Can Ideas Possess Capital? DAOs and Community Constitutions

While the internet has transformed the world as we know it and radically reshaped our lives, its primary effects have been on the “front-end” or the user experience. It has made it exponentially easier for us to access information and connect to people. However, the rise of the internet had almost no effect on companies’ “back-end” incentives and ownership structures.

In contrast, web3 is - first and foremost - a revolution in the back-end ownership and incentive structures of the internet economy. It replaces the top-down corporate hierarchies and management for shareholders with an ecosystem model of ownership. DAOs are a perfect example of this.

DAOs are one of the most significant innovations of web3. They allow communities of people to pool their money and invest in businesses, charities, platforms and protocols. DAOs have the potential to do to capital what the internet did to communication.

This is the second post in a series about the market potential of community-owned, self-evolving IP. You can find the first post here. In this post we will discuss what DAOs are, their potential to revolutionize the traditional financial ecosystem, and how they can be imbued with greater purpose and cohesion via Living Constitutions. You can find my previous post about decentralized books and the publishing industry here.

Unfortunately, the term DAO is the new AI or Big Data. It is a term that people

like to talk about without truly understanding what it means or trying to implement it. So first a definition of what we mean by DAO.

What is a DAO?

A Decentralized Autonomous Organization (DAO) is “an internet native business that’s collectively owned and managed by its members. They have built-in treasuries that no one has the authority to access without the approval of the group. Decisions are governed by proposals and voting to ensure everyone in the organization has a voice.” — Ethereum Foundation¹

Essentially, DAOs are platforms, owned and operated by their members, that use smart contracts to execute proposals and payments. Smart contracts allow DAOs to replace organizational functions typically performed by people in traditional organizations with code.

Once a proposal has passed, it is automatically executed by smart contracts in a manner that is “100% transparent and verifiable by anyone.”

DAOs enjoy a number of advantages over traditional organizations:

1. Efficiency
2. Community ownership
3. Adaptability and potentially intelligence
4. Global scale and reach

1. Efficiency

Properly structured, smart contracts allows DAOs to perform many of the same functions as normal companies with less people — replacing fallible people with auditable code. This allows DAOs to be significantly less error prone and more cost effective than typical organizations.

2. Community ownership

DAOs give their investors and customers an inherent stake in the future success of the organization improving incentive alignment. This is unique to Web3 and crowdfunding markets and very rare in web2. Properly structured and implemented, this ownership model creates an extremely loyal core customer base thereby accelerating the growth of the business.

3. Adaptability and emergent intelligence

The decentralized structure of DAOs often allows them to be far more nimble, adaptive and even intelligent than centralized organizations. The wisdom of crowds proves that in some circumstances the collective knowledge of groups of people expressed their through aggregated opinions or actions can outperform “expert” knowledge.

For more information on Emergence, see this thread.

4. DAOs are inherently global

While there are many multinational corporations, these organizations are not “born” with their global scale. In contrast, DAOs live on the internet. They are global from their inception. As our world becomes ever more globalized, DAOs with a global member base will possess an additional advantage over traditional organizations.

These advantages mean that we should expect DAOs to become more prevalent and integrate further into mainstream financial markets and businesses over time. The founder of JUMP, Jeff Kauffman, predicts that a DAO will buy a fortune 1000 company within the next 5 years.³ An example of how this might work would be a whiskey-focused DAO buying out one of their favourite boutique Whiskey distilleries and helping them design an expansion strategy while still staying core to their roots.

DAOs create exciting new opportunities for global collaboration and coordination. However, many of the current generation of DAOs suffer fro

m a number of problems.

Problems with Current

DAOs

While DAOs possess a number of attributes that make them very attractive they often don’t live up to their ideals in practice. Most current iterations suffer from a number of problems that limit their growth and appeal.

A non-exhaustive list of their problems would contain:

1. Centralization
2. Lack of cohesive vision
3. Low voter participation and long decision times
4. Problems with democracy

1. Centralization

While most DAOs claim to be decentralized they often have a creator and founding team that decides what proposals are voted on and which are decided internally. This creates centralized decision making structures. Members that want to contribute often find they can’t nor can they put proposals up for a vote.

As a result, most DAOs pretend to decentralization rather than actually embodying it.

