Governance aspects of DAOs
Liquid Democracy
It is a decision-making scheme, or government system, characterised by liquidity—that is the systemic and flexible mix of direct and representative democracy—and essentially based on the principles of voluntary delegation and proxy voting. So, votes can be delegated or proxied to other individuals such as friends, politicians, or subject matter experts. For example, in a liquid democracy, voter A could give voter B his vote and voter B would then vote for both himself and voter A. Liquid democracy is used at times as a governance mechanism for Decentralised Autonomous Organisations (DAOs) wherein every participant is able to vote or delegate their vote to another individual.
Delegated Proof of Stake (DPoS)
An alternative to the Proof-of-Stake consensus algorithms. In a Delegated Proof-of-Stake (DPoS) system, participants still can stake coins. However, rather than becoming responsible for validation themselves, stakeholders outsource that work to a delegate — groups of which are then responsible for reaching consensus between themselves.
DAO voting process: Lido Finance example
To exemplify a rather usual voting procedure in the DAO sphere, we can take a look at Lido Finance (LDO), which is a liquid staking solution for proof-of-stake cryptocurrencies. Its DAO regular voting process consists of three different stages:
A) Internal research forum
All ideas and proposals are initially published on Lido’s Research forum. The point of this is to receive community feedback. All the proposals go through a phase of improvements and objections. If the proposal is welcomed & feedback is incorporated, it could move on to the next step.
B) Snapshot
The next step is gas-less Snapshot voting. On Snapshot voting power is linearly proportional to the token balance of the voter on specified block (”snapshot”). The more LDO there is on a user’s balance, the greater the decision-making power the voter gets.
The preferred timeline for snapshot votings are 7 days long. Snapshot voting sets a minimum quorum equal to more than 5% of the total token supply that must vote for one of the options.
C) Aragon
Aragon is a DAO framework and toolkit with on-chain voting as one of the crucial features.
To reduce operational burden and voter fatigue several proposals are usually combined into a package. Such packages are called “Omnibus votes”.
Aragon voting lasts 72 hours and has 2 phases: The main phase, lasting 48h, is conventional voting, where one can vote both for and against. The objection phase, lasting 24h, when one can vote against or change their vote from for to against. Aragon voting sets two quorums for the vote to pass: Minimum approval of more than 5% of the *total token supply* must vote “Yes”, and more than 50% of the *tokens used to vote* must vote “Yes”.
Slashing condition
The slashing condition is a condition that, if triggered by a validator, causes the validator’s deposit to be destroyed. A process typically employed automatically by blockchain protocols that make use of a Proof-of-Stake (PoS) or related consensus mechanism. If an investor deposits or stakes his crypto assets inside a main network validator node and the node behaves in a dishonest or malicious manner, the token depositor can be penalised, resulting in a loss of a portion of the initial investment.
Governance (overview)
In the world of cryptocurrencies, governance is defined as the people or organizations that have decision-making powers regarding the project. Governance is an important aspect of all cryptocurrency projects. As decentralized blockchains, cryptocurrencies often have a very liberal governance structure. There are a number of different approaches to governance.
What it is usually meant when referring to governance in a DAO-like scenario is best described as “community governance”, as opposed to governance in traditional hierarchical societal structures where (especially at the vertex of nation states and corporations) the community has not a lot of voice in critical matters. The foundational pillars of governance in DAOs could be described by referring to three concepts: distributed control, permissionless participation, and equity ownership. Governance promotes order in decision making. For every group of individuals connected by a common interest or goal, governance structures must be put in place to check the behavior of each participant, generate profit for the organization, and regulate and manage the activities of the organization. Being a community-led entity, DAOs implore community governance strategies. Every participant of the DAO could in theory partake in decision-making. Each proposal or decision directly affects each participant (socially, economically, or financially), hence, they will be inclined to make pro-community choices. Final decisions are made through voting processes. Voting is done with tokens to influence rules, make new decisions, adopt new profit-based strategies or refine existing ones. Each participant of a DAO must hold a certain amount of the native token of the DAO. The higher the number of tokens a participant holds, the higher the voting power. The distribution and utility of the native token of a DAO is mentioned and regulated by its tokenomics. It may be seen how in not truly decentralised projects, such in the case of PancakeSwap, there are possibilities for a fair amount of community engagement (through its “Community voting portal”), still higher than with traditional corporations, but the results of any sort of consultation coordinated by the larger public of a platform do not have a guarantee of being listened to nor implemented by the DAO.
Governance Token
Governance tokens are tokens that developers create to allow token holders to help shape the future of a protocol. Governance token holders can influence decisions concerning the project such as proposing or deciding on new feature proposals and even changing the governance system itself. Governance tokens can often times be staked in order to earn a yield in exchange for help securing a Proof-of-Stake network. These tokens are the typical instrument employed for DAO governance.
