The emergence of DAO is inevitable, because the reduction of collaboration costs makes the synergy marginal effect more significant.

The essence of DAO is to allow all participants to share risks and benefits, which is "Skin in the game". So the key to this is to need Token to connect interests.

That's right, any organization involving multiple parties can become a DAO, and all value-creating DAOs need Token. How to create and govern DAO has become the biggest problem.

This article is from Future of a16z. The author is Tarun Chitra, CEO of Gauntlet, a protocol risk control platform. Rhythm BlockBeats translated the full text:

With the huge growth of the DeFi and NFT community, how to govern the decentralized protocol is particularly important. One of the toughest challenges these communities face now and in the years to come is figuring out governance, how collective decisions should be managed to optimize funding and business operations.

Governance, however, comes at a high cost of collaboration, as network participants need to actually vote on every decision. These collaboration costs can be radically reduced in new types of decentralized networks where participants can collaboratively govern through smart contracts.

These new networks are called DAOs (Decentralized Autonomous Organizations), where people have consistent incentives and common interests, there is no absolute leader, there is no single point of failure, and they run almost completely in accordance with the code . Many new protocols are being built using this structure, and so far most of the activity is based on open financial systems, although it is also increasingly being used in cultural networks for buying and trading art and other collectibles. In many ways, a DAO looks a lot like an investment bank, a corporation, and a community all tied together by cryptographic commitments.

Although it is called an "autonomous organization", in fact DAO is often not completely autonomous. Someone still needs to establish a decision-making framework to ensure that DAO can be effectively governed, and continue to motivate participants to participate in governance in terms of finance, so that DAO can grow strong.

Next, DAO founders and participants will face many problems, such as: What decisions need to be made? What financial incentives are available? Under what conditions should a DAO be formed? What are the main governance tasks required today? And what tools can be used to help governance?

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Experiment Paves the Way for Modern DAOs

The first time the world heard about these internet-native organizations was in 2016. In its early stages, the most famous DAO was called "The DAO," a collective investment vehicle that aimed to be a rationalist form of crowdfunding, a decentralized venture fund, and for the first time showed the world How should this decentralized organization that runs through code manage itself. Participants provide ETH to The DAO and get DAO Token. These Tokens represent the holder's economic interests and voting rights in The DAO.

The dream of The DAO is for any participant to be rewarded handsomely in the Ethereum ecosystem, regardless of their contribution to the treasury. The word DAO fell out of favor when a fatal smart contract bug caused funds in the DAO contract to be stolen by attackers, leading to the emergence of the "DAO winter" in the 2017 bear market.

With lowered expectations and less attention, some important governance experiments of this period paved the way for modern DAOs. The first of these experiments addressed security concerns, which are critical because no network can function, let alone grow, if users fear their funds will go up in smoke. First, Ethereum competitors such as Tezos promise to provide more secure smart contract programming languages, allowing developers to easily avoid The DAO's problems. Several experimental projects have also emerged on the Ethereum network, such as Aragon, dxDAO, Kleros, and Moloch. The promotion of these DAOs has brought better programming standards and experiments with new Token distribution mechanisms to this field.

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The Rise of Financial Incentives

In recent years, the rise of DeFi (decentralized finance) has opened the door to more complex open financial systems and financial instruments. At the same time, DeFi does not depend on banks or other traditional systems. Emerging DAOs are beginning to emerge that use financial incentives to encourage active users.

These incentives and the way they promote each other have become a key factor in DAO governance, because in the absence of financial incentives, members of the network have no reason to invest time, money and energy in the network, and there is no reason for DAO Proposals for improvement measures in the system are voted on, and no one cares whether these proposals can continue to develop and succeed.

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growth incentives

June 2020 is a crucial development node. The core developers of Compound (an on-chain lending protocol) will decentralize their rights and hand over the operation and ownership of their network to the community. Unlike previous DAOs, the Compound Governance DAO gives community members control over the protocol and the reserve assets, which are generated through the revenue generated by fees charged to lenders. These cash flows were the highest of any on-chain protocol revenue at the time.

