DAO or DAO Not, There Is No Try
About halfway through Star Wars Episode V: The Empire Strikes Back, Yoda teaches a shipwrecked Luke Skywalker to harness the light side of the force. After a few days in the marshes of Dagobah, Luke’s crashed ship sinks deeper into the swamp - frustrating and distracting the budding Jedi from his training. After a few failed attempts to resuscitate his sunken vessel using space magic, Yoda drops the classic line: “Do…or do not. There is no try.” Despite this motivational pseudo-aphorism, Luke fails once more, believing he’s too small to lift the enormous X-wing fighter. In a show of oneness with the force, Yoda effortlessly lifts the vehicle from its mire to prove that “size matters not.”
What do DAOs have to do with Yoda? Well, after participating in the rise and fall of a few DAOs (some large and some small), I think the “Story of the DAO” is only half told. I argue that DAOs can be great vehicles for some purposes, yet current iterations have succumb to the allure of bigness.
WTF is a DAO?
The literal definition of a DAO is a “Decentralized Autonomous Organization,” or a group of individuals that set out to accomplish some mission without a central leading authority. It might be easier to conceptualize it as a club, where some contribution or investment is generally required, and the club aims to do “X” with the collective skillsets and funding. While that sounds amorphous and ambiguous, that’s because it is: DAOs are formed for a wide variety of reasons, from investing with friends to buying a copy of the Constitution of the United States to “driving culture forward into the metaverse” (whatever that means).
By and large, the “antiquated” forms of organization - namely companies, religions, and governments - are pretty effective. The concept of “decentralizing” any of them can appear futile and confusing (though that seems to be the aim of many blockchain products nowadays). Most organizations use a hierarchical structure to streamline task management - an approach that generally works. The top of the chain manages and organizes complex issues, disperses them down the chain, and the bottom of the chain carries out the simpler tasks.
How are DAOs different? Theoretically, due to the first two words of the acronym:
Decentralized: The distribution of power and resources is heterarchical, so no single entity (CEO) or governing body (board of directors) has control over others in the organization.
Autonomous: The maintenance and processes of the organization are established through a vote of its members, as defined by code. In other words, a successful vote of any proposal shall be implemented.
Another way to think of it: If a company were to be run as a perfect democracy. A DAO might still have a frontman who interfaces with other organizations (or a “decentralized-CEO”), a group of coders contributing to the project (“decentralized-workers”), and even moderators managing spam or abusive members (“decentralized-HR”). However, none of them have direct authority over any other DAO member. (I won’t bother commenting on the physical decentralization aspect, given the rise of work-from-home.)
Not all of us can DAO great things.
Most DAOs today tend to land somewhere between these two categories:
Protocol management, where the DAO votes on upgrades or management proposals for the project. For example, Uniswap proposals are generated by users with respect to some of the application’s functionalities or funding.
Social groups, where access to the DAO is gated and the DAOs resources are focused on community building (instead of developing a product). For example, the Friends With Benefits community is a DAO that requires ownership of their token to stay connected with the group.
I use those generalized classifications because the majority of the DAOs I’ve seen fall somewhere in between. Seed Club builds communities and AAVE uses governance to change to the software. Projects like Olympus DAO are somewhere in between, where token holders have a strong sense of community and also push upgrades to the project.
Do these DAOs work? Yes and no. It takes a dedicated community member (or a deeply invested firm) to want to suggest proposals, especially in today’s limited-attention economy. It’s more common for users to invest in a DAO for profit potential, forget about using the token, and never participate in the DAO’s operation.
A lot of the DAOs I recognize as “functioning” are really just thinly veiled bottom-up management approaches. The developers get feedback from their community, see what ideas gain the most traction, then reward those users with tokens, a better application, and/or higher token valuations. This type of DAO makes sense in some contexts, but it requires an engaged community that want to improve your product for everyone’s benefit. While that sounds simple enough, it can be incredibly difficult to cultivate that kind of community when there’s a new “thing” served to us daily.
Conversely, I view a lot of the “non-functioning” DAOs as exit liquidity for hungry founders or prey for corporate raiders. In what now appears to be ancient history for the crypto world, I recall the drama surrounding Steemit - basically the crypto version of Reddit. That fiasco exhibits both qualifications for a non-functioning DAO: The founders unfairly pre-mined a bunch of coins before the “official” launch to dump on speculators, and a young crypto-mogul later tried to buy the whole system to milk it for profit. I would encourage you to read Decrypt’s excellent writeup of the spectacle.
To DAO, or not to DAO, that is the question.
The benefits to DAO token creators are obvious: Immediate exit liquidity for you and your venture backers, attract new users and speculative buyers, and bypass most securities registration laws around the world. All under the guise of a “decentralized” governance structure. As long as you promise not to tell the SEC: I think most DAO tokens are unregistered securities, and these new governance models aren’t really new - they just skip some of the bureaucracy involved with traditional companies. I digress.
