DAO Sovereignty and Why It's Important
Can DAO tooling keep pace with the DAO meme?
With the breakout success of DeFi and NFTs, more attention is being directed towards DAOs. Typically, the discourse focuses on the “D” in DAO and whether certain on-chain organizations are decentralized (or not). Yet the “A” is often overlooked. Some assume it stands for “automated”, but in fact, its true meaning, “autonomous”, is the most revolutionary aspect of DAOs. Being autonomous – or perhaps more appropriately, having sovereignty – means “having the power or right to govern itself” or to be “undertaken or carried on without outside control”.
A DAO can claim to be sovereign when its core governance power (in most cases, token holders) can act without relying on anyone in particular.
In reality, however, DAOs are not sovereign over much. Most have the ability to send and receive funds, while others can control certain protocol parameters. But all too often, trusted third parties are still needed for asset ownership and governance activity.
This is worrying, because DeFi protocols are becoming systemically important, and governance of them is crucial both for self risk management and for ensuring DeFi remains decentralized.
DeFi cannot reach the goal of being a fair and transparent global financial system if the DAOs that govern it do not have sovereignty.
The promise of DAOs
This definition of sovereignty is limited to things that occur in the blockchain world. But Bitcoin is much more than the Bitcoin blockchain and DAOs are no different. In the human world, memes are what we coordinate around, and DAOs have been wildly successful at the meme level.
ConstitutionDAO is the best example. The idea – a community that owns a copy of the US Constitution – is contagious on its own.
The promise of DAOs boils down to three things:
Easy-to-launch framework to coordinate with anyone around the world
Radical transparency through on-chain actions
Revolutionary new governance power structures (non-transferable reputation, futurarchy, etc).
While the power of a meme is undeniable, especially in DeFi, none of this promise can be achieved if DAO sovereignty is not prioritized. When a DAO is not sovereign, it’s less transparent, creates friction for permissionless engagement, and prevents innovation at the governance-system level.
DAOs and those interested in pushing decentralized governance forward should focus on achieving DAO sovereignty above all else.
Property rights and censorship resistance
At their core, blockchains are a censorship-resistant system for transferring property rights. In this world, users are 100% sovereign over their accounts. As long as users submit a transaction with an appropriate fee, they don’t have to rely on anyone in particular to have their transaction confirmed. Signing the transaction with their private keys gives them complete autonomy over that address’s actions on the blockchain.
DAOs add a layer of complexity. They can be represented by a single address – an avatar holds assets or controls smart contracts – but they can’t sign with a private key. DAOs are the way that multiple stakeholders can control an address.
Typically, DAOs’ sovereignty is weakened in two key ways – that interestingly also correspond with the core features of blockchains:
Translating voting into on-chain execution (censorship resistance)
Relying on trusted-third parties for real-world custody (property rights).
Perhaps the most pressing problem for DAOs today is the high cost of voting on-chain. Most DAOs use a liquid ERC20 token for the basis of their governance power, but voting on mainnet Ethereum can cost upwards of $50-100 for a single transaction. So passing a single proposal could cost $1,000.
Most DAOs get around this by using Snapshot, which has free token voting, requiring only a signature from an account holding an ERC20 governance token. The only catch is that you have to trust Snapshot to aggregate the signatures. There isn’t yet a low-cost way to publicly verify signatures, meaning it’s hard to trustlessly count votes.
ConstitutionDAO
It’s unclear why ConstitutionDAO captured such intense interest so quickly. Maybe Nicolas Cage had something to do with it? Anyway, for those who didn’t follow the saga, a quick recap. ConstitutionDAO was launched to raise funds to purchase one of the 13 original copies of the US Constitution. It was set up through Juicebox, a crowd-funding platform on Ethereum, and managed to raise almost $50 million in a matter of weeks. In return for their ETH deposits, individuals received PEOPLE tokens.
To state the obvious, the US Constitution is not on the Ethereum blockchain, so for it to have worked, there would need to be some real-world entity that coordinates on behalf of ConstitutionDAO. From the beginning, PEOPLE token holders had no real governance rights. The auction was held by Sotheby’s, which requires an in-person proxy bidder, plus the passing of KYC requirements regarding the source of the funds.