Compound proposes a novel Token distribution model, which aims to incentivize the capital growth of on-chain protocols and provide users with more appropriate borrowing prices. In this model, users who provide liquidity for the protocol or generate lending relationships through the protocol will continue to receive the native Token (COMP) from Compound as rewards. This makes every user of Compound a direct stakeholder, which makes many users active contributors and voters in the community.

yield farming

yield farming

With the development of governance Token distribution methods, in addition to investors and development teams, users in the agreement can also get Tokens, which also makes many new solutions possible. The first is protocol incentives like yield farming. Yield farming is when users are rewarded for providing liquidity to the agreement by lending, staking or other forms. These rewards are actually Tokens representing the ownership of the agreement itself. Those who are rewarded can accumulate these Tokens representing the ownership of the agreement, wait for the value of the agreement to rise, or immediately sell them in the open market, and then perform various compound interest operations. Let's imagine. If the bank gives you a small percentage of stock every time you make a deposit, you're more likely to deposit because it benefits both you and the bank.

For example, Compound users can earn governance tokens by locking assets in the agreement (using them as mortgage assets and lending through the agreement). In this way, Compound can use COMP (Compound's native Token) to stimulate growth, create a user base, and encourage users to vote and contribute to the community of the protocol, because the benefits can attract more users.

Once developers realized that they could attract funds to new DeFi primitives through yield farming, competition among DeFi protocols took place through DAO Token like the 2020 DeFi Sunmer. The launch of Yearn Finance (YFI), a revenue aggregator for DeFi, is the catalyst for DeFi growth in the summer of 2020. Its "fair launch (where all tokens are distributed to funders and project developers have no tokens)" shifts the narrative from VC-funded projects to community-funded projects. Once YFI goes online and achieves rapid growth, many competitors will start to "clone" and "counterfeit" products, and promise to make improvements, but more importantly, launch a new DAO governance token.

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retrospective airdrop

New protocols are often built on top of these models to further incentivize users. Airdrops are a typical example, sometimes sending tokens directly to user wallets as a way to spread awareness, build ownership, or retroactively reward early adopters. For example, the decentralized trading protocol Uniswap once issued UNI Token, and this Token is retroactively awarded to everyone who has used the Uniswap protocol. The airdrop gave some early users access to tens of millions of dollars worth of UNI.

More importantly, airdrops and Token issuance have become an effective capital protection weapon, and soon this has become a necessary way for new DeFi protocols to seek market share.

The increase in token issuance also led to a change in governance power—early users, unaware that their participation would bring governance power, began to own significant parts of the network, which in turn facilitated further decentralization.

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Cultural DAO and Game Guild

The development of the aforementioned financial incentives has contributed to the exponential growth of DeFi protocols over the past year. However, other types of DAOs with different cultures, incentive models, and governance structures are also emerging. Recently, we've seen the rise of DAOs whose token distribution model has nothing to do with usage or participation, unlike DeFi's DAOs.

This is the Collector DAO, made up of people who decide to collectively buy art or other digital items. An example is PleasrDAO, which was originally established to purchase the video work created by pplpleasr (Emily Yang) to celebrate the release of Uniswap V3. The video is seen as an iconic piece of art that captures the spirit of DeFi in 2020. The video was minted as an NFT and auctioned off, with proceeds going to charity. This auction and the collective ethos surrounding the artwork led some longtime DeFi developers and entrepreneurs to create a DAO to buy the artwork.

The advancement of PleasrDAO lies in having a unique mechanism to fragment NFTs, which makes it possible to collectively own a single artwork. This portrays The DAO as an art museum (like MoMA) where all works are collectively owned by funders.

