to flatten the participation curves in the multiple dimensions of the DAO community." (DAO Governance Primer: Flat DAOs).
Focusing contributor attention on effective work is a massive issue in DAOs today. It is most elegantly described by the Byzantine Generalization Problem which gets its name from the fun illustrative story, the Byzantine Generals’ Problem. This generalization problem is one in which “all issues in an organization or technical system are framed as governance issues. Any question that’s brought before an organization can become a question of who has the agency to provide the solution” (The Byzantine Generalization Problem-Subtle Strategy in the Context of Blockchain Governance).
In other words, the Byzantine Generalization Problem is one of over-deliberation in governance processes within DAOs. If one considers a DAO like a shared home that is suffering from broken plumbing (a governance issue), this analogy would see the inhabitants of the home debating who is best to take care of the plumbing issue while the pipes continue to leak.
Particularly in these early days without much formalized DAO infrastructure, the concept of argument surface is important. The argument surface characterizes the terrain through which humans make decisions or “the total optionality [or decision-making space] in a given system or organization,” and it naturally expands as the organization to which it belongs expands. As DAOs grow in size and contributor count, the decision space multiplies in size, limiting action clarity and decisiveness.
Adjacent issues to the generalization problem are the concept of bikeshedding or Parkinson’s Law of Triviality which points to over-deliberation or spending “too much time discussing trivial matters, and too little time discussing important matters as a result. It describes the inverse relationship between time spent and the importance of an issue” (The Byzantine Generalization Problem-Subtle Strategy in the Context of Blockchain Governance).
This happens because individuals prefer to speak on issues that they are most comfortable with which tend to be more easily comprehensible. The consequence is avoidance of challenging, potentially mission-critical topics precisely because they are daunting. As evidenced by the above voter apathy and centralized contributor data from some of today’s DAOs, the competence and confidence gap is a real issue in DAOs and will need to be addressed to ensure contributors' actions are directed most effectively.
These are human collective issues that apply to any organization, not just DAOs, and clever DAO tooling to mitigate these issues is an active area of research and development in the DAO space.
A massive risk for DAOs and the crypto space as a whole is centralization risk. For DAOs in particular, how to protect against “DAO ownership becoming largely subsumed and instrumentalized by centralized financial institutions” that are primarily involved for speculatory reasons is a critical question (Ownership in Cryptonetworks).
If DAOs do not build systems to protect against outside interests either speculating with internal currencies or gaining substantial governance rights within an underdeveloped governance scheme, the “ideas [of] DAO-governed commons become meaningless over time as DAOs ultimately congeal into speculatory investment vehicles” (Ownership in Cryptonetworks).
Related to the forthcoming section on one-way doors, “if something is truly decentralized, it becomes very difficult to change, and often remains stuck in time. That is a problem for technology, because the rest of the ecosystem is moving very quickly, and if you don’t keep up you will fail” (My First Impressions of Web3).
A second form of centralization risk is social centralization. For instance, if DAOs become concerned about protocol secrets getting leaked and begin to discriminate against anonymous contributors. KYC-ing contributors or forcing them to sign non-disclosure agreements could be a means by which traditional company practices could make their way into DAOs, centralizing these organizations in the process.
Adjacent to DAO centralization risk is platform centralization risk that commonly afflicts distributed protocols and could introduce further spillover centralization effects to DAOs connected to crypto protocols.
“A protocol moves much more slowly than a platform. After 30+ years, email is still unencrypted; meanwhile, WhatsApp went from unencrypted to full e2ee in a year. People are still trying to standardize sharing a video reliably over IRC; meanwhile, Slack lets you create custom reaction emoji based on your face” (My First Impressions of Web3).
“Royalties aren’t specified in ERC-721, and it’s too late to change it, so OpenSea has its own way of configuring royalties that exist in web2 space. Iterating quickly on centralized platforms is already outpacing the distributed protocols and consolidating control into platforms” (My First Impressions of Web3).
The most salient examples of centralization taking root within a decentralized ecosystem due to improved innovative efficiency are at the protocol level. Ethereum Improvement Proposals (EIP) and equivalent ecosystem improvement mechanisms offer low switching cost solutions to protocol design challenges, but, in the long run, control may consolidate into centralized platforms in a lasting way, stripping distributed protocols and their associated DAOs of innovative pressure. Effective distribution of ownership is a key part of the solution set to prevent an unwanted, centralized takeover, but that too is a challenge in its own right.
Today, the majority of DAOs, particularly those oriented around a product that requires technical expertise, are only partially decentralized. The typical path to decentralizing a DAO is called progressive decentralization whereby the core team that is chiefly responsible for developing the DAO’s product or core service progressively hands off more responsibility to the community.
To take an example, Rabbithole, a learn-to-earn protocol, is progressively decentralizing the Rabbithole DAO in three phases:
The challenge for Rabbithole DAO and many other progressively decentralizing DAOs is effectively distributing ownership at this community ownership handoff stage. The challenge is determining an effective way to distribute ownership of a network when contributors’ participation level, value add to the DAO, and community engagement level are all variable. Is holding some quantity of a governance token a sufficiently complete way to represent one’s ownership stake in a community?
Rabbithole’s endgame vision—building a robust and standardized on-chain credentialing system that could be used within the DAO ecosystem—suggests that maybe today’s token-weighted solutions to ownership distribution are insufficient.
An interesting byproduct of web3’s open-source ethos is the inversion of competition and cooperation compared to web2. In a competitive sense, building in the open in web3 means code is forkable (i.e. copyable) which implies that anyone can copy and remix a project to their liking. This suggests that instead of traditional sources of competitive advantage like proprietary IP, in web3, community loyalty and network effects are what differentiates good from bad projects. In a cooperative sense, things are more difficult in web3. Mergers and acquisitions, in web2, run comparatively smoothly when dealing with two centralized entities–only the two leadership teams need to be aligned to proceed.
In web3, however, aligning two distinct communities requires dual consensus which is a challenge (Ownership in Cryptonetworks). An example of this type of hard merge is exemplified by the merger between Rari Capital and Fei Protocol. Joey Santoro, the founder of Fei, notes that “It was really challenging to navigate a proposal this big. There were two whole DAOs worth of cooks in the kitchen. But Jai and the core teams and I were devoted to putting this out there” (Rari Capital, Fei Protocol Token Holders Approve Multibillion-Dollar DeFi Merger).
