The DAO: Judge it on what it becomes

Ethereum’s ‘The DAO’ can learn from existing models and the history of funding and investment. It needs good processes and management that go beyond voting mechanics and smart contracts, which is what much of the conversation is about. However, many criticisms of the DAO miss the important fact that it will necessarily evolve. The question is if it can evolve fast enough. And, perhaps, in the right direction.

This is a follow up to a post from my Ownage colleague and Colony co-founder Jack du Rose about the Ethereum community’s decentralised autonomous organisation, currently known as The DAO. It’s a crowdfunding project which has raised over $130m, at current exchange rates, to essentially act as a decentralised investment fund. Jack described some of the problems and proposes potential solutions.

Background

As someone who lived through the joys and pitfalls of the world of Bitcoin investments in the wild days of BTCT and Bitfunder, I’ve been quite thoughtful about the DAO. For those who don’t know, these were sites which allowed people to invest bitcoin in startups, mostly Bitcoin related. They showed up a number of problems which the DAO should be aware of, including:

The crowd wanted a very, very quick buck, not long term success.
The crowd demanded information almost daily because they wanted a higher token price or to know what their next ‘dividend’ was.
The crowd are easily trolled.
The crowd are easily scammed.
Some individuals get very emotional about even a single loss and they often couldn’t afford it.
Some individuals claim to not need laws or protection until the moment something goes wrong. Then they will call a lawyer and/or make personal threats.
Very few people appeared to have any meaningful comprehension of what they were buying into.
Virtually every company failed. Just like in the real world.

We’re all the crowd in one way or another. I was 1, 2, 3, and sadly 4 above. It was a chastening experience and not one I wish to repeat or see others go through. Already, I see comments on the DAO slack which show many people have little or no idea what they’ve put money into. History is in danger of repeating itself.

However, as long as we see this as the start of a long road then perhaps, maybe, possibly, it could work. To do so, the DAO community need to fight very hard against noise, trolls, and those wanting a quick buck. This is not by clashing and being defensive on Slack, Twitter or Reddit, but by ensuring good organisation and high expectations. To that end, I have some suggestions which take lessons from the way other funds work.

I believe they will secure a long term future for the DAO as well as setting expectations both for DAO members and proposers.

ROI

I suggest a number of ROI models which reduce DAO risk and ensure proposers take their responsibilities seriously rather than seeing it as helicopter money, whether they do so consciously or not. Most importantly, the DAO should not be used to bootstrap a business without the DAO making a significant return should the business progress onwards.

These proposals align the proposer’s incentives closer to those of the DAO since the proposer’s more general success also pays returns into the DAO, including in the event of a pivot or Series A funding. The companies being funded need to have skin in the game.

I am conveniently ignoring the theoretical idea that the DAO hires contractors because this is seen as an investment fund. If it walks like a duck and all that…

Propositions must declare how the DAO will make an on-going return since the DAO has no equity stake, e.g from profit and sales revenue. I’m dubious of profit based returns because accountants are clever people and profits are much harder to make than sales revenue.
In addition, propositions must agree to repay the DAO from any further source of income to the company, including revenue, angel or VC funding, loans and crowdfunding. The repayment could be at a rate of 10% on the dollar/eth up to 5x return, then 5% on the dollar/eth until a 20x return.
1+2 can be worded to function together rather than having the DAO double dip. The intention is that 2 ensures the DAO has a secondary avenue for a return, and a more likely, quicker one. Consider that perhaps 90% of tech start-ups will fail, let alone blockchain ones which are still almost completely unproven. Successes may take 3+ years, a very long time for the crypto crowd.
Alternatively, propose how a particular project will offer a short term fixed return to the DAO of 50% within 12 months of the first DAO payment, such as Ledger’s proposed hardware wallet.
Such projects need to be considered extremely low risk and low capital as the return does not allow for a majority failure rate. It may be worth it for PR and ethereum ecosystem value overall. Note that Ledger’s proposal was for a 25% ROI which I feel may be too low since there is risk attached. The DAO are not a loan company and not meant as a source of cheap finance.

I am ignoring the issue of legal provisions, only establishing principles. The community can argue the toss on actual numbers and implementations.

I have also not declared any ROI based on token investments and sales. This is possible but it’s a risky venture in itself, as well as likely requiring a public quorum on selling of tokens on the market. In the future, it may be possible for the DAO to take equity stakes and sign contracts in the real world via a real world entity.

Funding Categories

I suggest that funding is streamed into different categories, similar to those described by Jack.