In the fall of 2020, another culturally significant collector DAO, FingerprintsDAO, emerged. Unlike PleasrDAO, FingerprintsDAO focuses on creating collections of generative and on-chain art. NFT-based generative art is unique in that the artwork changes every time there is a change of ownership - for example, the artwork $HASH (Proof of Beauty) every time the artwork is transferred, the underlying metadata is updated according to the block The chain state changes randomly. FingerprintsDAO houses these collections and has the largest collection of Autoglyphs, Bitchcoins, and 0xDEAFBEEF.

FingerprintsDAO and PleasrDAO use governance tokens to manage treasuries, execute asset sales (including fragmentation returns), and perform asset management. DAO Token holders have the right to vote on these issues, and the results of these votes are directly executed by on-chain algorithms using DeFi protocols (such as Fractional or Uniswap).

Since the Token distribution of Collector DAO is not related to usage or participation, and the financial incentives are different from the usual DeFi DAO, this may cause the early organizers of DAO to take on increasing obligations to keep the DAO running effectively, and the DAO Complex dynamic relationships among members. This consistency challenge is specific to cultural DAOs, and builders in this space should use different types of governance strategies to keep DAOs running efficiently.

One way is that Collector DAO hires full-time engineers and product managers, and uses governance tokens to directly motivate (while ensuring the decentralized governance and operation of DAO). By ensuring that those who work for the DAO receive an increasing share of the DAO's assets, a stable balance can be created between early token holders and those engaged in the day-to-day management of the DAO.

The last type of DAO is the game guild, which has its own culture, incentive model, and governance structure. This is the DAOized version of the game guild (a team of players). These decentralized collectives own game items and/or collectibles and share usage rights and sale proceeds.

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At present, the general growth of DAOs and the huge success of some very innovative DAOs are declaring the fact that the help of DAOs is needed to achieve development and healthy network participation. When the market sentiment is high, it is not difficult to infer that all organizations, communities and projects need to join the DAO, just like Crypto that emerged with the ICO craze in 2017.

Of course, this is not entirely accurate. DAOs are most useful when the governance burdens related to curation, security, and risk fall faster than the coordination costs that automatically come with having members vote on every decision rise. This is why protocol builders, when deciding whether to form a DAO, must evaluate the true goals of the organization.

The areas of governance that are common to all DAOs are:

Collective asset ownership and management. The treasury and balance sheet of a DAO should be consistent with the functions of a decentralized enterprise, taking into account assets, liabilities, liquidity, income, and where financial resources are allocated. asset risk management. Real-time monitoring of market volatility, prices, and other market conditions is required. Asset curation. From art collections to collateral for loans, all DAO assets can benefit in achieving their curatorial goals.

One should only form a DAO if the community has clear requirements for these three areas of governance.

It’s worth noting that while a DAO only participates in some of the activities, it also needs to provide all three functions. This is because, assuming a cultural DAO owns an asset and can profit from it, even if the DAO has previously completely ignored risk management (focused only on asset curation), it will sell the asset. It is inevitable to face risks and challenges.

One of the prime examples of this type of event was PleasrDAO's $225 million sale of $DOGToken, which represented fractional ownership of the original Dogecoin Mystery NFT. Prior to this, PleasrDAO only focused on asset curation and ignored risk management. Since the team needs to issue Tokens on Sushi's Miso platform, it is necessary to learn the distribution mechanism and economic principles of different Tokens, especially when the divisible NFT market has just started. The team also had to set up a community development fund to ensure community members felt ownership of this NFT.

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Three key areas of governance

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collective asset management

Risk Management

Risk Management

Since DAO's assets are usually risky assets, it is particularly important to manage its currency risk to secure the source of funds for future business. Some DeFi and NFT DAOs have hundreds of millions or even billions of dollars in their vaults, which are used to fund development and audits, provide insurance for the underlying protocol, and spend on user growth and acquisitions. To achieve these goals, a DAO needs to manage its treasury efficiently to achieve specific metrics or KPIs, such as, “Can we survive a 95% drop in asset prices?” or “If we earn X % interest, can you still buy high-priced NFTs?”

