8 Steps to Decentralization
The decentralization movement is upon us. A core part of the equation is a clear path for projects and teams to become decentralized. This document aims to clarify this process for projects.
Reasons to decentralize include:
- Giving early stakeholders an easy way to exit
- Leveraging new forms of network effects, allowing projects without moats to have one
- Performing regulated activities (raising funds, allowing the trading of securities, issuing dividends, etc.) by removing “efforts from a 3rd party” from the equation.
Inspiration for this article was drawn from the number of projects in the space pushing the boundaries, as well as the concepts of Ownership Economy by Jesse Walden. At the end of this document, an example is given demonstrating how to apply this process to your project.
Proudly written in collaboration with MetaCartel Ventures, which is seeking to fund projects following this model , as well as DAOstack, a governance project building a product specifically targeting this market. Reach out for governance support! Thanks also to Gabriel Shapiro for his input.
Step 1: Initial Stakeholders
Most projects will already have a defined group of stakeholders. Usually this includes the founding team, investors, and it may also include token-holders if a token already exists. In the case of a legal entity, you would want to offer investors rights to future governance tokens (via a SAFG).
In all situations, stakeholders get governance tokens.
Step 2: Incentives & Ideal Stakeholders
Projects looking to decentralize need to think about who they want to govern their future protocol, in addition to initial stakeholders. Careful consideration should be given to ensure the right incentives are in place, as you could end up in a situation where your protocol gets hijacked if you don’t get this right.
For many projects, the ideal stakeholders will be acquired via some form of “activity mining”, while other projects may choose strategies such as:
- Airdropping governance to a certain group of people
- Giving governance away to an existing decentralized network, like an existing DAO
- Selling memberships (This has the advantage of also raising funds while also becoming decentralized)
Some projects may also choose to direct a certain amount of governance tokens to the project’s future DAO treasury. This has the benefit of allowing the community to have working capital as the community forms, particularly important in cases where the project does not yet have cash flow.
Step 2 is really about defining who you want to distribute governance tokens to, and what activities (if any) you want to incentivize on your protocol. You might choose not to define all incentives from the onset, and they may change over time.
The rest of this document is primarily focused on “activity mining” as a form of governance distribution as it seems most effective. Slight variations would be required for the other distribution models.
Step 3: Defining your Timeline
In general, the concepts of Ownership Economy can apply to every project. Giving users more ownership via some form of ‘activity mining’ will most definitely increase engagement.
The real question is: “how long should we keep these incentives in place?”. The answer depends on many factors, such as the project vision, investor / team timeline, defensibility, among other things.
It’s my belief that the projects that will last longest will choose to go with a continuous incentive model (i.e. no token cap), as this allows projects to continuously adapt and provide incentives to new users of the platform. It’s quite ironic that many in the Ethereum community make fun of BTC’s supply cap, while simultaneously creating protocols with token supply caps.
A shorter incentive period may be fine for projects with a shorter timeline, or a strong moat (such as YFI).
Step 3 is about understanding your timeline and your defensibility which help define the emissions schedule of tokens.
Step 4: Modelling the Token Economy
Questions that need to be answered before you start issuing ownership include:
- How much ownership should the founding stakeholders have after X months?
- Is there some sort of token burn model to decrease supply?
- Should initial stakeholder tokens vest alongside the activity mining activities, or should they have another vesting schedule?
- Are a portion of tokens going to be directed to a DAO and is there a vesting schedule on these tokens as well?
Once you are done with Steps 1–4, you’re almost there! You have your initial and future set of stakeholders along with their emission schedule, now you just need to execute.
Step 5: Issuing tokens
At this stage, you can start giving away tokens according to your incentives and your schedule. Note that tokens do nothing at this stage.
Step 6: Launching a DAO (optional)
If part of the distribution of tokens goes to a DAO, you will need to launch your DAO along with Step 5, above. If a DAO is not part of the token distribution schedule, the team can launch a DAO at any time. In either case, voting power is given to tokenholders either directly or indirectly.
Note that launching a DAO may require more community building effort, and support, but on the other hand, it can empower your community, and increase engagement.
At this stage, the DAO will only be signalling, since it isn’t yet the owner of your protocol.
Step 7: Reaching “Sufficient Decentralization”
The next milestone before handing off control of your protocol is becoming sufficiently decentralized.
This is the fuzziest area, and the one with the least guidance for projects. If you don’t sufficiently decentralize, you might end up in jail, so it is likely best to kick this can down the road. See this article by Gabriel Shapiro for a bit more information so you can stay safe. Below is an attempt to define decentralization in the context of DAOs, based on this article:
- The lower the amount of tokens held by affiliated groups, the better. In Gabriel’s article, he uses a 20% threshold.
- If users of the platform can fork somewhat easily, there is a stronger case that the network is decentralized.
- Ownership by the initial team is also an important factor, the amount held may be at that 20% upper limit, but for more conservative groups, 10% is even better.
Voter turnout and community participation is another variable to consider. Low participation may hinder your ability to claim decentralization, so tread carefully!
Step 8: Gifting the Protocol to the DAO
Once you have achieved sufficient decentralization with a network aligned with your project, you can decentralize ownership of your protocol. If you haven’t yet launched the DAO in Step 6, now would be the time to do it.
Ownership of your protocol can then be transferred over to the DAO, and you are good to go! Your project can now reap the benefits of being a decentralized network. From now on, your team will need to ask for funding from the DAO to keep operating, good luck :)
EXAMPLE: From Startup to Decentralized
Below is an example of what the process might look like for a project:
- Alice has a great idea for a startup, a P2P photo-sharing app, and she would like it to eventually owned by the stakeholders and users of the platform
- She would like the platform to have a lasting impact, and decides to have no token supply cap.
- She targets year 5 as the year all initial stakeholder tokens will vest. At that point, 40% of the network will be controlled by initial stakeholders, 30% will be controlled by users of the platform, and 30% of the network will be owned by an ecosystem DAO.
- She wants users who share photos or buy photos to receive tokens for doing so
- The initial stakeholders will include her founding team and investors. She decides there will be an initial allocation of 1M tokens to these initial stakeholders, and 20% of these tokens will be for investors.
- Alice wants the project to raise a bit of funds, then decentralize as soon as possible. She hopes that once the project is decentralized, the network will raise additional funds, and hopefully the network will continue to pay her team to develop the project.
Alice forms a company, and raises $1M from investors as a SAFG (which is a promise for 200,000 governance tokens once live). Once these funds are raised, the team executes and is able to build their platform.
1 year later, they are ready to start decentralizing the platform and giving away governance to its users.
- The team implements the incentives via smart contracts (users who share photos or buy photos receive governance tokens)
- The team also creates a vesting program for the initial investors such that their tokens vest over a 5 year period. At the end of the five years, the initial investors and team members will have 40% of all tokens, with the other 60% going to the protocol DAO and users of the platform. This means that at year 5:
- 160,000 tokens will be owned by investors (20% of 40%)
- 640,000 tokens will be owned by the initial team members (80% of 40%)
- 600,000 tokens will be owned by the DAO (30%)
- 600,000 tokens will be owned by users of the platform (30%)
- This is approximately 1100 tokens per day minted: with 666 tokens going to users and the DAO.
- After this initial vesting period, tokens for users and the DAO keep being minted at the same rate of 666 tokens per day, and can be changed by the DAO at any point.
After 6 months of activity mining, the project reaches sufficient decentralization, and the protocol is given to the DAO. 6 months later, Alice and company start asking the DAO for funds to continue building the product. Soon after, a handful of other companies start working for the DAO and contributing to the project.
Congratulations Alice, you created a decentralized network.