Issue #72: A Stupid Simple Governance Framework

This issue was inspired by Episode 2 of Reverie’s I Pledge Allegiance Podcast featuring guest Hasu. Once you’ve finished reading, give it a listen.

—

I’m a visual learner. Nothing gets me going quite like a good framework, so when I stumble on one I have to share it.

In the episode, Hasu shared a simple framework for assessing a DAO’s governance model.

For purposes of this issue, I’m calling it the “Stupid Simple Governance Framework”.

Let’s zoom in…

Stupid Simple Governance Framework

Governance can be a nebulous thing, especially in the context of DAOs…another nebulous thing. What we’re really talking about is the decision-making process. How does a DAO make decisions…about anything.

Here are three simple questions that get to the heart of the decision-making process:

• What decisions need to be made?

• Who decides?

• How are they incentivized?

You can break down any governance structure by answering these three questions.

1. What decisions need to be made?

There’s a spectrum.

On one extreme, some DAOs need to make decisions about everything. Protocol parameters. Protocol upgrades. Supporting new assets. Treasury management. Large expenditures. When to pause/shutdown the system. Phew. Talk about decision fatigue.

On the other extreme, nothing. Some protocols are immutable.

An example of an immutable system is Liquity, the interest-free borrowing protocol on Ethereum. Liquity’s code base is immutable, and as a result, governance-free. Their docs say it best…“all protocol parameters are either preset and immutable or algorithmically controlled by the protocol itself — making human interventions redundant.” I love that last part.

I used to think a governance-free protocol was short-sided. Now I’m starting to see the elegance and efficiency. For many DAOs, governance is a liability.

2. Who can govern?

Also a spectrum.

Assuming there are decisions to be made (excluding governance-free systems), on one extreme you have everyone. As we know, most protocols with a token confer governance rights to the tokenholder. Because the barrier to entry is simply owning the token, everyone is effectively eligible.

1 token = 1 vote. Most protocols operates this way.

On the other extreme, one person. Fortunately, we don’t see many instances of this. Instead, what’s becoming more common is small groups of specialists - “committees” or “pods” - making decisions over a specific operational function (i.e. treasury management or security).

There are circumstances where the extremes can work, but most projects ideally want to be somewhere in the middle. Equal parts centralization and decentralization is actually a pretty good governance cocktail.

3. How are they incentivized?

Charlie Munger famously said “show me the incentive, and I’ll show you the outcome”.

People don’t do anything for free. We work because we get paid. We eat because we’re hungry. We exercise to be healthy and look good. We vote because we want our interests represented.

Incentives drive human behavior. So what is motivating someone to participate in governance? Usually nothing.

Most DAOs don’t offer any incentive to their tokenholders to participate in the governance process. One exception is UMA, which issues voting rewards in the form of additional UMA tokens to tokenholders.

In DAOs with some semblance of specialization, the multisig signers, delegates and other specialists are financially compensated for their time.

So that’s it. Three questions that can help you structure or assess a DAO governance system. Next up, a sobering look at the current state of DAO governance.

Reality Check

First, let me say there isn’t a right answer to these questions. It depends on what you’re governing. Companies providing a product or service are governed differently than countries. That said, most DAOs today fit in one box:

• Everything needs to be decided

• Everyone can decide

• No incentives

I sat with this for a while, and I couldn’t come up with a single example of something I wanted governed by the above. This structure resembles neither corporate governance nor country governance.

Why is this model flawed?

Prioritizing the wrong outcome

As Hasu discusses in the podcast, most DAO governance models (especially straight tokenholder voting) are regulatory arbitrage. They are designed to reduce the risk of founders facing regulatory action.

While you’re optimizing for “not getting sued”, you sacrifice efficiency and expertise. Your product or service suffers as a result. For some projects, especially those with a low barrier to entry (aka competition), this may prove fatal.

My guess is if you gave every DeFi founding team immunity from regulatory action, you would see very different decision-making structures.

Rather than managing backwards from a regulatory action, a better approach may be determining what decisions need to be made, who is best positioned to make them, and figuring out how to accomplish those two things as efficiently as possible given based on your team’s risk appetite.

No Incentives

I think it’s common knowledge now that most tokenholders don’t participate in governance. Deribit published a great piece on this last year, equating DAO governance to student governments. I love this analogy.

Why don’t tokenholders participate in DAO governance? Same reason why most students don’t participate in student government. Because they don’t get anything in return.

Every DAO tokenholder does a quick cost-benefit analysis in their head and decides the cost of voting (time) isn’t worth the benefit (nothing).

Charlie Munger could have predicted this outcome.

Here are stats on a recent MakerDAO governance vote. 0.1% of addresses holding MKR voted.

Now you could argue the benefit to the tokenholder is the healthy governing of a system they have a financial interest in. And while that’s true, it’s not enough motivation for most tokenholders.

We need to start incentivizing governance participation. And it doesn’t necessarily have to be directly financial, although that’s an obvious place to start. People are also motivated by reputation, visibility and power. These natural human desires can be manipulated to drive participation.

Governance =/ community-building

Too often, governance is used as a strategy to attract users and build community.

Case in point, the airdrop. Tokens are distributed to a wide swath of wallets hoping recipients will feel part of the community, hold them and become active users and governance participants.

The challenge for most DAOs is there is no connection between using the product/service and the token. The only thing the token confers is governance rights. By transitive relation, the airdrop is intended to bootstrap a base of voters.

But…governance isn’t a community-building tactic. 99.9% of tokenholders don’t care about governance, so stop expecting and rewarding them with participation rights.

Your community is built around a collective mission/vision. When you nail that, you can cultivate a community around it. Some of that community will participate in governance.

Parting Thoughts

This is a long game, and teams are making progress on governance every day. But we need more experimentation.

With experimentation comes a healthy amount of failure. Let’s make sure they are novel experiments, followed by new failures.

There’s no excuse for new DAOs to repeat the same mistakes. Make new ones.

Thanks for reading,

Andy

—

Not a subscriber? Sign up below to receive a new issue of 30,000 Feet every Sunday.