Most of the cryptocurrency companies are being managed with the votes of cryptocurrency owners, as DAOs (Decentralized Autonomous Organizations). Since the cryptocurrencies are traded in a free market, any user having a sufficient amount of tokens can have the right of voting on the platform. Therefore, for deciding on a platform, it is required to convince thousands of users instead of a small group of executives. For this reason, the characteristics of a community are very important. In this challenging period, DAOs facing a variety of problems have been trying to make decisions according to their structures and pull through the existing process.
In order to see these decisions in a general perspective, by focusing on MakerDAO, Solend, Yield Guild Games (YGG), and Merit Circle DAO communities, we will investigate how DAOs produce solutions to the problems and what kind of character they demonstrate; therefore we will investigate their behavior models.
Yield Guild Games (YGG) and Merit Circle DAO
As known, venture capitals invest by providing funds for projects at earlier stages. There are venture capital companies in the cryptocurrency market both from the conventional economy and the crypto-world. YGG is a venture capital company from the crypto market that was established during the emergence of NFT-based games.
The incident we will explain under this subject starts with YGG investing in Merit Circle DAO, a metaverse project. Investing in the early stages of the project, YGG actually realized this investment without any substantial development and took a risk. The value of investment increased x30 and rewarded more than the level of risk taken. However, at this point, things did not go well for YGG…
In their statement dated 28 April, Merit Circle requested its early investors to specify the type of their contribution to the project. And YGG shared a responding statement, declaring the works YGG carried out for Merit Circle.
On 20 May, a proposal on MeritCircle DAO was submitted, suggesting that YGG did not make sufficient contribution to the project, although it is an early-stage investor, and already acquired a big amount of profit; therefore suggesting to return the investment amount to YGG and not to give any tokens. This action plan means writing off an approximately x30 profit of YGG.
YGG responded to this matter accusingly and somewhat aggressively. In the statement, it was stated that according to the investment agreement signed by YGG with Merit Circle Ltd. (Merit Circle DAO’s organization that is in an official company status and that conducts its legal form), YGG did not have the obligation to perform any work for the project, but still performed such work, listing those works; and that it was impossible to ignore the contribution of YGG on Merit’s current position.
Merit Circle Ltd. confirmed that there was no such clause in the agreement. But they stated that the sole discretion was on Merit Circle DAO and they had to adhere to the voting results.
And then things got interesting at this very point. Because legally, Merit Circle does not have the right to terminate the agreement. However, since the decision made by the community is decisive, the legal department has nothing to do. They have to execute the decision made.
So, what happens when DAOs make a decision that is against the laws? The main point that made this dispute interesting is this question. For instance, in case the dispute is taken to the court, how can the court’s decision be definite without being accepted in the DAO community? Let us assume that operations of Merit Circle Ltd. are ended due to the failure of implementation of the verdict. In this case, Merit Circle DAO can continue to operate. But since it loses its company with legal status, it will have to run all of its business through decentralized platforms. Therefore, when it comes to DAOs, as well as the design of smart contracts, the characteristics of the community are also very important. Because DAO is a new and experimental type of company structure. Therefore, although the improvements served by this innovation are attractive, it still has many structural problems.
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On 28 May, in the voting on the proposal about Merit Circle DAO, “Yes” votes constituted 83% of the total votes, and it was confirmed to return the investment amount of YGG and cancel its early investor status. But immediately after this voting, in another voting on 7 July, a relatively responsible decision was made. It was proposed to return approximately %30 of its current token value, instead of the investment amount, to YGG; which means a purchase of tokens by Merit Circle DAO. It was stated that in that case a repurchase agreement would be signed with YGG and it would be guaranteed that no legal actions would be taken. Probably the community doubted the setbacks the matter could create, and that proposal was accepted with 100% “Yes” votes. As a result, tokens of YGG, worth 5.2 million USD were repurchased by Merit for 1.7 million USD.
On 14 June, YGG and Merit Circle DAO made a mutual statement declaring that the dispute was resolved. In the statement, it was stated that Merit Circle DAO does not agree with the opinion that YGG did not contribute to the project, that proposal belonged to one of the shareholders of Merit, and it seems like the statement aimed not to discredit YGG and to make it clear that the issue put Merit into a difficult position.