2. Lack of a cohesive and adaptable vision

While proponents believe that DAOs will eventually do for capital what the internet did for communication, organizationally they have a long way to go.

Currently, DAOs are nonviable for complex organizations pursuing more long-term, mission driven ventures where the vision and strategy must continuously adapt to changing circumstances. The organizational structure of current DAOs does not deal well with the unknown. As the community often cannot develop a cohesive vision of how they should adapt.

Leaving the DAOs mission and vision open to interpretation creates problems as well. As community members rise to leadership roles, they can change workstreams to fit with their own individual understanding of the DAOs mission, occasionally steering the DAO in a questionable direction. This risks creating internal schisms with contradictory proposals and infighting which can eventually fracture the community.⁴

3. Low voter participation and long decision times

While DAOs represent a revolutionary way to coordinate individuals and make decisions in a democratic fashion, oftentimes these decisions take way too long and suffer from low voter turnout. For example, the decision to hard fork ethereum in response to the 2016 DAO hack passed with over 80% approval. However only 5% of Ethereum holders voted. Making it essentially a straw-man vote in which the outcome was determined by active whales.

Alternatively, proposals requiring a quorum often take weeks or even months to pass — due to members who are not especially diligent or timely in exercising their voting power — paralyzing organizational decision making. Recently, a Metaplex Foundation DAO vote to airdrop tokens to the community failed to reach quorum as only 6.5% of claimed tokens ended up participating.⁵

Both of these problems hobble DAOs by significantly limiting the effectiveness of a DAO’s decision making.

4. The flaws of pure democracy

Pure democratic votes often do not result in optimal decision outcomes.

This is especially true when considering decisions that require very specific or deep expertise that is not possessed by most members. If DAOs are trying to develop sophisticated and nuanced decision making in complex situations, pure democracy is often not the best solution.

Other potential options include:

1. Bridgewater’s “believability-weighted decision making” which assigns a different weight to everyone’s vote based upon their track record and domain expertise⁵
2. Democratically electing expert panels to decide complex technical questions

IF DAOs can overcome these challenges they promise to revolutionize the investment and business landscape as we know it.

Ordinary people will be able to connect via the internet and invest in mission-driven organizations, brands, and angel investor networks more quickly and easily through their phones. This will be an inherently global form of finance that is open to all. No bank accounts will be necessary in order to invest. The decentralized and transparent nature of DAOs will allow normal members to participate in decision making and audit the companies finances.

The potential of these organizations is enormous and I have no doubt that a DAOs will eventually acquire major companies. However, they clearly need better organizational practices if they are to fulfill their potential. We believe that DAOs strengths can be accentuated and their problems reduced by coupling them to decentralized constitutions.

In my previous post I discussed the market potential for adaptable community owned IP. By creating community-owned constitutions that outline a DAO’s raison d-etre and governing mechanisms promises we can bring greater decentralization, transparency, adaptability and cohesion to the these organizations.

DAOs governed by decentralized constitutions

Pairing DAOs with self-evolving, community owned constitutions would allow DAOs to overcome many of their most intractable problems.

Having a decentralized constitution gives members a venue through which to propose changes to the organizational structure and the division of responsibilities between the founding team and the community members. This would provide a valuable counter weight to the influence of the founding team. Members would be able to propose that specific decisions and roles be decentralized to the community. Votes would also provide transparency as to the aggregate level of community support for various initiatives.

While this is not pure decentralization, pure decentralization is not always desirable.

By forcing people to articulate and elucidate their suggested changes for general voting, we can create a form of meritocratic decentralization. This also gives the community a consistent feedback channel through which the community can influence the purpose and structure of the DAO.

Incorporating a decentralized constitution into DAO governance ensures that changes to the DAOs mission are explicitly proposed as alterations to the underlying constitution. This gives members the chance to vote and express their opinion on the direction they believe the DAO should take. Additionally, decentralized constitutions give DAOs the flexibility to develop entities with elements of decentralized and centralized governing mechanism while still remaining accountable to the community. If members feel that a given decision making strategy is not producing desirable results, they can propose changes to the voting mechanism and let the community decide which version to adopt.