As the DAO space matures, discovering the best practices for product and community consolidation, cooperation, and overlap will be key for the space to scale and onboard new users. Some potential approaches include token swaps and hard mergers.
The social repercussions of the extreme transparency baked into web3 and DAOs present unique challenges. At the heart of web3, the blockchain–an immutable transaction ledger–makes everyone's on-chain behavior publicly accessible. Everyday on-chain data is becoming more robust and multi-faceted. Such publicity and public vulnerability introduce issues of ultra surveillance, stifling innovation and experimentation.
In a space in which every action can be scrutinized, there is a risk that for the sake of maintaining reputation, developers and creatives may be disincentivized from experimenting for fear of being wrong. Always-on visibility “may discourage the kind of risk-taking that often leads to technological breakthroughs in the DAO space” (DAO Nation). Directly adjacent to stifled experimentation is the challenge of transparency discouraging contributors from speaking up about changes to the DAO’s vision and culture, leading to detrimental in-action as core issues are left undiscussed.
Similarly, openly discussing traditionally private matters presents challenges. “Public salary negotiations and salary flows remain unpopular for individual workers in the space” (DAO Nation). In the most extreme cases, there is the risk of off-chain coercion. “Without procedures to anonymize the voting process, outside parties can target individual stakeholders to influence decisions normally reserved for direct stakeholders, which, in turn, may disrupt the typical alignment between DAO and stakeholder interests” (DAO Nation).
Another key human challenge the DAO space faces is general contributor technical literacy. Particularly in these early days, technical governance proposals to build core infrastructure for DAOs are commonplace. The challenge is finding contributors with a sufficiently technical background to make meaningful contributions to the governance discourse. “Centralization is likely to coalesce around experts, developers, and system architects” given that “only a handful of software developers and system architects understand the ins and outs of specific blockchain protocols to make educated decisions about protocol upgrades” (Governance of Blockchain Networks & Other DAOs).
Related is the resulting principal-agent problem that arises when the broader DAO community has to delegate design judgment to experts, making them “the new ‘quasi’ agents in a distributed network where ‘code is law’” (Governance of Blockchain Networks & Other DAOs).
On the other end of the spectrum, “another common critique points to the low participation barriers of DAOs that may bring about scalability issues…. Not everybody will have the knowledge or incentive to make the right call,” yet unspecialized and potentially unqualified contributors may be filling the ranks of DAOs (Why DAOs are the new firms). Beyond technical governance proposals, it is important to note that most governance token-holders aren't plugged-in enough to the community to have an informed opinion about the best course of action.
This principal-agent problem and low barrier to entry make clear that a robust reputation/skill system is needed to help DAOs scale sustainably and responsibly. One possible solution to this reputation and delegation challenge could be domain-specific reputation scores with corresponding voting power to allow specialists to more heavily driving decision-making in their expertise.
Especially at scale, it can be very difficult for a DAO to follow a clear discussion procedure given multiple channels of communication and the current lack of effective reputation systems. What’s more, all the chatter in Discord channels and Telegram chats are not created equal.
“Where does reliable information come from, and what tools, such as visualizations and decision trees, are required to facilitate such processes? Experience from past protocol upgrades shows that if issues of information, moderation, transparency, aggregation, and reputation are not resolved, decentralization might become a meaningless word.” (Governance of Blockchain Networks & Other DAOs).
Hand-in-hand with information coherence and actionability is the challenge of task definability. (Incentive Design & Tooling for DAOs) illuminates how variable work in a DAO can be. Below are some considerations from the piece that highlights how many more considerations need to go into defining a task in the absence of hierarchies and direct management:
Some other human challenges common to any group of utility-maximizing individuals are:
One challenge of working with smart contracts is that once deployed its code is fixed, so developers will build mechanisms to implement any necessary protocol updates to help account for unforeseen scenarios. This intentional contract incompleteness mitigates technical or ideological lock-in. The difficulty with DAOs, in particular, is the tyranny of structurelessness which can be characterized as “a poorly lit space filled with vague cultural norms and technical limitations but still anything other than empty” (The Byzantine Generalization Problem-Subtle Strategy in the Context of Blockchain Governance).
The roadmap for DAOs is uncharted territory, so it presents a uniquely challenging environment to build for unforeseen circumstances. Along a similar vein, token generation events are a one-way door, meaning that “once launched, it’s extremely difficult to course correct should the initial implementation not satisfy the requirements for the organization or community around it." (DAO Nation). So on top of building with so much uncertainty, monetizing and giving agency to the community, strips the founding team of their ability to act swiftly and decisively, introducing more uncertainty to developing DAOs and their projects. The "Move fast and break things" ethos is no longer true. Founders need to be thinking years into the future; messing up small elements can doom the project from the start.
A final aside on DAO challenges pertains to the regulatory challenges that afflict investment DAOs in the absence of accredited investor status. Syndicate DAO—a DAO working on Venture DAOs infrastructure and tooling—is hard at work on this issue. Tom Shaughnessy wrote a great Twitter thread outlining the distinct challenges that Venture DAOs face if you are interested. The LAO, RaidGuild, and Moloch DAO are also hard at work on this issue (to be discussed later on).
In summary, DAOs are worth developing because of their unique functionality and efficiency at scale in comparison to web2 firms that have more rigid limitations on size and function. DAO strengths can be split between those related to scalability and efficient operation.
Before getting into why DAOs are such powerful and revolutionary organizational structures, it will be helpful to recall why companies or firms have been so integral to enabling greater levels of working coordination. Firms were essential in smoothing out market transaction costs like price discovery, contract negotiation, or onboarding services.
Firms address these and many other transaction costs, absorbing the cost, increasing market efficiency, and enabling high levels of coordination scale. At a certain point, however, “transaction costs increase through developments like departmental bureaucracy” and the firm reaches a practical limit at which the transaction costs it mitigates are outweighed by internal bureaucracy (A Prehistory of DAOs).
In contrast to the size limitations of firms that introduce undue bureaucracy, DAOs, in theory, increase efficiency at scale. Process automation via code is at the heart of this efficiency. Within a DAO, different functional groups within the whole can pool and manage assets quickly, and “[t]he equivalent process to establish a joint bank account could take months, and in some cases, it wouldn’t be possible for individuals from different jurisdictions to jointly manage a bank account” (A Prehistory of DAOs).