It seems like the negotiations of YGG and Merit Circle Ltd. opened a road to the second proposal and convinced the DAO community to decide within the legal boundaries. By accepting to stand back with x10 profit instead of only the initial investment amount, YGG seems to have accepted avoiding a very long trial process that would be full of uncertainties. Although the dispute between the two companies was resolved, it can be anticipated that, in the future, venture capital companies can request much more precise guarantees for the projects they invest in. Companies investing in any DAO can act much more timidly due to such decisions. One of the main reasons for this is that DAOs have no legal infrastructure yet.
In addition, we have seen the surprising impact of the persons that can manipulate communities on DAOs. The shareholder making the initial proposal can also be behind the statement on 28 April, which requests core investors to submit their contributions. It is clear that this statement created the infrastructure of the proposal against YGG. And it seems that it was not hard to lead users, who were already too depressive and aggressive due to the bear market, to such a manipulation. And it can be clearly seen with the 100% voting rate that in the second voting, people adopted a prudent approach and acted with the instinct to protect the project. Therefore, manipulation is another subject about DAO to be investigated and to take precautions on.
MakerDAO’s Actions
Being one of the oldest DAOs, MakerDAO is a DeFi platform providing credits against collaterals. Besides that, the only algorithmic stablecoin that has been operating properly and stably for a long time, DAI, is owned by MakerDAO. The platform owes its success to its decentralized structure and professional management form. MakerDAO’s moves during the liquidity crisis, which has been the most serious problem of the past month, are also very important.
Being managed as seriously as a bank, MakerDAO deserves credit for proving several times that it has a reliable community with its long-term stabilization.
Since both DAI and credits are only given against high collateral rates, the platform never had any liquidity crises. But since any platform offering banking services affect others, it was seen that MakerDAO took early precautions. One of these precautions is the decision made by MakerDAO on the Aave platform.
One of the most important subjects regarding the liquidity crises that emerged, led by Celsius and 3AC, was that the parity pool of stETH tokens did not have enough liquidity, therefore these companies could not obtain sufficient liquidity to pay off their debts by selling sufficient amounts of stETH. Since Aave was one of the platforms accepting stETH tokens as collateral and since stETH tokens had a problematic liquidity balance (actually imbalance), MakerDAO decided to stop the direct link of Aave where Aave has the authority to directly create DAI.
The reason for this direct link was to allow users, who would like to get loans from AAVE/DAI pool on Aave, to continuously trade with a fixed interest rate. For instance, if the interest rate for getting DAI loans changes from 6% to 4% daily, this will negatively affect the long-term plans of investors; therefore, it was aimed to offer a fixed interest rate. The interest rate is decided based on the parity balance in the pool. For example, if users get too many DAI loans, the AAVE amount in the pool increases, and the DAI amount decreases. In that case, the cost of borrowing, that is the amount of interest to be paid, increases. For avoiding the increase in interest rate, Aave was authorized to directly create DAI until the pool was balanced. When the debts are settled and DAIs are back, the balance is created by taking DAIs back and it becomes possible to get loans with a fixed interest rate. The system was operating in this way until the link was temporarily stopped.
Although there were no problems on the pool created with this direct link and Aave had sufficient liquidity in its operating system, the reason for MakerDAO to temporarily stop this link was to avoid a potential problem that could take place in Aave’s pools through stETH. Therefore, slowing down its operations, taking no high risks, and taking precautions; the MakerDAO community was praised for having very professional DAO management.
Another important decision made by MakerDAO recently was to transfer a part of its balance to short-term US treasury bills. After this decision was accepted, treasury bills worth 500 million USD were purchased, and it is possible to say that platform tried to protect its incomes from inflation. Since this bill type is extremely liquid, in case of any urgent needs, it can be returned to the platform quickly. Therefore, it is observed that an extremely balanced management strategy has been followed and the right efforts were put in to get through the current period.
Solend
Ethereum was not the only network being affected by the liquidity crisis. Solend platform on Solana also got its share of this crisis. Being managed as DAO, by voting; Solend was harshly criticized for its method of managing this crisis.
