Musings on Governance
Introduction
The state of DAOs is still nascent. Being an active participant in several projects for some time now, we’ve observed all sorts of things happening in DAO communities. This post is an attempt to share a short list of musings that were inspired by our experiences.
Treasuries are not funds, endowments, or other pools of capital
Over the last few months, we’ve seen one development that’s concerning to us: certain market participants see DAOs as honeypots from which they can generate fees, and no product generates fees for as little effort as the fund business model of “two and twenty.” More specifically, we have seen market participants propose DAOs sell their native token for a large pool of capital that can be used to generate “low risk” returns for the DAO. In other words, they want to run a hedge fund with the treasuries’ money.
Without commenting on any specific proposals, we see several issues here.
While a DAO may be able to generate 10-30% returns by investing its assets in financial assets, a well-managed DAO can generate far higher returns by investing in things that allow it to control its own destiny — investing in people (contributors), marketing, growth initiatives, and acquisitions. In our view, the returns from making the DAOs product better and more widely used will be far lower risk and higher upside than the returns generated by financial assets. (Even if returns from financial assets can be good, after hefty fees from service providers, those returns become merely decent).
The other issue with service providers using DAO assets to manage a hedge fund is it shifts the focus of the DAO and its community from building a product and community to generating returns. This loss of focus can result in a very significant “scope creep” that benefits service providers at the expense of tokenholders.
Our advice: focus on using your treasury to re-invest into the DAO. Re-investing into the DAO includes hiring rockstar contributors, investing in marketing and growth, and launching new products.
Contributors can have outside agendas
Given the open nature of DAOs, it’s very common to see contributors working for several DAOs at once. This stands in stark contrast to how traditional employment works, with an employee typically working full-time for one company at a time.
While there is nothing inherently wrong with working for several DAOs at once, it does bring up potential conflicts of interest.
For example, we’ve seen part-time contributors encourage unfavorable integrations, partnerships, and/or investments in other DAOs due to their personal stakes in them. While conflicts of interest are an unavoidable fact of life, without disclosure, they can lead to DAOs making decisions that benefit the individual making the proposal at the expense of the DAO and its tokenholders.
Our advice: require contributors and other governance participants to disclose their conflicts of interest for meaningful conflicts (e.g., investments that are >1% of their net worth).
Committees dilute accountability
There are good and bad parts to committees (e.g., grants committee, treasury management committee). Starting with the good: a multisig staffed with committee members acts as an internal control mechanism that prevents the bad apples from running away with the funds.
Now with the bad: committees tend to dilute accountability. That is, if a bad decision is made, there’s no one person to blame. As a result, accountability is diluted among a group of people who don’t get to suffer the consequences of a bad decision. Often, this results in “design by committee,” where the most popular decisions win instead of the most correct decisions.
Our advice: staff committees with people who have significant skin-in-the-game. Require committee members to be accountable to the DAO by evaluating their performance against their previously proposed plans. Make sure each committee has a “leader” that falls on the sword if things go wrong.
Openness and quality can be in opposition
Today, many DAOs are desperate for contributors. To find as many contributors as possible, many DAOs present themselves as “open” to encourage people to join them and start doing valuable work. While the intent is noble, the result of openness can be problematic.
The biggest trouble with DAOs being extremely open is they attract excellent talent, good talent, and bad talent too. Excellent and good talent is what you want. Bad talent is not. By being open, many DAOs open the floodgates to low-quality contributors, which are a net-negative to the DAO. The problem feeds on itself too; once you attract low-quality contributors, it’s very difficult to get rid of them without feeling cruel as you do so.
This isn’t meant as a knock on openness. DAOs should be open, but they should also keep the quality bar incredibly high. Practically, what that looks like is everyone should be welcome to join the DAO, but to contribute, the quality bar should be set very high. This shows people who join that the DAO cares about quality, and that if they want to contribute, their contributions need to be in-line with the minimum quality bar. Once a few A+ quality contributors are working for the DAO, their contributions start to get noticed by other A+ contributors, encouraging them to join the DAO as well.
