On Risks, Rewards and The Evolution Of DAOs

In order to scale, DAOs will have to continuously reinvent themselves.

The concept of DAOs (Decentralised Autonomous Organisations) has been explored in the blockchain space for some time but the recent rise of Ethereum and upcoming DAO crowdsales generate a lot of new interest in the community.

I’d like to share some thoughts on the nature of DAOs and their importance in the emerging programmable economies enabled by the blockchain.

What does the Wikipedia say about DAOs?

“A decentralized autonomous organization or distributed autonomous organization (DAO) can be thought of as a self-governing organization under the control of an incorruptible set of business rules. These rules are typically implemented as publicly auditable open-source software distributed across the computers of their stakeholders. A human becomes a stakeholder by buying digital tokens, similar to shares in a company, or by being paid in those tokens to provide services for the company. These tokens may entitle its owner to a share of the profits of the DAO, participation in its growth, and/or a say in how it is run.[1] [2]

Personally, I’m not a big fan of this definition. It explains the features and implementation details but doesn’t explain the benefits.

I’d like to offer another definition:

DAOs are the software-based mechanisms for aligning economic incentives over the internet by distributing risks & rewards among people that share a common economic goal but don’t know each other.

So DAOs are not really autonomous and are not organisations. At least not by the common definition of the word ‘organisation’. DAOs can be understood as risk/reward schemes, programmable sets of incentives that can be distributed over the internet that aim to affect change in the world without a formal, legal organisation.

I intentionally didn’t include the concepts such as blockchains, smart contracts, decentralisation, tokens, voting, crowdsales etc. These concepts are obviously fundamental building blocks of DAOs in the current state of the technology. But the real value of DAOs is not in ‘being recorded on the blockchain’ or ‘distributing tokens’ .

The real value of DAOs lies in providing a mechanism for evaluating, funding and distributing risks & rewards of new ventures that is accessible to everyone in the world.

In this regard, DAOs are similar to joint-stock companies of renaissance Italy.

The early joint-stock companies allowed shareholders to share risks & profits in sea expeditions that were notoriously dangerous — high profit but also high risk. Some of the voyages generated huge returns while unsuccessful ones brought zero. (Read more: http://szabo.best.vwh.net/jointstock.html) So it made sense to pool resources together to fund these expeditions and distribute risk to ensure more consistent returns. The invention of the joint-stock company as a mechanism for risk/reward distribution has generated a great wealth for Italian cities at the time.

In the XXI century, sea expeditions were replaced by startups as the wealth-generating engines with founders being new captains and startup teams being the new ship crews.

But the opportunities for funding and participation in new ventures haven’t changed much since the early sea expeditions. These opportunities are still geographically concentrated (the centre of wealth accumulation is now Silicon Valley), limited to wealthy individuals and still rely on national, legal and judicial systems for enforcement. The technologies of print & paper and hand signatures are still used to finalise agreements.

We praise the technology for being the great equalizing force in the world. It surely equalizes access to information but the missing component is the equal access to investment opportunities. Everyone can access information using Google, but only a selected few had access to investing in Google back in the 90s.

What if the ability to invest in the next Google was as widely available as the ability to access Google is today? On the flipside, the ability to lose money on the next Pets.com (one of the great failures of the dot-com era) should be also equally distributed.

I believe, that due to Ethereum and programmable blockchains, we’re on the cusp of the major transition in the way new ventures are evaluated & funded and DAOs will be central to that transition.

But even though we’re using the XXI century tech, old rules of human economic activity still apply.

To generate returns for investors DAOs will have to solve the same challenges that traditional organisations aim to solve:

  1. Attract and allocate various forms of capital (talent, technology, money) to create new solutions and deploy them in the real world.
  2. Allocate the risk of failure — define who absorbs the risk if things don’t work out as intended. Economic activity by definition has uncertain outcomes and this uncertainty has to be taken into account.
  3. Distribute rewards — define who reaps the benefits of success? how these benefits are distributed? What does success really mean?
  4. Design the evolutionary/scaling mechanism — organisation has to grow and adapt to the changing external conditions. It has to be able to attract more resources over time, by acquiring more talent, money and develop organisational structure that allows it to scale.