The beauty of DAOs is that they can “incorporate deeper practical knowledge in governance without increasing operational transaction costs: aspiring to become ‘more efficient’ as they scale" (A Prehistory of DAOs). As we discussed earlier, at a sufficient scale within a DAOs, human coordination challenges can arise, but with robust frameworks in place to systemize internal processes, many of these challenges can be mitigated, leaving room for efficient operation at scale.
DAOs do not make sense for early-stage companies. The up-front investment in efficiency doesn't amortize well and comes at the expense of agility. It is worth noting that many DAOs today are quite bureaucratic and inefficient. The majority would be better run as a corporate entity; however, DAOs in a perfect world with perfect tooling would be able to surmount these coordination challenges and realize their potential at scale.
A complementary idea to efficient operation at scale is the notion of operating as a minimally extractive coordinator. Chris Burniske wrote a piece back in 2019 about Protocols as Minimally Extractive Coordinators in which he outlines how protocols play by different rules to traditional firms. He describes protocols not as businesses but as “systems of logic that coordinate exchange between suppliers and consumers of a service. The flatness with which a protocol treats everyone that interfaces with it are part of what drives its efficiency as a coordinator of exchange (no room for human corruption or capture)" (Protocols as Minimally Extractive Coordinators).
What this means, in the long run, is that protocols are in a race to the bottom to provide the lowest costs to users to outcompete their more inefficient peers. In web3, “both suppliers and distributors are subject to market competition, as opposed to the proprietary selection process that a company goes through for its suppliers and distributors. Competitive markets kill inefficiencies and drive down costs, which should allow protocol-coordinated-services to outcompete company-coordinated-services, accruing to the consumer’s benefit.” (Protocols as Minimally Extractive Coordinators).
The most elegant part of this process is that “any unnecessary extraction from the process of exchange is a tax that will ultimately be weeded out by copy-paste competition in the world of open-source protocols” (Protocols as Minimally Extractive Coordinators). The forkability that is built-in to open source projects will necessarily force protocols to become minimally extracted to remain competitive.
I wager that a similar race to the bottom will be present for DAOs, and this will be a similarly powerful forcing function to maximize contributor utility. Instead of minimal friction, DAOs will be assessed by user experience, process fluidity, and efficacy of automated processes. While it is very difficult to copy and paste community, as the DAO ecosystem matures and contributors are in control of their on-chain credentials, reputation, and identity, DAOs without refined user experiences, value-add to contributors, or inefficient internal capital flows will be outcompeted by those collectives that do.
Like protocols, the community-building playbook for DAOs is being open-sourced. Everyone has visibility into what works and does not, suggesting that improved DAO operation and contributors' experience will be the product of this copy and paste forcing function. This process of all DAOs learning from each other, adopting best practices, and trending towards the flagship DAOs will be a tremendous innovating pressure that will allow DAOs to far outcompete and scale compared to their web2 analogs.
Another strength of DAOs that will contribute to this flywheel effect is their remarkable capital efficiency compared to companies. The analogy between a company and the DAO is imperfect, and the data to elucidate this analogy is from 2020, but the distinction is quite illustrative of my point. At the time this data was pulled, Uniswap had a $1.4 billion treasury (now $1.9 billion) and Paypal had $14 billion of cash and short-term investments. Interestingly, Paypal had operating expenses of $18.16 billion, and “Uniswap, on the other hand, has spent over 100 times less than its treasury size.” Assuming generous compensation for the same Uniswap team and $3 million a year to their grants program, as of 2020, Uniswap only “spends at maximum $11m/year… and unlike Paypal, there are no liabilities on Uniswap’s balance sheet — the DAO has unprecedented freedom to spend" (Ownership in Cryptonetworks). The self-sustaining maintenance of Uniswap’s treasury with so few liabilities means the DAOs are able to invest substantially more in its protocol development than a web2 analog would in their product at a comparable scale.
Vitalik generalizes this comparison well.
“A major power of cryptocurrency (and other digital assets such as domain names, virtual land and NFTs) is that it allows communities to summon up large amounts of capital without any individual person needing to personally donate that capital. However, this capital is constrained by conceptions of legitimacy: you cannot simply allocate it to a centralized team without compromising on what makes it valuable. While Bitcoin and Ethereum do already rely on conceptions of legitimacy to respond to 51% attacks, using conceptions of legitimacy to guide in-protocol funding of public goods is much harder. But at the increasingly rich application layer where new protocols are constantly being created, we have quite a bit more flexibility in where that funding could go” (The Most Important Scarce Resource is Legitimacy).
The coordination and funding of public goods at the application layer he refers to would be coordinated by a DAO. DAOs can facilitate coordination, fundraising, and capital deployment toward a wide range of use cases. This high capital efficiency and capital flexibility is a primary intrinsic strength of the DAO model that positions it well to proliferate as more use cases are uncovered.
Free-flowing cultural memory is another powerful intrinsic benefit of distributed and decentralized work. “Within a DAO network, teams who possess the most relevant expertise can easily share it with the ecosystem. When [one] views DAOs as constellations of teams, not monoliths, DAOs become networks to allow collective memory to flow freely" (Ownership in Cryptonetworks). As will be discussed in the DAO solution space portion of the paper, DAOs benefit greatly from leveraging comparative advantage and empowering contributors who are best equipped to solve specific issues.
The free flow of problem-solving practices, diverse contributor backgrounds, and functional expertise means that as functional teams within DAOs specialize further and channels for cross-communication remain open, there is the unparalleled capacity to crowdsource and collaborate to organically problem-solve that would be too difficult logistically in a hierarchical firm of a similar size. Composability is a powerful motif in crypto and, as it relates to DAOs, “as long as the collective memory freely circulates within a given crypto network, discovered solutions to problems can be reused." (Ownership in Cryptonetworks).
Arguably more impactful is free-flowing cultural memory between DAOs. DAOs are building and public and are able to pick up the institutional knowledge from other organizations, which isn't really true in web2. At present, institutional memory within DAOs is worse than within companies. It's hard to keep track of best practices, people aren't really working full-time, everything just blurs together, etc. With maturity and infrastructure development, however, best practices, internal and external, will be more easily codified and actionable at scale. Decentralized organizations will leverage this institutional knowledge to drive innovation from within in ways that web2 companies cannot at an enterprise scale. So while making cultural memory actionable may be challenging in today’s DAOs, in time, this weakness will become a tremendous strength and means for organic innovation.