The adaptable voting and organizational structures that decentralized constitutions would make possible also have the potential to solve the problem of low voter participation and long decision times.

One example of how this might work would be a system of revocable voting power delegation. This would allow inactive members to delegate their decision making power to more active members whose decision making track record they identify with. Such capability would likely create a core group of active and engaged members who wield most of the decision making power for less important, everyday decisions that most members don’t want to bother with. Conversely, members would be able to reclaim their voting power from their representative to cast in consequential votes they care about before choosing whether to re-delegate your voting power.

The introduction of malleable constitutions that enumerate the organization and voting mechanics promises to allow DAOs to adapt in the pursuit of long-term goals, thereby bringing DAOs to life.

Ideas with Capital

Humanity as a whole possesses more power and control over our environment than at any point in our history. We have gained the ability to split the atom, invent computers and land on the moon. Despite this, individually we are less in control of the effects of our actions than ever before. This is because globalization and the internet have made our world more complex. This increased complexity means there is no longer a simple causal relationship between our actions and their consequences.⁶

It is practically impossible to answer even simple questions like where does my dinner come from, who made the shirt I am wearing or what is my bank doing with my money. One of the biggest problems the world is that it has become exceptionally difficult to understand the ramifications of our actions.

This is extremely problematic as Yuval Noah Harari explains in 21 Lessons for the 21st Century:

“The greatest crimes in modern history resulted not just from hatred but even more so from ignorance and indifference. Charming English ladies financed the Atlantic slave trade by buying shares and bonds in the London Stock Exchange without ever setting foot in either Africa or the Caribbean. They sweetened their four o’clock tea with snow-white sugar cubes produced in hellish plantations about which they knew nothing.”

Ignorance is not an excuse. If we want to live in a better world we have to invest the requisite time to understand how our actions undermine or contribute to that goal.

Money simultaneously complicates our efforts to understand the consequences of our actions and offers the most promising opportunity to fix our collective problems. Money is the most powerful mechanism for collective action humanity has ever invented. Cumulatively, what we choose to spend our money on and where we choose to invest creates our species priorities. The flow of capital and value determine what we care about. Yet our financial world is so complicated and institutionalized that it is exceptionally difficult if not impossible to use your money in an intentional fashion to support businesses and ideas that you care about.

The flow of money within our economy directs human efforts by illuminating what we collectively find valuable. Yet, the increasing complexity of modern finance means that most people do not control their own money. The money that sits in your bank account or your pension fund is not really controlled by you. Financial professionals leverage that capital in order to conduct their business.

The result is that the destination of our collective money is now determined by a small number of financial professionals. This problem is growing more pronounced. The finance industry has grown its assets under management from $37 trillion in 2004 to an estimated $111 trillion in 2020. This represents almost 40% of the financial assets of the Mass-Affluent, High Net Worth Individuals, pension funds and sovereign wealth funds. The top 20 firms control 43% of those AUM. This means that the flow of money and value within our economy is determined by a tiny minority. In fact, a 2020 report from the Financial Times found that “just 18 individuals sitting within professional finance and wealth management firms held sufficient power over the bond markets to shift government policy on how and where to borrow and invest.”⁸

The recent trend Environmental, Social and Governance (ESG) investing seeks to allocate capital to businesses that have a positive impact on society which sounds nice in theory. In practice, the different rating agencies often produce wildly different estimates of companies’ ESG scores. Additionally, fund managers usually only pay lip service to ESG and often ignore ESG investment guidelines.⁷ The result is that the way that most people hold and invest their money right now creates negative externalities that they are unaware of. People put their money in bank accounts, pensions and index funds and in so doing, unknowingly support unethical businesses halfway around the world.

Many people, especially the younger generations, are turning to conscious consumerism and products labelled as ‘ethical’ to reduce the involuntary negative effect they have on the world. Yet conscious consumerism alone is not enough. Where and how we invest our money is “27 times more impactful on the environment than consumer choices to buy green and sustainable products.”⁷ Counter-intuitively, limiting the negative environmental and social effect of our existence requires consumers pay at least as much attention to the credit cards they use to purchase goods and where their savings are located than the items they are buying.

