ProtocolDAOs to drive innovation is like abstinence-only sex ed: an unrealistic, ineffective morality campaign for self-loathing and shaming”.
If you didn’t get the reference, the title and the first paragraph of this text are quotes from the famous TDD is dead by David Hansson (creator of Ruby on Rails).
DAOs are dead
First of all, this text is not intended to evaluate the importance or validity of DAOs in the new economy and Web3, but rather to question the ability of ProtocolDAOs to deliver constant innovation and growth. There are various types of DAOs: investment, collectives, collections, etc. This text only deals with ProtocolDAOs, such as Uniswap, Compound, MakerDAO, and Gitcoin, among many others.
That being said, we need to define what a ProtocolDAO is. The word “Protocol” refers to a set of rules and procedures established to govern the operation of a blockchain network or dApp. These rules and procedures are recorded in code that automates the service of the protocol, generating – or attempting to generate – some Network Effect.
To simplify the definition of Network Effect, let’s take the example of Uniswap. On one side, we have people wanting to exchange one token for another, and on the other side, we have liquidity providers who have the two tokens necessary for the exchange to occur. The more people come to Uniswap wanting to exchange tokens, the better it is for liquidity providers, as they will earn more fees for the exchanges; and the more liquidity providers make tokens available for trade, the better it is for those who want to exchange them, as they will have a greater variety of tokens and lower price volatility. This correlation generates a positive effect in which the service improves as more people use it. The famous and pursued Network Effect.
The word “DAO,” in turn, refers to how the protocol is managed. In this case, through a Decentralized Autonomous Organization. These organizations are groups of people who exercise some decision-making power in the protocol’s operation through governance tokens. In other words, organizations issue tokens, and only those with these tokens participate in decisions that change the protocol.
In the case of Uniswap, the token created was UNI, and those who hold UNI can access the governance portal to create proposals to improve Uniswap and vote on current proposals. Proposals can make new features, change parameters (such as the fee charged), and where to spend Uniswap’s treasury funds (hiring developers, producing events, improving infrastructure, etc.). A governance token can have other utilities besides governance – with that, an even greater market value – such as accessing premium services or providing liquidity to receive fees (veTokens).
Perhaps not everyone defines ProtocolDAOs as we did here, but now that we are on the same page, let’s move on!
How I met DAOs
The first time I heard about DAOs, in 2017, I was completely blown away. I had never thought of a model that could allow decision-making power to be placed in the hands of the people who use the services. For me, there was no doubt that this was “the future of organizations”. I was convinced of this idea for a long time. Until one day, in a casual conversation, I was questioned:
“But have you ever worked in any DAO? Have you seen the mess that is in there?“
That question shook me, primarily because I had no idea what it was like to work in a DAO at that time. And if you’re in the same position now, I’ll give you a brief preview:
Imagine that you are a business developer within ImaginaryDAO. You work 40 hours per week and are about to close a partnership that you believe could bring a large user base to your protocol. To complete this partnership, following the standard process of a decentralized organization, you need to:
- Write a proposal explaining to token holders why the partnership is good for the Protocol;
- Wait for token holders to read and discuss their opinions about the proposal;
- Open a vote for token holders to choose whether they approve or disapprove of the partnership;
- Wait for the time stipulated by the DAO so that as many people as possible can vote;
- Finally, only with your proposal approved, you can then close the partnership.
- If the proposal is not approved, you can either give up on the partnership or create a new proposal and go through the approval process again.
Hard huh? On average, this process takes 2 to 3 weeks when the proposal is approved on the first attempt!
After seeing all of this up close, I decided to deeply understand how DAOs work while leading my own ProtocolDAO after raising $3.5m with crypto VCs. It took a few hundred hours to study protocols such as Uniswap, Balancer, Synthetix, Yearn, and YGG. In this process, I had invaluable help from colleagues who had previously worked at MakerDAO, Solana, and Gitcoin.
Here are my conclusions…
1. ProtocolDAOs are bureaucratic
I gave you the example of how difficult it is to close partnerships in a DAO, but this applies to several other activities, such as: launching a marketing campaign, creating new product features, defining the company’s purpose, hiring lawyers, hiring auditors, hiring team members, deciding salaries for those members, firings, and so on.
I’m not counting the – strong – possibility of a proposal not being approved. Token holders may decide not to comply or simply not engage in reading or voting on the proposal. In these cases, the proposal must be rewritten, and the entire approval process starts over, making the work take even longer to be executed.
All this bureaucracy results from the immense difficulty of coordinating so many different opinions. The primary tool used is forums, where token holders usually discuss their ideas. This is the most vibrant and chaotic environment of a DAO. We are talking about an open environment where people of all technical levels and with various interests try to reach an agreement.
The most frustrating thing is to think that all this bureaucracy ends up having little relevance since most DAOs are in the hands of whales (people who hold large amounts of tokens of the protocol), which means that decisions cater much more to the interests of investors than to the interests of those who use the protocol. But that is a subject for another text.
2. ProtocolDAOs make top-down decisions
After the voting decision, DAO workers, who often abstain from voting, simply have to carry out what was decided. It’s a completely top-down process. What is decided is law. And we all know that when the workforce is voiceless, it tends to become apathetic.
An apathetic workforce is not creative. And without creativity, there is no innovation.