Related to DAOs’ leveraging comparative advantage and open communication is the potential for DAOs to develop robust internal economies. I think “DAOs as economies” is a more apt analogy than DAOs being likened to firms. “When autonomous working groups are given a pool of capital to use at their discretion, they will begin to standardize around rates for work to better budget and predict expenses, inevitably kickstarting an internal economy” (DAOs as Economic Engines). As is the case in any open economy, competition induces comparative advantage and specialization which, in the DAO case, serves to bolster the operating procedures of functional groups as capital flows to the edges of the DAO (DAOs as Economic Engines).
In an ideal, mature DAO ecosystem, there will exist within a DAO “complex structures where each node in the network interacts with the others to receive and distribute capital in the form of grants, revenue splits, bounties, paid positions, and more” (DAOs as Economic Engines).
Another example that punctuates this analogy is the concept of the velocity of money. In a standard economy, one unit of currency can be spent multiple times on goods and services as it moves through the economy. A similar phenomenon is emerging in the DAO ecosystem. A prime example is Bankless DAO’s $BANK currency moving fluidly through their Guilds (functional groups):
“Bankless DAO has recently funded the writers guild. Let’s say that 600 $BANK will go to compensating a new member who has completed the writers guild's first quest. A third of that payment gets redirected to the First Quest team, who then use the 200 $BANK to pay a designer to create a new graphic. That 200 $BANK has now changed hands three times despite being the same 200 $BANK." (DAOs as Economic Engines).
When it comes to external economies, there is certainly much work to be done when merging DAOs. An alternative to pure-play M&A is co-ownership which allows both participating DAOs to earn financial upside and engage in mutual governance. This induces powerful network effects that will drive a strong “DAOification'' process as co-ownership becomes more common. As outlined by Chase Chapman on DAOn the Rabbithole with Diana Chen, “Co-ops, when they exist in isolation fail more often than when they exist in networks of other coops. The reason that happens is you have a lot more cooperation and shared ownership between these different organizations” (DAOn the Rabbithole SOEP5). Chase predicts that a burgeoning external economy filled with many more DAO-to-DAO collaborations will likely eat into the traditional SaaS world, coining the term ‘digitally-native DAOification’ in the process. An example of the synergies of DAO co-ownership is elucidated in the same podcast episode:
“A perfect example of this is Bankless, which is a media DAO that creates podcasts and newsletters and collaborates with Index, a DAO that creates indexes. They created their own index called the Bed index and have been promoting it via the media they create because they believe in it. It uses Index's protocol. Bankless gets a percentage for managing it, and Index gets people holding their products. Interesting positive-sum where they made 1+1=3. You have the technology they are leveraging and the distribution which is what Bankless provides” - Chase Chapman (DAOn the Rabbithole SOEP5).
"Why would you ever want to use a B2B SaaS tool for your DAO when you could use a tool that another DAO built and get a few of their tokens in return and you pay them in your governance tokens. We will be creating this token economy in which it will not make sense to be a B2B SaaS company, which will accelerate the transition from traditional companies to becoming DAO-oriented. From that perspective, I think 10 years from now, we are going to see a lot more DAOs, and it is going to be strange to be a company" - Chase Chapman (DAOn the Rabbithole SOEP5).
The power of co-ownership and external economies that exists natively in DAO-to-DAO contributions is also a powerful means of penetrating and DAOifying web2 entities. “DAOs endogenously structure a self-sovereign, crypto-institutional control network of their own, generally aiming for separation or mitigation from centralized organizations” (Ownership in Cryptonetworks). It is highly probable that web3 and the DAO ecosystem have captured sufficient financial, cultural, and political power that “centralized institutions [will] move towards decentralization to more favorably integrate with the crypto sphere” (Ownership in Cryptonetworks).
Just as institutional investors and firms historically have moved to participate in value capture in high-growth industries, institutional money and firms will want to capture some of the crypto upside. To participate in the web3-native entities, web2 entities will need to adapt and somewhat decentralize their operations to participate, suggesting that web3 will have a spillover effect into web2, slowly evolving hierarchical organization into something that is more compatible with decentralization and process automation via smart contracts.
Finally, agility is a key strength of DAO. Not all DAOs are created the same. Because process automation handles the coordination and compensation processes within the DAO, if needed, DAOs can move very quickly to accomplish time-sensitive tasks. As mentioned previously, larger DAOs are struggling with coordination in their nascent form, but smaller, more fleeting DAOs can collect and deploy capital swiftly.
“For example, recently we saw the launch of PartyBid, the first known experiment of an ephemeral DAO where 400+ individuals came together to purchase a highly sought after Crypto Punk. The DAO ownership will last in perpetuity - but had the group not been successful, the capital would have been returned. This novel approach to short-term pooling and distribution of capital is massively unexplored and provides an agile and exciting counterweight to the relative seriousness of protocol DAOs" (DAO Nation).
At scale, DAOs will benefit greatly from automation sitting at the center of a wide variety of contributors with disparate backgrounds. It is a novel phenomenon to have strangers making financial decisions “together immediately without having time to develop coherence and trust” (A Prehistory of DAOs). The DAO model enables high levels of coordination across “different levels of coherence and trust” and experience.
This need-to-know mentality can allow micro hierarchies and comparative advantage to flourish organically within the DAO in a trust-minimized way whereby contributors only get access to communication channels, documents, tools, and other project-relevant assets in accordance with their designated role, competence, and specialty. This highly precise tiered access will allow workstreams of variable complexity, duration, and coordination to run in parallel as DAOs scale without top-down design contributing to DAO efficiency at scale.
The process of acquiring skilled laborers for a traditional corporation is often grueling. “Startups can’t afford to hire the wrong people, interviewing is a lengthy and demanding process. Only afterward do both sides feel comfortable entering into a long-term commitment, and even then it’s never usually optimal" (Soft and Hard Consensus - BanklessDAO’s First Week).
In contrast to the “knife-like precision that startups employ” when identifying hires, DAOs are crowdsourcing talent whereby “when they arrive, people self-organize into niches based on what excites them and autonomously begin to explore those ideas collectively." (Soft and Hard Consensus - BanklessDAO’s First Week). In DAOs, finding, inspiring, and providing value to contributors happens simultaneously, initiating a much more fluid and attractive user experience for contributors in comparison to web2 hiring.