At first glance, shares, which are the traditional type of instrument that grants access to the economic benefits and governance in a corporation, and tokens, may be seen as identical tools. This is especially true in networks that run on Proof of Stake mechanisms (vs. Proof of Work, like Bitcoin). In fact, tokens and shares serve various purposes such as capital raising, talent attraction, ownership representation, and measuring project or business value. They can be managed to adjust supply and tokens offer additional functionalities like locking for voting power or yield access. While shares are governed by a board of directors who decide on new issuances or buybacks, in the crypto space, token holders fulfil this role. They can vote to issue more tokens or burn them, with the key distinction being that token issuance is often programmed into smart contracts (see dYdX) or encoded into mechanisms such as Ethereum EIP-1559, which involves burning tokens with each transaction. From an investment perspective, if the only tokens present within a network serve the function of governance, then the public may evaluate them in a similar way than a business, therefore seeing the governance token as a share (having voting rights). The business in this case is the underlying set of mechanisms, such as revenue and profit creation, put in place by the network that make it more or less valuable.
One clear difference between shares and governance tokens is the regulatory side. Indeed up until now just few national jurisdictions have enacted comprehensive regulations that recognise and assign certain rights to token holders, etc. Shareholders on the contrary, especially in public markets, have a longstanding list of substantive and procedural legal rules protecting them. But, although these rules for token holders still are not widespread, signs of change are appearing and it won’t be long when assimilations or novel regulations will encapsulate norms for the protection and enforcement of rights. Apart from the prospected changes, the basic set of rules are (or can be) encoded in smart contracts, initially at the sole discretion of the founders of a new network. On the flip side, as already stated, tokens do allow for a wider flexibility in terms of what can be voted on and the effective power in decision-making activities.
An interesting closing remark about the comparison of a traditional financial instrument and a newer form of participation such as tokens is offered by activist investors. These professional investors, most often hedge funds, leverage the ownership of a set of publicly traded shares plus public announcements and private shareholders discussion to pressurise the management of a target company in acting in a particular way. These situations can be seen, from an observer point of view, like a boost towards a situation which is implicitly present in DAOs, where certain people propose a direction for the project to take and try to lobby its positive outcome by way of public and private discussions. So, maybe, in the future with greater economic and governance participation by more and more people or groups of people carrying specific interests, there will be an ever growing number of activity that someone can label as investor / shareholder activism.
Off-Chain Governance
A blockchain-based mechanism that generally takes place externally to the underlying blockchain network protocol, typically in a face-to face fashion by several interrelated parties. This procedure often refers to a means of establishing rules for the on-chain protocol and overall blockchain ecosystem, oftentimes through a voting process by different constituents working to determine the overall direction of the project. Off-chain governance also takes into consideration the underlying global blockchain community and several on-chain parameters to realise a stronger overall governance system. Blockchain governance evolves and changes over time with the goal of improving the system as time goes on. An example of off-chain governance is given by the Snapshot. There is no code that ties these constituents to precise actions, but rather, they determine what is in their best interests in light of the other stakeholders' known preferences.
Off-Chain
A classification that refers to any type of transaction or mechanism (including governance, tokenised asset creation, consensus design etc.) that occurs outside of a blockchain network protocol. An off-chain mechanism is typically executed outside of the actual blockchain network through other mechanisms that compliment on-chain methodologies. For example, voting by a governance council or a steering committee to determine the governance structure of a blockchain ecosystem, and its underlying protocol may be conducted off-chain.
On-Chain
A classification that refers to any type of transaction or mechanism (including governance, tokenised asset creation, consensus design etc.) that occurs within a blockchain network protocol. An on-chain mechanism is typically executed automatically through the use of cryptographic and algorithmic computerised code underlying a blockchain platform, specifically smart contracts.
Quorum
Broadly defined as the minimum number of members required to conduct business within a specific group. Traditionally, a quorum is the minimum number of members of an assembly or group that must be present at any of its meetings to make the proceedings of that meeting, or vote, valid. As it pertains to blockchain technology, quorum biasing denotes that if many voters participate, the vote is more legitimate than if, in turn, very few participate. This mechanism can be used to determine the fairness of specific proposed blockchain-based governance parameters, such as the minimum amount of participating tokens (based on the total token supply) required for a vote to be valid. Typically, if a vote fails to reach the quorum, then it is automatically canceled or does not produce effects.