3. ProtocolDAOs are political
As DAOs grew, new governance challenges emerged; consequently, new organizational processes had to be implemented.
That’s what happened with MakerDAO. As it grew so much, there came the point where token holders could no longer keep up with the proposals made by contributors, and they decided to create a new position: delegates. The idea was soon adopted by several other ProtocolDAOs.
Token holders delegate their tokens to delegates, who use those tokens to vote on proposals. A delegate has the voting power of all the tokens delegated to them and, in some cases, may even receive a salary for voting for the token holders.
In other words, a person is paid to make decisions on behalf of a group of people who have entrusted their votes to them. Do you see any similarities with the job of a congressman? If so, then you understood it correctly.
With due proportion, delegates are like members of Congress. And we all know that congress members need to play political games with supporters and opponents to try to stay in office every 4 years. However, the position of a delegate in a ProtocolDAO does not last 4 years. In fact, delegates can lose their position anytime if token holders decide not to support them anymore. This instability makes the political game even more intense inside.
This text shows a super controversial vote by MakerDAO and the change in support of the delegates as they debated the issue.
In short: ProtocolDAOs are bureaucratic, with top-down decisions and political
I don’t know about you, but I particularly don’t feel comfortable working in a bureaucratic, political, and top-down decision-making organization. And those are definitely not the characteristics I’m looking for in my project, Ribon.
Disclaimer: I am a big fan of absolutely all the protocols mentioned above, and I am a token holder of practically all of them. For this reason, I feel more comfortable pointing out structural problems in their organizations, and I do so with the sole intention of seeking solutions to these problems, avoiding them from being experienced by other organizations, such as Ribon.
Despite all the problems mentioned above, DAOs brought up a critical innovation: the governance token.
The governance token model is fascinating because if created correctly, its functionalities mean that it probably does not fit as a security, and therefore does not need to be regulated by the SEC (Securities and Exchange Commission).
This text from Variant explains how governance tokens resemble more to a cooperative share, a type of share that was deemed non-security by the US government. This decision was made because, when subjected to the Howey test, specifically in the question “when buying the share, are you expecting a profit for the work of others?”, the answer for cooperative shares was no, because the “others” in this case was everyone (including the owner of the share).
However, this lower regulatory burden brings significant dangers that must be highlighted. Many projects in Web3 are being forced into the model of a ProtocolDAO just to enable the launch of a governance token. It scares me to see founders realizing that their organizations are chaotic internally and still opting for this model just to avoid regulation. The consequence is that the project ends up dying from within and suffering a rapid devaluation of its tokens.
The good news is that some of the best crypto thinkers we have today are trying to propose improvements in the governance process to reduce bureaucracy, politics, and top-down decision-making within DAOs. I can mention, for example, this super interesting proposal that Hasu made for Maker, or the many other ideas that I had the pleasure of hearing in person at the Devcon Bogota 2022 talks.
The issue is that, by definition, DAOs require consensus, and consensus is incompatible with innovation, as consensus requires bureaucracy, and innovation requires agility to test and fail as quickly as possible. Considering this, I come to a conclusion that:
Perhaps, these are inherent problems of decentralized organizations.
The text Disagreeing and Committing by Mark Schwartz explains very well how an innovation environment requires people to have the freedom to make decisions even when they disagree.
Then you may ask me: “but is innovation really necessary for a ProtocolDAO?”
Well, protocols are technologies, and in current times, technologies need to be in constant and rapid renewal to remain useful to society. This means that any organization that manages a technology necessarily needs a high level of innovation. And if we are talking about a bureaucratic and consensus-based management model, it is easy to conclude that this model does not promote innovation.
That’s why the provocative title “DAOs are dead”.
Despite all the problems we have reflected on here, we cannot deny that DAO is a revolutionary model that brings solutions to several problems we see in centralized for-profit company models.
Currently, ProtocolDAOs are not corrupted to bring maximum profit to shareholders, as is the case with Facebook, Celsius, 3 Arrows Capital, and so many other companies in the traditional market.
I believe that if we learn from past mistakes, DAOs can indeed be a good governance solution. In fact, we can say that DAOs already represent a considerable evolution compared to other organizations such as democratic governments, churches, and armies. This is especially true because decision-making power has become much more accessible with DAOs.
But the question that remains is: what would be the ideal model for managing protocols that require innovation?
The answer to this question lies in the only characteristic of DAOs we did not discuss in this text yet: autonomous.
There is a model called Teal Organizations that proposes an evolution from the decentralized model to the fully autonomous management model. Adopting pods (autonomous teams), which has become an increasingly popular practice in ProtocolDAOs, is an example of an approach from Teal Organizations. Whether intentional or not, it is already possible to see the crypto community adopting characteristics of this model.
In part 2 of this text we will dive into several other characteristics of this model and understand the connection between ProtocolDAOs and Teal Organizations.
See you there!
Note 1: I especially want to thank Danilo Borges, my greatest coworker these last few months. I would also like to thank other people who, without them, the ideas in this text would not have existed: Moriah Rickli, Duda Barbirato, Gary Latta, Yuan Han Li, Alp Ergin, and Bailey Tan.
Note 2: The information contained in this article are not intended to be and do not constitute financial advice, investment advice or legal advice.