Bitcoin (we can call it a proto-DAO) proved that 1–3 are possible to achieve without the legacy organisational structures.

To use an example of Bitcoin, the Bitcoin’s software managed to attract talent, deploy thousands of specialised chips in the real world, evolve its code base, push the Moore’s law to its limits and bootstrap an entire industry just by providing certain incentives in code. Without any legal entity at the top, Bitcoin’s code made people behave in a certain way, work on certain things by exploiting their curiosity, ambition, greed, fear and appetite for risk.

But most importantly it distributed rewards of its success to people based on objective measures — everyone could participate. People made money, and people lost money but the risks were visible to those who wanted to inspect them.

The challenge we have is the point #4 — how DAOs can grow and adapt over time?

The topic that is rarely discussed in is the evolutionary/scaling mechanism for DAOs. How DAOs can adapt and evolve over time, attract new talent & capital and become more competitive.

Most of the blockchain and DAO designs focus on incentivising early adopters. But not many discussions are focused on how to incentivise the late adopters to join the original DAO rather than to fork.

What we learn from Bitcoin and it’s recent scaling discussions is that DAOs won’t be immune to universal market forces that affect traditional organisations.

The combination of talent, capital, community and products that contributed to organisation’s early success, very often is not optimal to take the organisation to the next level.

Different skillsets will be required at various stages of organisation’s evolution and organisational design should account for that.

In the traditional organisations, founders cash out and are replaced by professional CEOs, early investors who no longer contribute are bought out and replaced be the new ones. New talent and new investors have to be vested in the success of the organisation to help it evolve and compete externally.

How to achieve this feature in the context of decentralised organisations where the participants don’t know each other, the organisation itself is embedded in code and there are many conflicting visions for the future?

How to accommodate interests of early adopters who came in early and want to sit on their investments and watch them increase in value with interests of newcomers who could contribute to the DAO but the equity has been allocated already.

Without the equity, they’re incentivised to fork the DAO and allocate new equity to themselves effectively launching a competitor.

In the traditional company, the early investors would be diluted to allocate new equity to talent coming in at the later stage and create a win-win for everyone. Early adopters would have a smaller piece of the larger pie so the absolute value of their investment grows. Newcomers are compensated with equity and have ‘skin-in-the-game’ to join forces rather than to go on their own.

So far, achieving this has been impossible in the cryptocurrency world. The evolutionary mechanism that emerged in the cryptocurrency world forces innovators to fork the original chain and launch a competitor.

The success of Bitcoin inspired the founders of Ethereum and the recent rise of Ethereum, immediately resulted in the Lisk ‘competitor’ and its succesful crowdsale.

“Why join Ethereum and be the 10000th investor, when I can join Lisk and be the 1st. After all, it’s like Ethereum but better because XYZ” (I’m not talking about the technological merits here, just the reasoning of the average investor).

Will the same process repeat itself with the successful DAOs on the Ethereum blockchain? Probably yes.

If a DAO achieves even a moderate level of success, why late-comers should contribute to the original DAO instead of launching a fork with a new allocation of shares?

My bet is that Ethereum based DAOs will be forked even more often that Bitcoin was in its early days. You don’t have to bootstrap the entire network from scratch and the DAO code has to be open source anyway.

But what if we designed a DAO that leverages forking as its decision making mechanism? If forks cannot be prevented, we might very well leverage them as a feature not a bug.

This way we could decrease one of the major risks facing the DAO investors — the risk of being forked.

I’ll explore this topic in more detail and propose an ‘evolutionary DAO’ model in the next article in this series.

Ideas presented in this article were developed in collaboration with Kuba Kucharski. We spent many hours discussing Ethereum, DAOs and ways to scale attention marketplaces described in the Userfeeds article. We’ve realised that the model we design for Userfeeds can be applied more generally to other types of DAOs. Most of the ideas presented here are as much his as mine.