The downside to this organic recruitment model is contributors self-selecting into DAOs. At present, active recruiting is far rarer in DAOs which in many cases can yield the highest-value hires.
Complementary to self-organizing talent is the generative nature of a decentralized organization. Individuals collect around the ideas they are passionate about and organically produce new products, functional groups, and ideas from within the DAO to help it evolve. A prime example of this was in BanklessDAO’s early days when they found that “there are enough people to fill into spaces where there are things to do. They literally crop up everywhere. A conversation about legal status turned into the Legal Guild and is slowly beginning to make moves'' (Soft and Hard Consensus - BanklessDAO’s First Week).
Considering the array of challenges for DAOs to work through and the myriad intrinsic strengths that will facilitate and accelerate innovation of the DAO ecosystem, below are 5 principles DAOs should optimize around to ensure alignment and synergy with their intrinsic strengths.
These principles are composability, automation, standardization, specialization, and financialization.
We will discuss why leaning into each principle will be massively beneficial for developing DAOs and highlight the projects that are setting an example and innovating along these axes. It is also worth noting that these concepts, in practice, are not perfectly distinct. For instance, composability necessarily requires standardizing components and introducing universalized financial assets, but these concepts will be investigated separately. The DAO projects explored below are by no means comprehensive. They are just illustrative examples of designing DAOs with a careful eye on their intrinsic strengths.
Composability is the cross-compatibility and combinability of components belonging to distinct applications that, when interacting seamlessly, produce efficient and powerful synergies and processes. Within the same composability cluster—applications built within the same virtual machine/application ecosystem—developers are able to use “huge amounts of existing, reliable code and focus only on building the components that are missing for their project… This exponentially increases the rate of experimentation and innovation. Not having to reinvent the wheel (or worry about being sued by regulators and patent trolls) every time you build a business makes Web3 magnitudes more efficient at allocating resources than Web2" (What is Composability?).
As discussed earlier in the section on minimally extractive coordinators, the “favorable regulation, aggressive patent enforcement, high switching costs, data hoarding, and many other self-preservation strategies” that are commonplace in web2 competitive environments are giving way to “the open-source, permissionless, transparent world of Web3… [where] organizations have to build on the assumption that their code will be reused by others and turn this into the vanguard of their growth strategy” (What is Composability?).
In the Ethereum ecosystem which is pioneering in the practice of composable systems, the ERC-20 token can run interchangeably on applications built on top of Ethereum (Understanding DeFi: Composability explained). As will be discussed below, DAOs are starting to mimic protocol composability in the modules they use like DAOhaus Boosts and Gnosis’ Zodiac Open Standard which are standardizing and building composable open standards to allow “anybody, as long as their code adheres to a shared interface, to build their own ‘expansion packs’ as needs emerge within their own communities. Under this paradigm, the ecosystem of DAO plug-ins will grow akin to that of open-source software packages” (Organizational Legos: The State of DAO Tooling).
As we discussed, through external economies enabled by co-ownership, the skeleton of a composable DAO system is emerging but is still largely underdeveloped. Despite the ecosystem's infancy, given that “the switching costs for users are so low and the benefits of interoperability are so high, the dynamics and desire are in place for the industry to align on a shared set of standards as soon as possible" (What is Composability?).
The question remains: what does DAO composability look like in practice?
DAO composability can take multiple forms, and one such novel realization of the power of composability as it applies to governance practices is called metagovernance.
Metagovernance is simply the process of one DAO voting on proposals in another DAO. It is not dissimilar to investment stewardship in the traditional finance world (Metagovernance in Crypto). An example of this in practice is what Fei Protocol—a Defi stablecoin protocol—did in the Aave proposal to add Fei to the Aave—liquidity market protocol. The process went like this:
Governance is an integral feature of DAOs, so the beginning of composable governance between DAOs is a promising step toward the powerful interconnectivity of a fully integrated DAO ecosystem. As a cool aside there is even levered metagovernance by “when DAO #1 uses a small number of tokens to vote on a proposal in DAO #2 that then uses a much larger amount of tokens to vote on a proposal in DAO #3" (Seb’s Tweet).
From a DAO infrastructure perspective, DAOstack— an “open source project advancing the technology and adoption of decentralized governance”—is expanding its library of modules for building DAO backends with Arc.
“Arc contains the master contracts that coordinate all the various pieces of DAOs together, as well as any number of flexible “schemes” that enable other DAO functions, such as defining the types of proposals users can submit. These modules can be mixed, matched, and modified to create the complete governance protocol for any given DAO" (DAOstack).
Arc is complemented by ArcHives which provides a “way of organizing and curating the modules within each layer… The ArcHives will be a set of registries for the various types of modules in the stack–Arc contracts, applications, DAOs, and so on–registries that will be curated by the DAOstack community itself." (DAOstack).
Arc and ArcHives will introduce modular DAO construction and a community-created shopping-like experience for DAO components, contributing to the DAOstack vision of a platform “designed to underpin an entire ecosystem of decentralized organizations — a community of interoperable DAOs, able to share talent, ideas, and learnings with one another. DAOs will even be able to act as members of other DAOs, creating a fluid ‘DAO mesh’ or ‘internet of work’ in which collectives of collectives are commonplace, and in which any given individual might participate in dozens of different DAOs" (DAOstack).
Also in the DAO infrastructure space, Gnosis—a protocol building a new market mechanism for DeFi—aims to build tools on an open standard to enable composable DAO components. The newly added modules are:
Automation is the second principle DAOs should lean into where possible to increase efficiency and improve opportunities to scale their DAOs operations.
Designing incentives to inspire contribution is a key area that needs development in the DAO ecosystem. Automating the invoicing, quality assurance, and payment processes to make doing work in a DAO will be important for scalability. One way to introduce automation to this value creation process is through streams and algorithmic network analysis.
"Streams are likely to become the salaries of Web3 because they have many of the same unique properties but provide a more digitally native and logical solution. These programmable cash flows can deliver payments block-by-block to contributors or other parties. For this reason, they are a great way to reward long-term contributors and break the “monthly payment” model institutionalized in much of Web2" (Incentive Design & Tooling for DAOs).
Sourcecred is pioneering algorithmic network analysis—“participatory actions and recognition workflows to be created such that the algorithm makes calculations around how value has been created and accrued. Think of it as a bot keeping score of actions, impressions, and other activity in Discord, GitHub, and community forums like Discourse. The greatness of this system is that it removes much of the daily administrative burden for DAO operators and is decentralized” (Incentive Design & Tooling for DAOs).