It is crucial to understand that there is no such thing as passive investment, only the abrogation of responsibility for the choice of where to invest your money. Over the last decade, the explosive growth of crowdfunding and P2P platforms have been giving people back control over their money. These platforms are built around the “idea that finance works best when people themselves decide what their money is used for.”⁸ Unfortunately, determining where to invest your money investment by investment is difficult and time consuming, which is why most people trust these decisions to financial professionals and invest in indexes.

While most people have little to no opinion on the merits of individual stocks, we as a species believe in causes or ideas that we are particularly passionate about. One of the problems with mainstream finance is that it is unclear how investments in specific companies contribute to solving large-scale problems.

DAOs governed by decentralized constitutions offer a way to cut through this financial ambiguity by enabling decentralized financing vehicles organized around thematic investing in various causes. These DAOs would layout their investment focus and governing mechanisms in their constitutions. Holders would be able to propose changes to that constitution and vote on various investment decisions thereby influencing how the DAO invests its capital. This will allow DAOs to evolve and improve over time. Furthermore, the investments of the DAO would be visible to everyone allowing investors to see the companies they are supporting.

Transparent, decentralized financing vehicles will make investing in causes easier. This structure offers the best of both worlds. It simultaneously simplifies the process of investing as people can read through the constitutions of various DAOs and determine which causes they want to support with their capital. Investors also have full control over their money so if the DAO evolves in a direction they disapprove of they can sell their money and move their funds to a different DAO.

Thematic DAO examples:

Web3 DAO — invests in the technology, infrastructure and startups that are helping to build out the web3 ecosystem. The Library is a good example of this.

Cannabis DAO — Invests in both medical and recreational cannabis and CBD companies as well as lobbying for a more rational drug policy

Climate Change DAO — invests in companies and technologies focused on solving climate change

Sustainable Building Materials DAO — invests in companies developing technology and processes to reduce the greenhouse gas emissions of building materials like concrete

Breaking Glass Ceilings DAO — invests in companies with female founders or a certain percentage of female executives

These DAOs would meaningfully accelerate the pace of development and innovation in their domains of focus. Creating value for startups and portfolio companies alike. Having an overarching investment thesis imbue these DAOs with the confidence to invest early in emerging industries. If these industries prosper the DAO will benefit from getting in at the ground floor. Similarly, these thematic investment DAOs can offer startups both more patient capital and a large community of members inherently interested in a portfolio companies products. Having a large member base means that some of the DAOs portfolio investments may even be sourced from the community of holders. These attributes should allow these DAOs preferential access to interesting deals. These vehicles are also likely to be great investments. It is a truism that the worlds greatest problems are also the worlds biggest business opportunities.

By fashioning ideas and investment philosophies into decentralized constitutions and integrating them into DAOs we can create a new type of goal-oriented permanent capital vehicle. These vehicles would be managed in a decentralized fashion and organized around investing in businesses that are aligned with the DAOs ultimate objective. As ownership of these DAOs would be traded on secondary markets through NFTs and tokens, allowing investors to gain exposure to underlying investment themes like an ETF. As liquidity in these funds would be generated by secondary markets there would be no need for redemption allowing the DAO to invest with an indefinite time horizon.

“When you invest, you’re shaping the future. When you put your money here, you’re not just following the wind, you’re making it blow. So the real question is: ‘What is the world you want to live in?’” — Marie Ekeland

DAOs and decentralized constitutions have the potential to create missions and social causes that can possess their own capital, pursue goal-oriented action and evolve over time.

1. https://ethereum.org/en/dao/
2. https://ethereum.org/en/web3/
3. https://www.coindesk.com/business/2022/04/05/jeff-kauffman-daos-will-own-big-brands/
4. https://beincrypto.com/daos-stop-the-dao-ization-of-everything-it-wont-solve-every-problem/
5. Laura Shin, The Cryptopians
6. https://www.linkedin.com/pulse/work-principle-5-believability-weight-your-decision-making-ray-dalio/
7. Yuval Noah Harari, 21 Lessons for the 21st Century
8. Mark Davis and Bruce Davis, Crowdfunding and the Democratization of Finance
9. Ibid.
10. Yuval Noah Harari, Sapiens
11. https://www.ft.com/content/c1fd5ed0-e3f1-4c54-91f7-f0ad5a10af9a