Evaluating decentralized autonomous organization governance for businesses

Decentralized autonomous organizations (DAOs) have emerged as the preferred organizational structure for web3 enterprises that utilize blockchain technologies and digital assets as part of their service offerings. This is significant as DAOs are becoming some of the largest allocators of capital in the web3 space. According to DAO analytics provider DeepDAO, at the time of writing, the 220 largest DAOs have over US$9 billion in assets under their control. DAOs have been embraced by members of the web3 movement as they have enabled the “decentralization” of governance and have the potential to organize projects and businesses innovatively.

The promise of decentralized governance and benefits to communities operating through a DAO have led some industry participants to call them the “corporation of the future.” However, issues resulting from their use in emerging businesses demonstrate a need for refinement in this context. The general approach of using them to apply direct democracy principles to the organizational governance of companies should be reconsidered in favour of a modified approach.

Why are DAOs being embraced?

DAOs are seen as embodying the general web3 culture. They are used to further the “decentralization” of the governance of a project by allowing for decisions to be decided and voted upon directly by a broad community, mirroring a direct democracy. This contrasts with corporations governed by a board of directors and a limited group of officers who make decisions on behalf of organizations, relying primarily on representative democracy with direct democracy used in limited circumstances. DAOs attempt to align their incentives with those of the community it interacts with by providing them with decision-making, voting rights and, in many cases, ownership in the form of tokens that may be distributed to participants for contributions.

This structure differs from corporations, where ownership and control are typically separated. With DAOs, the belief is that bundling ownership and management will lead to greater participation and stewardship of activities and initiatives. However, in practice, this approach hasn’t yielded those intended results for a significant number of web3 projects.

Governance by referendums

Over the past few years DAOs have steered towards employing a direct democracy approach to governance where every token holder (the DAO’s “community”) is permitted to vote on proposals for actions to be taken by the DAO they hold tokens for. These proposals can be viewed in most cases as referendums for routine actions to be taken by a DAO that is voted “on-chain” (voted on and reflected on a blockchain). There are differing standards amongst DAOs as to which proposals are voted on, whether a proposal is added to a general queue or “fast-tracked,” and what constitutes a quorum for a proposal vote.

This decision-making process is a lengthier and more time-consuming process than the conventional approach of having company insiders and staff make decisions on behalf of an organization. Compounding this issue has been the low voting turnout for proposals of many of the largest DAOs, with many experiencing less than five per cent participation for proposals.

This low voter turnout hampers the speed at which proposals can either be rejected or acted upon. It also casts doubt on the belief that providing ownership and votes for governance in a project will meaningfully influence the community’s involvement in projects. If this low voter turnout also occurs due to mundane but necessary proposals made by insiders of DAOs, the benefit of employing a direct democracy approach becomes even less clear.

Community politics

DAOs are also promoted for how they distribute governance across their members and consider the diversity of their community into decision-making. Although having a variety of opinions is beneficial to organizational decision-making, not accounting for preference uniformity amongst DAO community members appears to limit their success. For corporations, diverse opinions amongst management and shareholders are beneficial for profit maximization. This contrasts with DAOs where diverse opinions can result in disagreement and disputes.

In many instances, diverse groups directly governing DAOs has led to inefficient governance and public fighting. In the case of Uniswap, the largest decentralized finance exchange by market share, there was significant uproar over the plutocratic approval of a proposal for a US$20-million grant. For the proposal, the majority of “in favour” votes were concentrated in only 10 separate wallets, with the largest token holder voting in favour of it being the party that wrote the proposal. In the case of RomeDAO, a DAO involved in the governance of an emerging game development studio, its operations were disbanded over what insiders described as having significant disagreements with a toxic community governing the project. In both instances and in others, having a community with diverse interests deciding directly on matters resulted in political breakdowns that were publicly displayed for the community to witness.

Moving DAO governance forward

As governance models for DAOs continue to improve, it is likely that they will more closely conform to the representative democracy approach relied upon by traditional corporations when used for businesses; for example, creating expert or insider committees for DAOs who can make decisions on their behalf for particular subject matter or providing DAO insiders with greater authority over segments of a DAO’s funds. These are just some mechanisms that DAO researchers and advocates have proposed over the past year.

What may accelerate this trend is shifting the focus on what “decentralization” should mean for a DAO. Decentralized governance is a core tenet to run a DAO. However, as new problems arise, it may be beneficial to focus on their ways of decentralizing operations and allowing people to organize and interact with one another innovatively. By moving towards a representative democracy approach and improving the model of traditional corporate governance, DAOs have the potential to become the “corporation of the future.”

This article was originally published by The Lawyer’s Daily (www.thelawyersdaily.ca), part of LexisNexis Canada Inc.

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