Govrn is building on this idea with their Movements Model with “which the community assigns weight to different types of contributions depending on its priorities…. Movement Models may look completely different from one DAO to another, but that’s the idea. The community shouldn’t have to retrofit itself to metrics that were defined elsewhere ” (Organizational Legos: The State of DAO Tooling). Coordinape (incubated by Yearn as an internal tool initially) is a popular and promising project in this category.
Automating lengthy governance procedures should be another priority to improve DAO efficiency and focus on priority tasks for the DAO. Two ways to do this are with conviction voting and liquid democracy.
184.108.40.206 Conviction Voting
Conviction voting is a decision-making mechanism that “funds proposals based on the aggregated preference of community members, expressed continuously. In practice, that means that voters have ways of asserting their preferences for which proposals they would like to see approved, rather than casting votes in a single time-boxed session. A member can change their preference at any time, but the longer they keep their preference for the same proposal, the stronger their conviction gets" (Conviction Voting: A Novel Continuous Decision Making Alternative to Governance). This voting method would address the voter apathy we discussed earlier while allowing contributors to fully characterize their preference profile for other contributors to see. Conviction voting also solves last-minute voting swings, mitigating the intensity of time-boxed governance sessions and the threat of short-term governance swings being used as an attack vector.
220.127.116.11 Liquid Democracy
Liquid democracy allows the voting system to be fractional. “One vote can now be split in any number of ways between multiple delegates or sent entirely to your chosen delegate, and your delegate can delegate to someone else" (Liquid Democracy).
“As an example take a busy college student who just doesn’t have time to vote, she could delegate ½ her vote to her mom and ½ her vote to her professor. If either of them wanted they could allocate a portion of the vote or all of it to a popular politically active persona that acts as a representative for the local community and controls an influential % of the total vote" (Liquid Democracy).
The power of liquid democracy and the fractional vote delegation is that "codifying your vote could allow you to tag different delegates to represent you based on the subject matter for the initiative. This means that if one initiative has an economic tag your vote for that initiative would be automatically allocated to the delegate you want to represent you on the economic issues, if another initiative carries the environmental tag your vote would be automatically allocated to your environmental delegate” (Liquid Democracy).
As mentioned earlier, the Ragequit function allows DAO members to pool capital to source and approve investment opportunities (and “rage quit” if they want their capital back). This exit module “allows participants to redeem a designated token for a proportional share of an avatar's (e.g. DAO sub-unit) digital assets (Charting the Path to Unaccredited DAOs with Minion and Zodiac: The expansion pack for DAOs).
Another area in DAOs for process automation is the conflict resolution process. Kleros self-identifies as a justice protocol and is offering a decentralized arbitration service for disputes in web3, currently servicing the following use cases: small claims, insurance, e-commerce, finance, freelancing, token listing, content moderation, and intellectual property.
Standardization is the third principle DAOs should build around, and it goes hand-in-hand with composability. Building standard processes and component templates not only improve contributor user experience, but also codify a common design language that will be the foundation for a composable DAO ecosystem, portable contributor reputation/accolades, and generally a more coherent, interconnected ecosystem that will benefit massively from network effects.
The ERC-20 token standard was first proposed in November 2015 and was later formalized in 2017. It “describes how Ethereum tokens should behave, including basic functionality like the transfer of tokens and approval for spending tokens. It allows third-party developers to easily support any token that complies with the ERC-20 standard” (What is Composability?). Realizing the true promise of the DAO ecosystems and composable systems requires standardized DAO design standards. DAOstar is trying to create just this with their EIP-4824 regarding Decentralized Autonomous Organizations.
DAOStar is working toward a common interface/user experience for DAOs, chiefly through DAOstar One–“a roundtable of key organizations in the DAO ecosystems” collaborating to define the components of common interfaces for DAOs. “In particular, a standard daoURI, similar to tokenURI in ERC-721, will enhance DAO search, discoverability, legibility, and proposal simulation. More consistent data across the ecosystem is also a prerequisite for future DAO standards” (DAOstar One).
The EIP-4824 (Ethereum Improvement Proposal) contains modules:
Governance procedure is also a process that is ripe for standardization. Governance proposal types can vary drastically so simplifying the contributors’ governance touchpoint is a powerful way to make DAO governance more efficient. Pairwise Preferencing is a voting mechanism in which contributors' votes “take the form of a ‘pairwise preference’ between two competing items (i.e. “A vs B”) [asking not] ‘what is generally good’, preferring instead ‘what is relatively more important’” (Introducing BudgetBox). The collection of votes on what initiatives are relatively more important from contributors are consolidated using machine learning techniques and turned into a “probability distribution over the items, where the probability represents the odds of one item being chosen over all the others… These numbers [are interpreted] not as probabilities, but as percentages of a budget" (Introducing BudgetBox).
A final example of standardizing DAO practices is standardizing financial engagement between sub-DAOs or pods in the context of the internal DAO economies we discussed earlier. Bankless DAO’s Guilds or sub-units interact with one another and leverage each other's specialties to produce for the DAO.
Bankless DAO’s marketing guild is pioneering standardized deliverables within the Bankless DAO ecosystem which is setting a precedent of standard payments rates and token swaps for services within the DAO ecosystem.
“Simply put: I believe particularly assertive DAOs should find and recruit the best collection of squads to grow themselves” (Ownership in Cryptonetworks).
Specialization is the fourth principle DAO should optimize around which further crystalizes the analogy that DAOs function as micro-economies. As outlined in the intrinsic strength section, DAOs with specialized sub-DAOs that have their own specialized leaders and micro-governance schema increase the resilience and ingenuity of the larger parent DAO. One functional group will organically solve problems for another given their distinct expertise and unique backgrounds. This level of autonomy and self-custody is difficult under centralized leadership, setting DAOs apart in their ability to reconcile distinct operations within a collective.
On the frontier of DAO innovation, there is a sub-DAO revolution well underway. Below I will highlight some of the best examples of why specialized sub-units within a large DAO organization is a key unlock toward DAO operational efficiency at scale.
The Minion Framework is a sub-DAO architecture built by RaidGuild in collaboration with Moloch DAO. It effectively operates as an internal accounting system that operates effectively as an internal escrow program.
