Author: Sam McCarthy

An overview of the challenges facing decentralized governance and some ideas for the future.

*Part 1 of a series of articles on the state of decentralized governance of cryptocurrencies. The continuation of this article is"Governance as a Source of Value"。

Decentralized governance is at the core of the ideological foundation of cryptocurrencies: all participants have an equal opportunity to participate. Especially in the field of decentralized finance (DeFi), more and more projects are following the practice of progressive decentralization and handing over the keys to their protocols to their communities. This means that in addition to team members and institutional investors, users and token holders have more control over protocol parameters, capital expenditures, and more generally the future of the industry.

To enable this revolution in governance systems, DeFi protocols leverage Decentralized Autonomous Organizations (DAOs). Without going into too much detail (this topic has been written many times), DAOs are a way of aggregating financial and human capital according to rules encoded on a blockchain. An important difference between DAOs and traditional businesses or corporations is that they coordinate rather than control participants. Ideally, anyone should be allowed to contribute money or ideas, and the DAO should be able to turn those inputs into real results. DeFi protocol DAO is constantly experimenting with various decentralized governance implementations, including organizing contributors through committees (see: Synthetix) and distributing funds through reward programs (see: Aave, Compound, and Uniswap).

While the goals of DAOs and decentralized governance are still worthwhile, there are many challenges on the way to their realization.

In this article, I describe three of the most pressing problems, along with suggestions for addressing them. These challenges are: separating signal from noise, building consistent leadership, and ensuring a community of influence.

Signal and Noise

Most DeFi applications today use some combination of online forums (examples here and here) and Discord channels to coordinate the social layer of governance. Applications like Snapshot are then used to perform "off-chain" voting to determine community consensus before protocol changes are encoded on the blockchain. While the organic evolution of DeFi governance has ensured open participation and broad perspectives, the process has become noisy, with proposals, discussions, and voting scattered across many platforms. As the size of some project communities grew, the number of individual contributions made in different locations began to obscure the discussion. This added complexity is a hindrance to the governance process, as time is spent parsing through the large volume of posts to determine which ones add unique value, while the most valuable ideas get lost in the crowd. Plus, this clunky experience acts as another barrier to entry for newcomers who can feel overwhelmed by the sheer amount of material and too many places to go to keep up.

Going forward, there will be a need to streamline the proposal and discussion process to separate signal from noise and balance inclusion with efficacy. For example, governance app Boardroom offers a new idea tool that allows the community to show support for new ideas through a mechanism similar to Reddit's upvoting feature. In this way, users can easily vote for the best and most valuable discussions by the community. Additionally, Cinneamhain Ventures partner Adam Cochran recently suggested that decentralized protocols should draw on traditional political bill sponsorship. Currently, when a DeFi community member proposes an idea on a governance forum, there is a flood of responses, many of which may be very similar. Cochrane emphasized that it was important to make small concessions in order to gain support from other policymakers and to reach some kind of consensus before ensuing discussions, rather than each participant steering the discussion in their own direction, This may not be much different from other views. It’s worth noting, however, that this shouldn’t come at the expense of centralizing influence or sacrificing transparency.

To improve governance efficiency while maintaining broad participation and distributed control, I believe that most of the discussion and consensus process needs to happen at the DAO level. It's important to note that while most DeFi applications are controlled by DAOs (or planned to be sometime in the future), not all DAOs are DeFi protocol DAOs.

I envision a future in which DAOs become more fundamental DeFi protocol ownership entities and thus more active in protocol governance. Individuals will still be able to hold and vote with their own tokens, but DAOs representing larger groups of individuals will end up gaining greater power and status within the protocol community. DAOs have the ability to pool tokens and aggregate the views of their members, thus being able to speak on behalf of a wide range of individuals following a consensus within their own community. DAOs taking on a larger role in protocol governance on behalf of their constituencies will add more order to the idea generation and feedback process, while still recognizing the differing opinions of all stakeholders.

protocol leadership

Former Synthetix “benevolent dictator” Kain Warwick recently elaborated on a problem raised by the protocol’s decentralized governance structure. Warwick recounts his departure from actual leadership positions and his departure from the Spartan council. The Spartan Council is a community democratically elected body responsible for approving proposed changes to the Synthetix protocol and informally responsible for the core contributors to the project. Warwick noted, “It was never the intention of the committee to directly control core contributors, but to create a legal mechanism for token holders to control the direction of the protocol. Therefore, without Warwick’s centralized management and guidance, there is no one in charge of the core contributors, leading to significant coordination and execution issues. This illustrates an interesting distinction between operational and strategic governance, and raises the question of who should oversee which aspect of the project.