Voting mechanics in DAOs
Unlike traditional representative democracies in which each citizen in its adulthood has the right to cast one single vote (one man = one vote), DAO governance features a dynamic much similar to corporations and shareholders’ voting. DAO members with more tokens will have the right to influence the outcome of a certain decision more easily, as voting power is based on the number of tokens in possession at the moment of voting. This is thus very different from what happens in democracy, and, as it stands, may strikingly depict a future in which DAOs are seen more as plutocracies (or oligarchies) rather than full democracies. It has to be noted though that in many jurisdictions some types of corporate voting procedures, either by national law or decided within the company bylaws and statutes, can be carried out by the assumption of “one man = one vote” thus foregoing the economic weight of certain shareholders. Community decisions surrounding DAOs may decide on a similar attitude towards voting power, therefore it is primarily an arbitrary decision of each community.
On-chain voting
With on-chain DAOs, voters don’t need to trust that administrators (also known as key contributors) will honor the results of a vote. Smart contracts automatically implement successful proposals. Smart contracts can be designed to execute proposals automatically based on the outcome of on-chain votes, removing the need for a trusted third party or core team to enact vote results. Examples of on-chain voting systems include MakerDAO, Aave, and protocols built on Compound's governance framework. The benefits of on-chain voting can be that: No trusted third party is required to count or enact votes; passed proposals execute automatically; works well for approving protocol changes or other high-stakes votes. This system has many advantages but also has one major disadvantage: Transaction fees associated with each vote. And depending on a network’s congestion (too much usage at the same time) this could lead to potentially high fees to cast each vote, thus becoming economically disincentivizing. To partially mitigate this issue one popular alternative to full on-chain voting is currently brought by Snapshot (off-chain voting).
Snapshot
Snapshot is a voting tool based on the IPFS (InterPlanetary File System) decentralised storage system, used by many crypto projects to poll their user bases. The project uses 'off-chain' signing techniques to make voting fee less. It doesn’t use ‘on-chain’ verification, thus all votes are essentially fee-less. It’s a popular tool for DAOs looking to query what their audiences think using blockchain technology, and the possible real outcome of a subsequent on-chain vote, as on Snapshot voting power is linearly proportional to the token balance of the voter on specified block (“snapshot”). The more tokens there are on a user’s balance, the greater the decision-making power the voter gets.
Quadratic voting
Quadratic voting is a collective decision-making procedure which allows people to allocate votes to express the degree of their preferences, rather than just the direction of their preferences. This all means the results of a vote reflect the intensity of people’s preferences in collective decisions. By doing so, quadratic voting seeks to address issues of the Condorcet paradox and majority rule. Quadratic voting works by allowing users to "pay" for additional votes on a given matter to express their support for given issues more strongly, resulting in voting outcomes that are aligned with the highest willingness to pay outcome, rather than just the outcome preferred by the majority regardless of the intensity of individual preferences.
Fork
A fork occurs when two blocks are generated pointing to the same block as their parent, and some portion of miners see one block first and some see the other. This may lead to two blockchains growing at the same time. Generally, it is mathematically near-certain that a fork will resolve itself within four blocks as miners on one chain will eventually get lucky and that chain will grow longer and all miners switch to it; however, forks may last longer if miners disagree on whether or not a particular block is valid. With permissionless blockchains network being open source, anyone can contribute to improvements and changes within the code, which often results in blockchain updates. There are also times when forks can be conducted to enable new features to a blockchain, to eliminate bugs, or to address the effects of major hacking - like we saw with "The DAO" in 2016, when Ethereum hard forked.
Hard Fork
Hard forks are backward-incompatible permanent divergence in a blockchain. Typically, these occur when nodes add new rules in a way that conflicts with the rules of old nodes. The breakaway fork thus becomes a new implementation of a new set of rules for the Blockchain.
Private Sale
Generally the first round of funding that is allocated to a blockchain startup prior to the pre-sale and public sale, or Initial Coin Offering (ICO). The purpose of a private sale is to give large institutional investors the opportunity to invest large amounts of capital to fund the development of projects early on. While this practice may be criticised because of its arguably centralised approach, it is often a viable way for startups to acquire the capital they need to realise their ongoing development goals.
Pre-sale
Exclusive "early bird" opportunity for people to purchase coins before the ICO is made public. The pre-sale period is an effective way for companies or projects to accumulate funds and use them to launch an effective marketing campaign before the project or app is fully launched. For investors, it is a good way to get a higher discount or bonus than a public sale while avoiding the drawbacks or risks that may occur during a private sale.
Public Sale
Term used when a project makes their tokens available to the general public. This phenomenon is part of an ICO, which sums private sale, pre-sale, and public sale. The public sale is usually the last step of this fundraising mechanism, and does not put any restrictions on who the buyer can be. Public sales are usually heavily marketed and promoted to capture people’s attention. Buyers may have less risk to purchase tokens at this stage in time due to the fact that the project has already raised capital before. On the opposite though, some can argue that in this phase, without attentive tokenomics in place, earlier investors, with insider information on the project, can sell off their previously acquired tokens to the wider public which are unaware of the health status of the project.