Like MakerDAO or Aave; Solend platform is another cryptocurrency platform that provides credits against collaterals. However, the problem here is that Solend does not have a pool as deep as other platforms. That means, the amount of credits the platform can give is relatively limited.
An anonymous user gave 5.7 million SOL tokens as collateral to the Solend platform and received credits worth 108 million USDC. With this trade; this user, who can be described as a whale, purchased 88% of the USDC amount Solend can lend. Therefore, the platform ran out of USDC to pay to the users that would like to withdraw their USDC balance. The only thing the users could do was to wait for the whale to pay its debt back…
But the main reason forcing the Solend community to vote on this matter was the fact that this credit approached the liquidity threshold. When the price of SOL tokens kept falling due to the negative outlook in the market, the value of 5.7 million SOLs, which were given as collateral, also went down. In case the collateral is close to a level that will not cover the credit, the smart contract automatically distrains the collateral and by selling SOL tokens, puts the borrowed USDCs back into the pool. In a normal market, there will be no problem to make such a mechanism work. But an instant 5.7 million SOL-worth selling in such a period when the demand was too low could dramatically lower the price of SOL tokens and constituted a risk.
In the proposal offered to the community, it was suggested, while approaching the critical liquidity limit, to manually distrain the credit and sell SOL tokens taken as collateral through OTC, not in the free market, in order to prevent the impact on price.
Although this proposal makes sense operationally, it is quite contrary to the principles of DeFi. Systems like collaterals locked to smart contracts, and automatic liquidation are systems that were created against the traditional banking system and the main principle behind them is decentralization. Such a manual distrain will cause Solend to become a traditional bank and has the potential to seriously shake the trust on the platform.
Since the DeFi principles were ignored, the community had serious criticisms of voting. However, since only one account having a %88 voting right voted for “yes”, the proposal was automatically accepted. This way, it was seen that Solend DAO was extremely centralized and the opinions of the community were dependent on the approval of only one account.
After this proposal, the credit owner was contacted and the middle course was taken by mitigating the risk carried by Solend with various adjustments. And due to the reactions from the community, the manual credit distraining decision was canceled. However, the fact that Solend DAO was not decentralized caused an extremely negative outlook.
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In MakerDAO and YGG-Merit Circle DAO cases, we have seen how decisions, which could positively and negatively affect, were made by the votes of the community. However, in both matters, we cannot talk about centralization. When a DAO is under the control of a single person or group, that platform turns almost into a private company that is operated transparently. However, the aim of DAO is to create companies without a boss, or decision-maker, where the community manages itself.
And manipulations such as in the Merit Circle DAO case are an important example of potential problems such communities can face. If YGG took legal action, we would probably see new problems and have new experiences.
DAO models where everyone controls each other, each decision is voted after long discussions, and the proposals are not accepted without a broad consensus, like Bitcoin, represent the ideal point where existing DAOs would like to reach. However, although such long discussions and broad consensus minimize errors, they prevent fast decision-making. The bases of difference in this matter are the characteristics and behavior models mentioned at the beginning of this article.
The trust in systems like Bitcoin and the belief in the future success of this system prioritizes the long-term targets of the project in the voting. The ones voting by connecting to the Bitcoin network as miners trust the Bitcoin system and become a part of this system. Therefore, at this point, we can say that the system creates the characteristics of the community and the participants adapt themselves to the characteristics of this system.
In the Solend example, we saw that decentralized operation principles were neglected with single voting; and in the Merit Circle example, we faced situations where the investor was “dismissed” when the Merit Circle did not need its investment anymore. Such shortcut solutions used by these DAOs show that, unlike Bitcoin, the characteristics of the community shape the system itself.
In conclusion, it is important to remember that each new problem in this brand new management system provides an important experience. Such problems can also allow DAOs to regulate themselves through smart contracts. The important thing here is not to regard DAOs that make centralized and unethical decisions and is that the communities react to such DAOs.
Prepared By: Berkay Aybey
The opinions and comments expressed here belong to BV Crypto. BV Crypto cannot be held responsible for any financial transactions made on the basis of this post. Every investment and trading move involves risk. When making your decision, you should do your own research.
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