The team that set up the Juicebox crowdfunding campaign arranged for a multisig to receive the funds, and for those signers to go through the KYC process. They set up an LLC, and it was this entity that bid on but ultimately lost the auction (to Billionaire Ken Griffin).
While wildly successful as a meme, the concept of ConstitutionDAO has very little sovereignty. PEOPLE token holders have no control over the funds or the ability to mint or burn PEOPLE tokens. Their only real power is to reclaim their funds after the failed bid (sans gas fees, of course).
On-chain governance
To reach its stated mission, ConstitutionDAO needed to exist outside of Ethereum (for Sotheby’s at least), but as DeFi and NFT activity accelerates, the goals of DAOs are increasingly on-chain. This means that DAOs can participate directly, without having to rely on a trusted-third party. When economic activity is on-chain, DAOs can be sovereign.
The best example of on-chain DAOs are the DeFi lending platforms. MakerDAO is governed by MKR token holders who have complete control to raise or lower interest rates for Dai loans. What’s more, MKR token holders have the singular ability to mint Dai. Yes, there is a formal governance process with checks and balances, but the smart contracts that run MakerDAO are immutable and ultimately, the protocol parameters are in the hands of MKR holders.
Compound is similar. Its COMP token governs lending and borrowing markets on the Compound protocol, which does not exist outside of Ethereum, so COMP holders don’t have to worry about relying on a third party to implement a protocol change. Proposal execution facilitates everything.
Compound governance (like Aave governance) controls the algorithm that calculates an asset’s lending and borrowing rate, as well as which assets can be accepted as collateral. Compound and Aave governance are both sovereign, but they still have quorum requirements, which means only certain addresses can submit proposals.
Pushing DAO sovereignty forward
While the DAO meme has grown faster than DAO tooling and on-chain governance capabilities, there have still been great strides in 2021. Perhaps, the most noteworthy example of this is DXdao, which is pushing DAO sovereignty forward.
For those unfamiliar, DXdao is completely on-chain, with a $100m treasury (majority ETH), bases on three chains (mainnet, xDai and Arbitrum) and pays 15+ full-time contributors a month through on-chain proposals.
The key innovation – in a 100% unbiased opinion – is that DXdao is sovereign over its front-ends, and not just sovereign over the protocols and smart contracts it governs on Ethereum (which it is too).
DXdao owns the ENS domain names for all of its products as well as its own website. On-chain proposals can change the IPFS hash of the latest website release from the development team. Only an on-chain proposal could take the website down.
There are still dependencies, but this distinction between the front-end (which typically runs on a server owned by a legal entity), and the underlying protocol (which runs on Ethereum), is likely to grow. Many DeFi protocols are governed by on-chain entities, but none – outside of DXdao – have sovereignty over their front-end.
Odds and Ends
DXdao* month in review Link
Sushiswap CTO resigns Link
BadgerDAO exploit technical post-mortem Link
CoinTelegraph: DEX aggregator trading volumes surge to new highs Link
Spreadsheet comparing DEX and AMM landscape Link
Only three borrowers are 55% of MakerDAO’s loan exposure Link
STAKE token holders approve merger with Gnosis Link
Thoughts and Prognostications
Endgame [Vitalik]
Fei <> Rari: This Is Not an Exit, or Is It? [Luca Prosperi/Dirt Roads]
Should Uniswap be an oracle protocol? Always has been. [Alex Kroeger]
Optimistic and ZK rollups will coexist because they have different use cases [Bartek.ETH]
On the formalization of MEV in a multichain world [Alejo Salles/Flashbots]
Comparing Returns Across the Major ERC-20 Tokens [Kyle Waters & Nate Maddrey/Coin Metrics]
That’s it! Feedback appreciated. Just hit reply. Written in sunny and warm Florida, where I had a birdie today but a lot more double-bogeys.
Dose of DeFi is written by Chris Powers, with help from Denis Suslov and Financial Content Lab. I spend most of my time contributing to DXdao* and benefit financially from it and its products’ success. All content is for informational purposes and is not intended as investment advice.