Initial Coin Offering (ICO)
Short for Initial Coin Offering, an ICO is a type of crowdfunding, or crowd-sale, using cryptocurrencies as a means of raising capital for early-stage companies. Particularly famous since the 2017 bull market.
Initial DEX Offering (IDO)
Initial DEX offerings, or IDOs, are tokens that represent any type of asset hosted on a decentralised exchange (DEX) — an IDO is when a project launches a token through a decentralised liquidity exchange.
Initial Farm Offering (IFO)
Initial Farm Offering (IFO) helps DeFi (decentralised finance) projects raise capital through the farming feature offered by decentralised exchanges.
Fan Token Offering (FTO)
A fan token is a cryptocurrency issued by a specific sports team and allows its holders to participate in the governing activities and attain exclusive rewards and discounts.
Staking
Staking is a way of earning token rewards while holding onto certain cryptocurrencies. It may clearly and simply explained by assimilating it to a bank interest account, where interest is accrued based on the market conditions and the duration in which money is deposited. On the Ethereum Proof-of-Stake network, those wishing to participate in consensus must first lock up, or ‘stake’, 32 ETH into a smart contract. This ETH may be ‘slashed’ (taken from them and ‘burned’, put out of circulation) in the event that their validator behaves maliciously or does not meet performance requirements. Similar Proof-of-Stake mechanisms are in operation on other networks, as well. Although this is the canonical meaning of the word, similar actions taken at the level of a decentralised exchange (DEX) or another decentralised applications (dApps) are often called ‘staking’, though it would probably be more accurate and descriptive to just call this ‘locking up tokens’. The process through which a blockchain network user 'stakes' or locks their cryptocurrency assets on a network forms part of the consensus mechanism, thus ensuring the security and functionality of the chain. Staked assets are usually held in a validator node or crypto wallet, and in order to encourage staking most projects reward the holders of staked tokens with annualised financial returns, which are typically paid out on a regular basis. Staking is a core feature of Proof-of-Stake blockchain networks, and each blockchain project which incorporates a staking feature has its own policies for staking requirements and withdrawal restrictions.
Airdrop
An "airdrop" refers to a method of distributing cryptocurrency to the public, via the fact that they own certain other tokens or wallets on a particular blockchain. This is usually done for marketing purposes to incentivise the holding of other tokens or induce them to become a participant in the blockchain network. Sometimes protocols issue free governance tokens when they are just starting out, in order to create new interest, awareness and add liquidity to the protocol. In late 2020, Uniswap “airdropped” their UNI governance token to the public. Anyone who had interacted with the protocol before the drop was entitled to 400 UNI tokens. UNI is trading at $4.5 as of time of writing — those original token holders are now sitting on about $1.800 in value, with a peak at almost $10.000 during the latest bull market.
Block reward
A block reward is the payment awarded to a blockchain network miner upon successfully validating a new block. Typically paid out in the native asset of its network at a fixed, but regressive rate, block rewards are often the only source of new currency creation on a network, for example Bitcoin. They provide a key element of the incentive structure that keeps blockchain networks operating in a decentralised and secure fashion. In Proof-of-Work blockchains like Bitcoin, block validation and block rewards are the remit of miners. In newer models like Ethereum’s Proof-of-Stake, the block reward is paid to the validator nodes which stake ETH
Mining Reward
Also referred to as a block reward, and specific to Proof-of-Work networks, are native assets of a network that miners receive for successfully mining blocks of transactions. A mining reward can vary over time. For example, a Bitcoin block reward decreases by 50% every 210,000 blocks (every 4 years approximately).
Bounty and Bug bounty
A bug bounty is a reward offered for exposing vulnerabilities and issues in computer code of a particular DAO, dApp, or blockchain network. A bounty is a reward or series of rewards advertised by a blockchain project to incentivise community participation to promote the project. Bounties are mainly marketing strategies that give community participants tokens in exchange for fulfilling specific predetermined tasks, like sharing the project on social media. Bounties can occur at any time of a project's development, but usually take place during start-up phase to facilitate go-to-market.
Lockup (vesting)
Locking or vesting periods prevent the personal transfer, withdrawal, or burning of a set amount of tokens for a designated period. Lockups are designed to limit the sell side pressure of an asset, so the asset doesn't experience a sudden selloff. These lockups can also release predetermined amounts of tokens according to a schedule rather than all at once. For cryptocurrencies to maintain some value when first released they need to ensure that there are tokens available in their ecosystem. Lock-up periods typically follow big events such as Initial Coin Offerings or purchases of a large number of tokens, the sale of which could easily collapse the currency’s value. Locking up tokens also prevents developers and early investors from immediately liquidating the cash invested into a token and leaving everyone else who purchased a token with nothing, commonly referred to as a "rug-pull". This is similar to vesting periods for stocks and shares in traditional finance post-IPO.