“Through Minion, Moloch-based DAOs will be able to seamlessly create sub-groups of DAOs, which enable DAO members to segregate and pool funds in a way that will protect investors, manage tax risk, and potentially also decrease the risk of fraud. They also open up the possibility of creating DAOs to interact with liquidity pools” (Charting the Path to Unaccredited DAOs with Minions). This speeds up the efficiency of new projects with automatic capital allocation and compartmentalizes legal risk for the parent DAO.
"These [Baby DAOs] can be thought of as ‘throwaway’ pools that can be used to raise funding or provide investment for a specific project or initiative. For example, when DAO babies are combined with Moloch v2 functionality, you can coordinate a wider range of financial functions and explore more opportunities to cooperate without losing the security and trust assumptions of smart contracts" (Charting the Path to Unaccredited DAOs with Minions).
A similar solution comes from Aragon with their Fast DAOs whereby the Main DAO is turned into more of a managerial DAO, supported by “several so-called ‘Fast DAOs’ focused on different initiatives like R&D or communications" (Aragon).
"Fast DAO members can use these payments to compensate contributors or cover expenses without the need for explicit approval from [the Main DAO]" (Aragon).
As mentioned above, Bankless DAO has been a premier example of the division of labor into specialized DAOs or Guilds.
“Bankless DAO is organized into 13 guilds. These guilds are talent pools and represent different competencies available for other members of the DAO to join or tap into—writers, developers, analytics, design, legal, etc" (DAOs as Economic Engines).
“As expected, many of these guilds have bootstrapped and funded projects that fall within their domain, effectively creating 14 total sources of funding in addition to the singular grants committee. These guilds are limited in their budget, amounting to a fraction of what the grants committee can allocate, which makes guilds perfect for micro-grants that can roll up into larger grants after demonstrating some Proof of Concept (PoC) or MVP" (DAOs as Economic Engines).
Finally, Orca—a DAO working on building standardized, modular infrastructure for DAO governance and contributor experience—is focused on their Pod structure which they define as “small working groups [aiming] to build governance around people based on their expertise, not just their wallet” (Orca).
“Pods are Orca Protocol’s answer to the scaling problems that DAOs face. Pods are small working groups, usually centered around one expertise. In place of—or in addition to—one massive, centralized DAO treasury, each pod has its own multi-sig wallet that is controlled by the pod members. So pods can be thought of as mini-DAOs within a larger DAO. By creating a pod around expertise, certain elements of a DAO can be hardened. This means that it is possible for a DAO to codify specific roles and responsibilities within its ecosystem; we like to call this process podifying. Podifying a DAO will turn slow and inefficient, centralized and rigid structures into fast and fluid organizations" (Pods: The DAOnfall of Token Voting).
“Orca Protocol recognizes that DAOs are at the frontier of organizational design. As such, it should be left to a DAO and its users to explore the best options for their vision and needs, rather than imposing predefined organizational shapes. Orca Protocol can, thus, be thought of as a set of governance primitives" (Pods: The DAOnfall of Token Voting).
The final tenet DAOs should optimize around is financialization. At scale, with semi-pseudonymous actors making up the contributor base, it is key to note that everyone will behave like a rational agent, so building incentives financial or otherwise to motivate healthy and energetic contributors should be the target. Financializing processes like governance are innovative ways to introduce market dynamics to conventionally non-financial processes.
“The individual shareholder is driven by greed; the network, by growth. Squads empowered with ownership navigate and mediate this tension between micro and macro by growing the network in pursuit of squad wealth.” (Ownership in Cryptonetworks).
The first form of financialization comes from Bankless HQ thinking innovatively about how to design novel revenue streams for their expense-heavy guilds. Bankless’ First Quest team is responsible for onboarding new DAO members, and it partners with other guilds for specific onboarding tasks most relevant to the new DAO member. The First Quest Guild is a cost center in the sense that onboarding is not a revenue-generating activity. Bankless DAO has been thinking about how to better incorporate cost centers into its internal economy.
They envision that eventually “going through First Quest will lead directly to a guild workstream. Like a funnel with multiple outlets, new members can find a guild they most resonate with and jump directly into a guild-specific first quest. For example, the writers guild's first quest would be to complete an editing or writing task to gauge competency and familiarize new members with how the writers guild operates." (DAOs as Economic Engines).
To integrate this cost center into the internal economy, Bankless “foresee[s] the First Quest team taking a cut of the writers guild first quest bounty (or any guild’s first quest) for each new member referred to the guild. In this way, First Quest has incoming capital flows instead of acting as a pure cost center." (DAOs as Economic Engines).
The lion’s share of the financialization opportunities surrounds governance processes. Below we will round out our discussion of novel governance systems like conviction voting, liquid democracy, and pairwise preference voting with three more additions—quadratic voting, holographic consensus, and futarchy. These governance systems demonstrate the power of financialized governance in a way that is sustainable, functional at scale, and avoids the challenges of centralization by whales—wealthy contributors.
18.104.22.168 Quadratic Voting
Quadratic voting is the process whereby the marginal cost of a vote is proportional to the amount of support that the proposal already has, meaning "your n'th unit of influence costs $n." In other words, to support a proposal at its conception is fairly inexpensive, but, as it gains popularity, it costs progressively more to back the proposal, diluting the power of wealthier voters when the proposal is broadly known.
This model is fascinating because it solves the simple voting ("one person one vote") challenge of weaker voices getting washed out, and, on the other hand, solves the centralization risk of a private-goods market mechanism in which “the individual with the stronger preferences (or the wealthiest) carries everything. As illustrated in the above graph, quadratic voting is positioned squarely between the two extremes, scaling vote cost with the strength of support” (Quadratic Payments: A Primer).
22.214.171.124 Holographic Consensus
Another financialized approach to governance comes from Gnosis DAO and is called holographic consensus. This governance process is aimed at solving the tragedy of the common issue with collective decision-making by allowing small groups to make decisions on “behalf of the larger majority in such a way that guarantees perfect alignment between the two” (An explanation of DAOstack in Fairly Simple Terms).
“Since predictors are incentivized to pick out the best, most DAO-aligned proposals, we can lower the passing requirements for the top predicted proposals: these proposals can be passed much more quickly and with fewer total votes than other proposals. This creates a dynamic we call holographic consensus. Here, as in a hologram, a smaller part of the whole (a small group of voters) can be made to effectively represent the whole (all the voters), allowing DAOs to make fast decisions while maintaining value alignment. This effect is compounded by opening the staking system to anyone, be they a voting member of the DAO or not” (An explanation of DAOstack in Fairly Simple Terms).