Most DAOs I’ve seen all vie for the same thing: Ignorant capital. People to invest in your company who expect nothing in return but the hope of profit. I believe that’s one reason why so many crypto companies turn to DAO structures. If you market something, reward early adopters with capital gains, and attract new investors, then you’ve created a self-fulfilling prophecy - which is great for selling your “founder” tokens at higher and higher valuations.
This leads me to the crux in my argument: Too many DAO “owners” can be a negative, and might cause users to act contrary to a core concept of DAOs. My sentiment can be reduced to a couple of proverbs: “Too many cooks spoil the broth” and “You can lead a horse to water but you can’t make it drink.”
With too many owners, protocol developers will oftentimes receive conflicting feedback. That alone is easy enough to navigate (simply ignore the minority), but, as was the case with Steemit and Hive, disgruntled users can simply release their own identical projects. For example: Protocol A has a proposal that is highly contentious with 50% of users voting Yes and 48% of users voting No. If the vote proceeds, that 48% minority can literally copy and paste the code, remove what they don’t like, and effectively cut Protocol A’s user base in half - assuming they’re strongly united.
My other issue with too many owners is low participation. It’s safe to say that many DAOs suffer from very poor user engagement with the decentralized voting process, but the bigger the DAO the bigger the problem appears to be.
In the chart below, we can see limited engagement is apparent among retail shareholders of traditional equities:
However, the participation rates for major DAOs are abysmal by comparison:
I picked the the six largest DAOs on snapshot.org, as well as two smaller DAOs for comparison. It’s immediately apparent that voter engagement is much lower with larger membership bases; ENS and AAVE have tens of thousands of registered members, yet average 0.76% and 6.06% voter participation per proposal, respectively. By contrast, Yearn has around 3,200 members and SquidDAO had 55 members, yet saw much higher voter turnout with 27.63% and 67.64% respectively. I will admit, however, that my quick and dirty analysis focuses on DAO members voting, not tokens voting - i.e. individual accounts participating, not percent ownership of tokens (which was slightly higher, but still <10% participation for all top six DAOs).
Why is there such a disparity? Well, I’d venture to say that most big-DAO token holders care more about their coin’s valuation than the protocol it’s intended to support.
Size DAO-sn’t matter.
Despite the dubious regulatory status, I think the concept of a DAO makes sense in certain, more intimate contexts. For example, a closely held corporation might benefit from a DAO structure to gauge management decisions. Where a board of directors might issue directions to the company’s managers, a DAO structure might give non-board members a platform to voice their opinions. Further, if a small company forms a DAO and issues tokens instead of shares, the DAO tokens might offer greater liquidity options for the owners (subject to certain rules, of course).
A key reason why the DAO structure might actually work better in this case is the transparent accountability for both owners and managers. Memorializing the decision-making process onto an immutable ledger should reduce conflicts originating from poor communication. When it comes to closely held companies, I have first-hand experience of the results of poor decisions devolving into “he said, she said” arguments. I recall many occasions where bad ideas suddenly became my bad ideas when they fell apart - even if the rest of the company agreed to pursue them too. (Not that I’ve ever had a bad idea, mind you!)
In contrast, with a DAO structure, any major decision can be reviewed on two bases: Validity of concept vs. execution. If an owner suggests a plan that is approved by the majority and ends up being a disaster - well, the result of the vote and those who supported it are made obvious. The failure of the proposal falls squarely on either the idea or its realization. Supporters be damned, there’s no rolling back your vote - next time you can think of a different plan.
Another DAO application that makes sense to me is small investment clubs. I enjoy discussing finance with friends, but it’s inconvenient to pool our money together to test out our theories. Using a DAO, we can set up a transparent, liquid operation where everyone has a vote on a potential investment. Putting it all on the blockchain helps avoid miscreancy and keeps a record of your performance (so you know exactly who to blame if a trade goes wrong).
DAO-n’t give up on me!
Like the miniature yet potent Yoda, I believe a DAO can be strong when it is small. With too many owners and opinions, a big DAO’s maneuverability is hampered, which can make it inferior to a traditional company setup. For a smaller group, a DAO can be a great tool to increase transparency between owners and managers, as well as offering liquidity options with less tortuous legalities to navigate.
In a time where “dollar amount” is often conflated with quality, it’s imperative that you truly understand the objective of a DAO before investing in it. A bunch of strangers pooling millions of dollars together to buy a rare piece of art doesn’t make it a good deal. A few people starting up a small NFT fund might work better for you, especially if you want to be a part of the process. If you, dear reader, ever decide to join a DAO - large or small - I would urge you to really engage with its community. DAO or DAO not, there is no try.