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asset curation

Asset curation is generally performed in NFT collection DAOs, such as PleasrDAO. These DAOs also naturally play the role of curators of art and culture, and the governance tokens of DAOs are used to vote on the increase or decrease of curatorial assets. However, DAOs on DeFi often face such a problem. Although some mechanisms like Uniswap allow people to add assets at will and use them to create a trading pool, most other leveraged mechanisms do not allow people to this way. Especially lending protocols like Aave and Compound, which need to use governance to determine the increase and decrease of assets. This is because these mechanisms must be considered for the security of the protocol, and they must carefully determine the corresponding parameters for each asset, including margin ratios, interest rate curves, and insurance fees.

Let's use a simple example to illustrate what can go wrong. Suppose we mint a new type of asset - TarunCoin, and I hold the entire supply of that coin. Suppose I create a loan pool at this time, so that I can borrow by mortgaging TarunCoin. If I can link TarunCoin to the US dollar (for example, through the Uniswap fund pool, and I am the only liquidity provider in it), then I can greatly increase the market value of TarunCoin (for example, it reaches 100 million US dollars), and then I will $100 million can be borrowed by staking TarunCoin. However, since TarunCoin has little liquidity, loan defaults are inevitable, and those borrowers will suffer losses as a result.

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How to run a DAO

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Make good use of governance tools

First, there are now many quantitative tools that have appeared in the market, which allow the community to visualize the risks in DAOs (and possibly related protocols) and combine them with the market environment to form a function. For example, let DAO members understand what proposals such as lowering collateral/margin standards or raising interest rates mean for the protocol. This adds overall transparency to the risks that exist in a DAO's vault and allows the community to update the components in the vault to meet specific KPIs.

For example, the billions of dollars in assets held in lending protocols Aave and Compound can effectively serve as insurance backing for lending protocols. For example, if a large price shock occurs, causing a large number of loan defaults and causing lenders to suffer losses in the agreement, these DAOs can use the treasury to compensate (for example, the DAI liquidation event in the Compound agreement).

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The goal of these tools and services is to enable communities to expand to larger and more diverse populations. Due to the composability of smart contracts, agreements become more and more intricate, and governance becomes more and more difficult for each new member. This in turn can make it more difficult for new members to participate in the DAO in a meaningful way.

By explaining to users in a simple form the complex behavior hidden in the DAO, visualization is the key to helping new members "get on board". For example, tools can allow all members to understand what they are voting on without needing to understand the underlying complex technology. Each DAO's tool or service can then display the DAO's health from a technical, financial, and community perspective in an easy-to-understand dashboard.

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Divide DAOs into smaller "subgroups"

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Hiring

One final note on DAO governance: Once a DAO has a large enough community and assets, it is paramount that it hires people who can dedicate their energy to maintaining, communicating with the community, and managing the DAO. However, DAO must be careful not to recruit those who are very active in the community just to increase the price of Token. Therefore, we need to recruit all kinds of employees in a decentralized manner.

If the DAO cannot successfully hire full-time developers, community managers, and other staff, it will be very difficult when the DAO coffers run out of money or need help. The ever-popular DeFi protocol failed due to the exhaustion of DAO assets, and no DAOde members thought they had enough motivation to ensure the operation of the protocol (such as through protocol improvement or asset redistribution).

PleasrDAO has a committee (similar to a company's board of directors) that can help the DAO specify its long-term direction. Core contributors will be responsible for the initiation of the DAO, funding issues, and the smooth completion of the curation. As such, DAOs can often borrow from traditional corporate practices.

These online decentralized and asset-holding synergies are often considered a classic example of the "Wild West." But many of the problems and solutions that arise in traditional systems can often be used in DAOs because they all require human collaboration. These solutions have been tried and tested, so they may still be applicable in the new field of DAO. By learning the past development history of DAO, it may help people build future online institutions more effectively.