The magic of this model is its emphasis on reputation staking whereby “predictors have to ‘bet’ that (if boosted) the proposal will be accepted by the vote. If a bad proposal is likely to be boosted, it creates an incentive (fisherman concept) to predict against it and make a profit by alarming reputation holders to make sure they vote against it, and thus the proposal is rejected. In cases where a good proposal is boosted, and no predictors are predicting against the proposal, the DAO itself will always play the role of the counterparty (predict against any proposal) and thus ensure correct predictions are rewarded" (An explanation of DAOstack in Fairly Simple Terms).
126.96.36.199 Futarchy from Gnosis DAO
Gnosis DAO is also innovating with some novel ideas around futarchy—governance by prediction markets.
“That is, elected representatives would still formally define and manage an after-the-fact measurement of national welfare via traditional-democratic processes, but now—market speculators and participants will get to decide on the policies that should be put in place to get the nation to those chosen ends" (A Deep Dive into Futarchy).
Here is an example of how it would work:
"Let’s say that this end-goal has been selected as the end goal to work towards through a traditional-democratic voting process. Predictions markets will now take over to determine the actual policies that will be implemented to achieve it… For the sake of this little thought experiment, let us use policy “x” as someone’s proposed means of reaching the above end goal, where markets y¹ and y² represent the pricing of the options determining the fate of the policy… If y¹ represents the price of “yes,” and exceeds that of y² representing the price of “no” by the time the market closes, the policy will be implemented, and all trades on the “no” market are reverted." (A Deep Dive into Futarchy).
A final interesting topic regarding financialization and gamification involves innovation in disclosures as they relate to the DAO ecosystem. Chris Brummer, a professor at Georgetown Law, writes about the state of financial disclosure and envisions a future where the novelty of digital scarcity could be used to revamp and even monetize disclosure agreements via NFTs.
"Once the disclosures were read, the reader could be directed to answer one or more test questions — or even a game testing their understanding of the app. When the question(s) are answered, or the game was successfully navigated, a disclosure token could be issued to the end-user or investor in the project to their wallet. The tokens disbursed to the end-user would be unique, embedding the fact that a particular person passed the test, but not transferable" (Introducing Disclosure NFTs, Disclosure DAOs, and Disclosure DIDs).
"Disclosure tokens could also double as social tokens, and be used to access portals or gateways for social networking, guild-building and participating in governing DAOs in DeFi" (Introducing Disclosure NFTs, Disclosure DAOs, and Disclosure DIDs). These disclosure tokens could be powerful axes of the reputation system we have discussed in this piece, offering new dimensions of expertise within DAOs that could all be verified on-chain.
DAOs that have begun to emerge as micro-economies producing content and services in a decentralized way are in need of strong foundation principles to guide their growth and maturation. While this organization type has had little time to wrestle with its most pressing challenges, its intrinsic strength against the backdrop of hierarchical firms, and the five design principles—composability, automation, standardization, specialization, and financialization—I laid out in this piece may offer guidance for challenges to come as the ecosystem evolves.
DAOstack Project shares some powerful sentiments on where this ecosystem could go:
"Imagine tens or hundreds of millions of people participating in this kind of collaborative economy — one in which no one wields a disproportionate amount of power, all are rewarded in proportion to the value they contribute, and everyone is incentivized to act in alignment with the common good.”
"The DAOstack project, at its essence, endeavors to use crypto-economics and other technologies to create moment-to-moment micro-incentives that, when multiplied across thousands of individuals and millions of moments, enable crowds to collaborate more resiliently and efficiently than any other system that has yet existed" (An Explanation of DAOstack in Fairly Simple Terms).
In closing, I want to highlight the Common Stack Project which I think epitomizes a commitment to all the principles laid out above. While still in development, their framework wishes to harness the power of scalability within standardized and composable systems. They also aim to automate processes and induce comparative advantage through specialized sub-units to make the DAOs that use their product that much more powerful.
“We are building commons-based microeconomies to sustain public goods through incentive alignment, continuous funding, and community governance. Our library of open-source, interoperable web3 components will put effective new tools in the hands of communities, enabling them to raise and allocate shared funds, make transparent decisions, and monitor their progress in supporting the Commons.” (Common Stack Project).
Their 6 iterations or product modules are as follows:
Their example and so many others from Moloch, Orca, Rabbithole, Bankless, Gnosis, Aragon, DAOstack, and DAOstar are shining the way for DAO innovation. The Regen Network is taking some of these innovative models outside the digital-first domain and asking how DAOs can be useful governance collectives to help save our ecosystem.
“The Regen Network project, a public blockchain for ecosystem services, takes another approach to this distribution problem. They have set aside 30% of their tokens for land stewards, climate scientists, and other stakeholders in regenerative land management to form community DAOs that participate in network governance…. Stakeholders with practical knowledge, or “tacit knowledge'', like land stewards in the case of Regen Network, benefit from governance by incorporating informal practices in decision making. Here, DAOs begin to introduce new dimensions that exceed what the operating principles of a digital cooperative notionally encompass.” (A Prehistory of DAOs).
Projects like this one are a healthy reminder that the innovation and hard work that goes into refining user experience, organization architecture, governance procedures, and so much more is worthwhile so the world can enjoy the benefits of decentralized coordination. In this piece, I have endeavored to characterize the DAO ecosystem innovation landscape. We explored the challenges and intrinsic strengths of this digital cooperative which led us to five broad principles—composability, automation, standardization, specialization, and financialization—to design around to ensure that the promise of DAOs and decentralized coordination can be realized.
If you stuck around to the end, I am eternally grateful. More to come soon :)
All suggestions and feedback are welcome! Please do not hesitate to reach out @adebdoh on Twitter. All views are my own.
About the author: Alex Debayo-Doherty is a software and crypto growth investor and technology hobbyist. His interests lie at the intersection of crypto/web3 and the future of work, education, climate action, and digital identity. His research looks into how the DAO innovation landscape is evolving, offering DAO design principles to capitalize on the intrinsic strengths of this new organization type.
Disclaimer: Harvard Blockchain and the author of this piece are not financial advisors. Nothing contained in this research piece should be construed as investment advice.