This works similarly to traditional hiring wisdom: A’s hire A’s, B’s hire C’s, and C’s hire D’s and F’s. It’s a lot easier to hire A’s from the start than to get rid of the B’s and C’s after the fact.
Our advice: set the minimum quality bar incredibly high. Reward A+ contributors with high financial-upside and let go of poorly performing contributors.
Bikeshedding is the enemy of organizations
If you look at activity in most governance forums, you’ll notice one consistent issue: communities debate compensation / payment for proposals more than they do the quality of ideas. This is a classic sign of bikeshedding, where relatively unimportant issues get discussed more than the important (but far more difficult to discuss) issues.
Let’s take a simple proposal for a grants program, for example. If a grants program has a $2M budget, ~10% is typically set aside for paying the grants team (leaving $1.8M available for grants). When these proposals are put forward, the community almost always focuses on discussing compensation for the grants team (which is ~$200k in this case) instead of debating whether the grants program is a good idea in the first place. That’s because it’s far easier to discuss how much someone should get paid than to evaluate the merit of the idea.
In reality, the compensation discussion matters far less than the discussion to evaluate the idea. Going back to the earlier grants program example, the most the DAO can spend on compensation is $200k. But if the grants program is a bad idea in the first place, then the DAO loses not only $200k on compensation, but also $1.8M on pursuing a bad idea.
Our advice: evaluate each idea based on its upside/downside. If the downside of a grants program is $2M and the upside is $10M of value generated, then debating whether to pay the team $100k or $300k isn’t worth anyone’s time.
On community and investor ownership
A recurring debate we see again and again is “the investors own too much” and “the community owns too little.”
From our point of view, thinking about which group of tokenholder owns how much of the project is the wrong way of looking at things. Instead, we prefer to think in terms of how motivated people are to track their investments.
For example, if a fund owns 10M tokens that amount to 10% of the fund, they will be motivated to track their investment. On the flipside, an individual community member with 150 tokens that amount to 2% of his net worth will be less motivated to actively track his investment. Despite these differences in motivation, the common narrative is to bow-down to the community opinion. In our view, this is precisely the wrong thing to do.
We would much rather participate in a DAO with ten motivated 10% owners than a DAO with 10,000 lackadaisical 0.01% owners. The outcome in the former case is likely to be far more positive than the outcome in the latter.
Our advice: give more signal to ideas proposed by tokenholders who hold a significant chunk of their fund / net worth in your token.
Governance is politics
Today, getting a proposal passed through the governance process requires some degree of lobbying and politics. Some people see this as a black eye for governance; they say that crypto governance is beginning to look like national politics, which can get dirty and crooked.
In our experience, the reality of the situation is far more banal: you need to lobby large tokenholders to vote for your proposal because they are busy and don’t keep track of every single proposal that’s posted on the forums. In short, proposal lobbying looks more like outreach than cronyism.
Every once in a while (albeit rarely), proposers do need to engage in some level of politics. Otherwise, you risk second-rate proposals beating you to the punch. On this point, Plato may have summarized the situation best: “One of the penalties for refusing to participate in politics is that you end up being governed by your inferiors.”
The politics of crypto projects are practical and generally simple to understand: if you need X votes to meet the quorum and Y votes to pass, tokenholders and community members will naturally consolidate into groups to vote as a collective block. Failing to consolidate into voting blocks (i.e., staying fragmented) would result in each group failing to meet the governance thresholds, and thus, failing to achieve any success in the governance process.
Our advice: operate with the assumption that tokenholders will speak in private, lobby based on self-serving needs, and in general, make proposals that benefit them more than the DAO. These are not bad things; they do get bad, however, when governance processes are designed in a way that don’t confront the reality of what actually happens behind-the-scenes.
Coda
The last year and a half has been good for DAOs — the hype was loud, and many issues faced by DAOs have been swept under the rug. When token prices inevitably face the force of gravity, the rug will come off and all the previously swept-under issues will surface. We hope this post helps teams deal with some of these issues head-on.
Shout-out to Hasu, Jeff Amico, and Jacob Phillips for reviewing earlier versions of this post.