Bottom line: A mature decentralized project doesn't need a leader, but its core contributors do. While gathering diverse input from the community can positively influence the development and trajectory of the protocol, the process can also stall and often neglect day-to-day protocol maintenance and implementation. This is partly due to participants not being interested in the details of running a DeFi application, and partly due to the generally chaotic nature of decentralized governance. Therefore, when gradually decentralizing your protocol governance, it is important to clearly describe the operations of the core contributor team and have a dedicated, motivated leader to coordinate them.

In reality, decentralized governance is not suitable for every aspect of the project. First, in the early stages of protocol development and community formation, more controls are needed. Once a project reaches a certain level of maturity, the community retains the power to propose and vote on key protocol changes and influence the overall strategic direction of the project. Synthetix case studies show that the ongoing business of an organization also requires stable leadership. While I admit that the term "leadership" often has centralized connotations, the transparency of blockchain technology ensures ultimate accountability for any changes or transactions on-chain without community agreement.

sense of control

For a decentralized governance model to work, the user community and token holders either need to control the protocol, or at least feel like they do. This means that even if the community does not own more tokens than insiders (team members and investors), their collective voice should be heard and considered in all major strategic initiatives. Not only is this key to decentralized governance, but the notion that community contributions are valuable also adds meaning to community membership and participation. A major shortcoming of local government today is voter apathy, claiming that your vote "doesn't mean much", which leads to low turnout, and results that are not representative of the voter base (a similar argument can be made for shareholder voting). If people believe their input and participation will have an impact, they are more likely to engage and invest more energy in making a value-added contribution. As a result, DeFi protocols can improve decentralized governance by increasing the community's emotional stake in the process, while also leveraging the financial incentive power inherent in token ownership.

We recently observed this hypothesis in real-time as Uniswap’s DeFi Education Fund and Sushiswap’s Strategic Fund raises coincided. In the first case, a group of influential Uniswap users passed a proposal to create a "DeFi Education Fund" (DEF), which aims to address government action against cryptocurrencies. The problem started in the final stages of Uniswap’s governance process before voting and implementation on-chain, consensus checks showed that more than 96% of the votes in favor of the proposal came from just 10 wallets (the largest of which came from the proposal’s author, Harvard Law Block chain and fintech initiatives). In addition, after successfully providing 1 million UNI tokens to DEF, DEF immediately sold half of its UNI shares held in USDC and claimed that it planned to distribute funds within 4-5 years. This raises questions about the legitimacy of the fund and whether the formation of DEF is in the best interest of UNI token holders. Uniswap’s decentralized governance already has a reputation for being more form than substance (which has previously led to issues with voter apathy), and this public incident further undermined the community’s confidence in their ability to have a substantive impact on the project.

in conclusion

in conclusion

In DeFi, decentralized governance allows all stakeholders to have a say in protocol development and value creation. By welcoming a greater diversity of ideas and beliefs, DeFi projects, and most crypto projects in general, have the potential to create more value for their communities and generate more social good. However, to generate these benefits, projects should not sacrifice operational efficiency. Just as traditional corporations were created to minimize transaction costs, decentralized governance through DAOs can revolutionize bureaucratic decision-making in institutions. To operate more efficiently while promoting greater inclusiveness, DeFi projects should encourage DAOs to participate more in protocol governance, delineate roles and responsibilities between strategy and operations, and maximize the perceived value of community contributions.

Experimentation remains one of the “killer apps” of DeFi and crypto. In addition to testing incentives and financial fundamentals, founders and developers are able to endlessly test various governance processes. Using the automation and transparency enabled by cryptocurrencies and blockchain technology, system designers and policymakers can explore different ways to foster participation, increase efficiency, and increase fairness. The results of these experiments will inevitably help these projects continue to innovate and move the entire industry forward.