Research Project Grants: $5k — $30k
Research grants to individuals to work on open source decentralised technologies, freely published research or reports that benefit The DAO or DAO projects. These may be Ethereum developers, legal work, IoT research, etc.

Ethereum Project Grants: $50k — $150k
Development grants specifically to complete non profit open source projects which significantly enhance the Ethereum platform and which are not already happening in a meaningful manner. Whisper and Swarm are two such examples. Since I’m considering the DAO is a for profit investment fund, my argument is that it will enhance the value of Ethereum and projects the DAO may have or wish to invest in.

This category of grant should be highly exceptional and rarely approved since there is no profit aspect and it’s easily abused. It is also specific to development rather than research.

Proof of Concept: $50k — $150k
Production Stage 1: $150k — $500k
Production Stage 2: $500k — $3m
These are close to Jack’s suggestions but all should have a declared ROI according to both rules 1 and 2.

Proposers can apply for each stage as their company progresses or skip to the most appropriate stage for them. All proposals should be individual companies and the ROI must be from that company, not the project.

I’ve kept Jack’s $3m cap because I believe larger funding risks losses beyond what the DAO can sustain, as well as bad PR should such a large investment fail. Where a company needs more funding than applicable, this should be through a crowdfunder or regular VC funding. It must be understood by members that the DAO does not replace either of these but it can help put companies on a firm footing.

Micro Project: $50k — $150k
Small, complete projects for which ROI rules 1, 2 and 3 can apply. Proposals may be project based such that ROI rule 3 applies only to the project and not to company income.

Proposal Framework

I urge that all proposals are made on a standard framework. Each category should have its own template documentation and guides but they should be based on the same approach and have significant commonalities. This ensures that all proposals can be fairly and easily compared.

Rather than me compose a framework right now, I’ll provide two example documents for a UK innovation funding scheme:

Guidance for Applicants
Project Costs

When you look at these you’ll be swearing, I assure you. They’re a pain in the backside to fill in, although if you’ve ever seen EU funding forms... the horrors!

However, whilst we can make DAO templates a little simpler, particularly for the smallest projects, many of the core fields are or can be made relevant to DAO proposals. Indeed, to be absolutely clear about this, proposers are asking for your money and they should have to work hard to get it. This is not paperwork for paperwork’s sake, it’s ensuring they put together a high quality proposal and that members can review it properly.

For the funding scheme referred to in my examples, fields are scored and each commented on by experts according to the scoring criteria provided. I’m sure it’s possible for the DAO to allow people to score and sign proposals (cryptographically, perhaps just via submission to a contract from the token address). The scoring isn’t binding in any way but it will be informative as one can look at a scorer’s history or potentially know who they are.

Finally, we need reporting requirements and relevant templates. All projects should have quarterly reports and financials for 3 years, longer if applicable. Although some may wish to see weekly reports, they can actually be detrimental to progress therefore I think that should be optional rather than a formal requirement.

Given how the crypto crowd demand progress reports on an almost daily basis, I think this an important line in the sand. If you fund the business then you need to let the business get on with their job rather than interfere with it. The more demanding angel/vc/crowd funders are in terms of understanding everything a business does, the more disruptive they are to day to day operations.

Now we have:

A clear expectation of the level of detail from proposers
A standard template for all proposals
A way for an open community to rate the proposals pseudo-anonymously or otherwise
A formal reporting system

Added together, we now have the makings of a strong framework to allow the crowd to evaluate projects. Having looked at various vague proposals thus far, I can’t reiterate enough how much this is needed. It will save a huge amount of time for DAO members as all the information has to be present in one place and in one format.

It will also stop many frivolous proposals because ‘proof of work’ in a sense. Proposers will see how good other proposals are, pushing the quality bar up whilst also helping the less experienced to understand how to design their businesses.

Everyone wins except for those with shoddy propositions. Those without business experience can form partnerships, hire consultants, or ask for community help. If someone whines about this and calls it unnecessary then take it from me, you don’t want to be funding them with your money.

Funding Rounds

In order to make the process more manageable for all concerned, I suggest arranging the funding categories to a fixed schedule and capped budget.

For example, PoC every month, production stages every 3 months, and so on. This means everyone knows in advance when the voting periods are and won’t get caught out. This may also help avoid quorum issues, something we know may be a problem. Indeed, the quorum requirements could differ depending upon the category, i.e. the amount requested.

Additionally, the budget available to each category and round should have a fixed upper limit. The most popular projects should be funded in that round up until the limit is reached, assuming the project has reached quorum of course. The total budget limit could be designed to ensure the DAO’s life is a minimum of 3 years and always +1 more year, and can be adjusted live based on actual funding and revenues.

