DAO Governance Systems: Why They Matter

As DeFi and NFT communities continue to grow, the pressure to answer questions on how to govern decentralized protocols will become more urgent. Governance is the act of managing collective decision-making to optimize funds and operations.

Governance requires network participants to be involved in voting on every decision and coordinating costs. Reducing these costs is possible with the help of DAOs (decentralized autonomous organizations). In this case, a DAO is represented as people united with a common interest. With DAOs, there is no single leader or point of failure. And every operation runs almost entirely by code.

A DAO is the amalgamation of parts of companies, social clubs, and banks that are stitched together via cryptographic commitments.

However, despite the name, DAOs are not completely autonomous. Someone has to create decision frameworks to ensure that a DAO is governed effectively as well as financially incentivize network participants to participate so the DAO can grow.

Let’s dive deeper into the governance aspects of DAOs, figure out whether it’s possible for them to actually remain decentralized and autonomous, and look at the challenges facing the DAO voting process.

What are DAO Governance Areas?

The general areas of management for DAOs include:

1. Collective ownership and management of assets. DAO treasuries and balance sheets should function like decentralized corporations, considering assets and liabilities, liquidity, income, and where to direct financial resources.
2. Asset Risk Management. Volatility, price, and other market conditions require constant monitoring.
3. Asset curation. From art collected to collateral for lending, all DAO assets benefit from the goals and processes associated with curation.

A DAO should only be created when it is clear that all of these areas of governance are required by the community.

It’s important to note that while a DAO may focus on a subset of these activities, it must actually provide all three. For example, suppose a cultural DAO owns an asset that is suddenly given the opportunity to generate revenue or income. Even if, up to this point, the DAO has completely ignored risk management (for example, focusing solely on asset curation), it faces this problem after such a sale.

One of the most prominent examples of this was the PleasrDAO’s $225 million sale of the $DOG token, representing distributed ownership of the original Dogecoin NFT meme. Until now, PleasrDAO focused exclusively on asset curation and ignored risk management issues. The launch of the token through the Sushi Miso platform made the group aware of the various mechanisms and economics of token distribution, especially as the factional structure of the NFT market is in its infancy.

The group also had to ensure that community members felt a real sense of ownership over the NFT by establishing a community development fund.

The key lesson here is that DAOs will need to add new collective skills and management processes as their operations change and that successful DAOs are able to recognize shortcomings quickly.

Decision-Making Process in DAOs

According to BlockchainHub (2018), organizations need to fulfill the following requirements to identify as a DAO:

• Transaction tokens — a DAO should contain a valuable property in the form of tokens that could be used for rewards and can represent the voting power of each member.
• Autonomous execution — the DAO as an entity acts independently and cannot be influenced by external forces. The organization and its open-source code are fully transparent and, therefore, incorruptible. The functionalities and program rules are written in code and maintained on the blockchain.
• Consensus — stakeholders need unanimous agreement on decisions that need to be made, for example, if a member wants to withdraw funds. Furthermore, bugs and optimizations need democratic voting and decision-making, which can be seen as security issues if bugs are corrected too late.
• Contractors — in order to accomplish tasks and reach business goals, the DAO “hires” manufacturers, developers, and other contractors based on the say of shareholders.
• Proposals — the decision-making process always starts with a proposal. A proposal could also require a monetary deposit to prevent a network overload of proposals.
• Voting — this step is crucial as activities like money raising, investing, and repairing can only take place if a majority vote is reached.

The voting process in DAOs provides an alternative to the current state of hierarchic and managerial decision-making in traditional companies. A DAO could have various stakeholders whereby each would have voting rights on how to allocate the organization’s funds. Funds could be used for paying salaries or as an internal currency to reward work. Voting rights could be distributed evenly or based on the number of tokens owned.

DAO Voting Mechanisms and Problems Associated with them

Originally, tokens and shares were the primary factors of voting rights. However, today a more significant number of DAO voting mechanisms have been proposed. These mechanisms ensure that voting and governance remain decentralized and encourage more community members to participate in decision-making.

DAO voting mechanisms include:

1. Permitted relative majority
2. Holographic Consensus
3. Quorum voting based on tokens
4. Rage Quitting
5. Quadratic voting
6. Conviction Voting
7. Multisig Voting
8. Liquid Democracy

Due to the fact that DAOs are still a new form of organization, no voting mechanism has yet proven itself as the best and most effective. Each of them may have its own advantages, however, they’re not without their issues either.

Consider a common situation where the business structure of your project consists of six developers. They have launched the protocol and they also make all the day-to-day decisions on business operations. So is it actually a DAO?

Are these the people who run the department, write the papers, and manage the project? If yes, then the voting mechanism here is just window dressing to make everything look like there is room for participation. Consider also the moment that most voting in crypto has very poor participation. Large shareholders usually influence it, making it the least ideal mechanism for DAO governance.

In Conclusion

As the project and community grow, parts of the project will become more and more decentralized and managed by non-founding members.

Many modern projects integrate their communities into the daily operations of their organization, handing off critical business roles to non-founding members sourced directly from their community.

The Standard Protocol is on the path to be governed by a community of “Standard Token” holders which form a Decentralized Autonomous Organization (DAO). The Standard DAO will manage the protocol by making key decisions that utilize the smart voting mechanisms and prediction markets.

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