The Role of Governance in DAOs
One doesn’t have to be in DeFi very long to come across the word “governance.” People commonly wave their hands and say, “that’s up to governance,” or “governance hands out those grants.” Every DAO has governance in some form or another. Like national governments, however, DAO governance can vary widely in the breadth of its powers, the complexity of its internal processes, and its ability to deliver results.
DAO governance ranges from supposedly benevolent despotisms to oligarchic multisigs to plutocratic republics (“one token, one vote”) to democratic republics enforced by mechanisms like quadratic voting. The one thing they all have in common: assist in making decisions for a DAO.
In theory, DAOs are supposed to be a group of decentralized, loosely affiliated actors all working toward a common goal of developing a software protocol, sharing a hobby, or even buying a historical artifact. But when it comes to getting consensus or coordination out of a decentralized community, people get madder than a rained-on rooster over things large and small. Once the one-line zingers or multi-page forum rants begin, cacophony becomes more likely than consensus. Too much noise and a DAO stops executing its mission while projects atrophy and fail.
This is a natural challenge. A genuinely decentralized DAO — as opposed to one adopting the name only — is a tangled mess of diverging interests brought together only by their common goal. There is no “team” in DAO, and unless it has been coopted by a centralizing force, a DAO must expect conflict.
This is where good governance comes in. DAO governance is a process — either formalized or through cultural norms — that keeps the wheels on the bus so it can continue moving. For a DAO that hopes to upgrade a protocol, that means building and protecting a culture that respects substantive debate on the issues while not becoming so entrenched in bureaucratic processes that concentrations of power can occur.
Note that for truly decentralized DAOs — where no group or individual can unilaterally execute proposals or ignore the outcome of an on-chain vote — governance via formal processes is not strictly necessary. In theory, token holders can begin a proposal and then vote on it without ever discussing the topic amongst themselves.
In practice, however, only emergency responses are likely to garner the votes required to act without deliberation. This leaves DAO governance to referee those discussions between token holders, maintain a fair and productive forum for communication, and keep stakeholders current on ideas to improve the protocol.
DAOs are social structures built on top of protocols, and governance is the sum of the actors and processes within that DAO. Governance should never be confused with the rules of the protocol itself. Protocols act according to their encoded rules; individuals and entities that participate in a DAO act according to the rules of the DAO’s governance.
A protocol has code as law. It is an unthinking, intangible collection of smart contracts. It does not need governance; it is self-governing. Humans, of course, are messy, beautiful organisms that require some way to establish their own rule of law. High-quality governance ultimately provides this by being neutral, consistent, and facilitating action rather than inertia. Low-quality governance, in contrast, can take many forms — capricious, arbitrary, inconsistent, process for the sake of process.
It is important to emphasize that last one again: good governance avoids process for the sake of process. Just as with governments, byzantine processes to create, pass, or implement a proposal undercut a DAO’s ability to maintain and expand the protocol’s utility.
Byzantine processes are a sort of sand in the gears that the real world has accumulated by the ton, but Web3 has largely avoided thus far. DAO governance should exist only to the extent that it enables a DAO to fulfill its purpose. Governance is not an end unto itself; it should facilitate rather than obstruct progress.
Specifically, the proper role of governance in a DAO is to:
- Facilitate unbiased incentive alignment for stakeholders;
- Provide communication channels for discussions to take place;
- Be clear, concise, and easy to understand, even to someone unfamiliar with the DAO;
- Offer a repository (but not the exclusive one) of information about the DAO;
- Focus on the core mission of the DAO.
While the above are essential to the governance of any decentralized organization, current implementations of DAO governance can provide further lessons.
Notable Governance Models Today
Despite being one of the oldest and most established protocols, Compound has struggled to form a vibrant DAO. Lacking many of the formalized processes of Aave or MakerDAO, Compound’s forum often gets described as a ghost town. It has struggled to attract fresh community members (and even paid contributors) in an environment where newer DAOs like Tribe or Olympus exert more gravitational pull on energetic market participants.
This has (perhaps ironically) resulted in Compound being extremely decentralized in practice. Aside from risk parameter adjustments and the occasional addition of a new collateral type, the protocol nearly runs itself. Unfortunately, that means there is no clear reason for anyone to participate in its governance. As a result, Compound has fallen behind its competitors. Even in the absence of serious new competition, it is slowly becoming the weakest of the “blue chip” DeFi protocols.
Note Compound protocol having ½ to ⅓ the Total Value Locked (“TVL”) of Aave and Maker protocols. Source: DeFi Pulse
MakerDAO, on the other hand, tops the chart above in TVL but faces a very different sort of challenge. It is one of the oldest surviving DAOs, and its governance model is the polar opposite of Compound’s. Rather than struggle to attract contributors to innovate around the core protocol, MakerDAO has onboarded and retained dozens of paid contributors and community members.
Among the things MakerDAO has done correctly, the most important is creating a culture that values rigorous technical evaluation and unbiased processes. As an example, MakerDAO welcomes even anonymous actors to make proposals, and its community attempts to evaluate all proposals on merits.
MakerDAO’s governance process has become a victim of its success, however. Increasingly more intricate processes around the social and political interactions of the DAO have evolved MakerDAO into something resembling a traditional organization — complete with 20 distinct departments (called core units) and an approved budget for 130 full-time, paid contributors. While exact estimates vary, there may be more than $54 million in cash expenses solely for regularly paid contributors, many of whom maintain an increasingly complex internal infrastructure or handle transactions with explicit counterparties.
Furthermore, the proposal process is a snarl of mandatory deadlines, declarations, and formats. While, in theory, proposals are permissionless within MakerDAO, it has become common practice for prospective partners to either seek the assistance of friendly insiders or pay external services to navigate the proposal process. This ossification of byzantine governance rituals is now considered a significant impediment to enacting new proposals. Recently, a slew of proposals attempted to become “self contained” to bypass the typical processes, which have resulted in months of waiting with little action.
Increasingly formalized roles and specialized responsibilities give nefarious actors methods to fast-track, slow down, or outright decide which proposals reach a vote. Even after the vote, they can then influence the order in which approved proposals are executed.
Despite its name, MakerDAO looks more like a traditional business than a DAO.
As MakerDAO and Compound demonstrate, it is difficult to strike the proper balance. Too little structure leads to disengagement, while too much endangers the regulatory arbitrage and sense of informal community on which DAOs ultimately rely.
Takeaway
Proper governance provides the stakeholders with a safe, well-trodden path when they want to add utility to a protocol. This can include processes to review and adjust parameters, consider and implement integrations, or deploying a new instance of the protocol’s code on another chain. Without any guard rails, governance quickly collapses into chaos or abandonment. Too many formalities stifle innovation and re-create the very form of organization that DeFi participants sought to escape.
At the core of any DAO is its community of token holders. They ultimately determine the future of the project. DAO governance cannot provide a definitive institutional strategy. It can only provide the community with whole cloth; the community must stitch something useful out of it. Anything less and the DAO withers; much more and it becomes a traditional business.