I suggest this because I greatly fear the DAO spending it’s money too quickly when ethereum itself has another 3 years of very significant and risky work, such as to ensure it can scale amongst other things. There is a very real chance the DAO will have little revenue for 3 years under the current model and the long term nature of investment should be made explicit.

Technology businesses don’t often make a profit after 1–2 years of operation, let alone blockchain businesses who struggle even to find any revenue. ROI rule 2 would improve the situation however as it allows for VC input and the long game. The history of blockchain startups effectively mandates ROI rule 2 as a necessity for me. They run on angel/VC funding. I implore members not to fool themselves by saying it’ll be different this time. If it is then they win. If it isn’t then hey look — they can win too.

A Note on Ethereum Volatility

Cryptocurrencies are massively volatile and companies should never, ever gamble on cryptocurrency values. Perhaps in the future hedging will be possible, whether on chain or off chain. However, in the mean time applicants and the DAO need to plan accordingly.

Some proposers may denominate their funding in ether. In this case, the ROI should be ether denominated and the DAO should ensure than an ether denominated contribution is appropriate and realistic. With a highly volatile ether price this may be very difficult.

Most proposers, however, will need to work in dollars. If DAO contributions are regular, e.g. monthly, and proposers guarantee they will convert to USD within 7 days of receipt (they can have this pre-arranged to avoid affecting markets if large amounts), then the only real issue is ensuring the DAO has sufficient reserves. I suspect DAO members can handle that risk since they believe in Ethereum’s value anyway.

However, it is important that proposers do not take the same risk. If they are requesting dollars, they should be compelled to work in dollars at all times.

Exchange rate speculation is not their business. I cannot emphasise that enough.

A Note on Trust

Anyone being funded for any purpose is being trusted to do what they said they would do. For the DAO the situation is worse than for other forms of funding because there appears to be no easy legal outlet for non-performance. I’m not saying there is no way out, be it legal or community action, just that it may be complicated and will be messy.

It may appear that another obvious way to handle this is to force smart contracts on everyone but this doesn’t work.

Firstly, the ROI sources I’ve suggested may come from regular fiat funding so they just aren’t applicable. ROI 2, in particular, is important to reduce the DAO’s risk.

Secondly, forcing smart contracts as payment systems immediately cuts off the vast majority of likely income for many projects — that of Joe Public or enterprise businesses paying using credit cards, debit cards, PayPal, bank transfers and so on. As such, to mandate that would be asking projects to be profitable whilst removing by far and away their largest likely source of income. Let’s not pretend we can or should force people to use ether or even cryptocurrency. We also cannot forget that returns happen, it’s not just chargebacks for non crypto that have to be considered.

Thirdly, the proposer can do what they like anyway. They could say they’ll use smart contracts and just ignore them. Or they could do 99% of their sales outside of those contracts because that’s what their customers want, and the DAO only gets the 1% paying through a smart contract. Clearly, that’d be nonsense.

Of course, some projects suit the smart contract paradigm, such as Slock’s proposal, as well as some of the other wonderful Ethereum projects we’re seeing. However, the current model Slock suggest has no ROI 2, which I consider very important, and from the sound of it the DAO would be funding more than just the contract network Slock’s hardware will support.

Note that Slock have yet to do a formal proposal and I’m very much looking forwards to seeing it as they have a great team behind them. This post is only providing business considerations for a potential DAO funding it.

The point here is that the DAO is always having to trust the proposer as well as believe in the proposal. As such, proposers should be able to sell how they wish. Still, every sale could be registered on the blockchain even if it wasn’t made on there, with provision for flagging up returns.

Conclusion

I don’t know how the above ideas will be taken but I hope DAO members pay attention to how real world grants and funds operate. They are imperfect, as is the DAO, but learning from the successes and mistakes of history is crucial. When a 90–95% failure rate is not only possible but likely, and there is no equity involved, which is how VCs make their money, it’s even more critical to make the right decisions and to have a good ROI plan for projects which do work out.

The ideas I’ve presented here are intended to help put a structure around proposals to protect and help the DAO’s members as well as to encourage the right kind of investment rather than the wrong kind.

At the same time, it would remain a gloriously open system with all proposals public, and all voted on by its members. I believe this makes it unique across the world.

I’d also like to show that we don’t need protection through regulation. We can get protection through process and transparency. And, maybe, the DAO can profit!

This is day zero. Don’t judge the DAO on what it is now, judge it on what it becomes.