DAOs and Web3 Governance: The Promise, Implications and Challenges Ahead

The past two years in crypto have been absolutely astounding. From “DeFi summer” (now $250 billion+ in total value locked) to “NFT craze” ($3.4 billion in monthly GMV on Opensea alone in August 2021) to Solana’s epic rise and various memecoin’s ultimate demise), the sheer pace of adoption and activity across the crypto ecosystem has been an incredible force.

Every venture fund in the world is currently deepening or developing a crypto thesis. Talent from traditional industries is pouring into crypto. And we now have an overarching, epochal narrative to define the movement: web3.

Amongst all the areas to focus on, I have chosen to write about Decentralized Autonomous Organizations (DAOs). The reason for this is as follows:

All Innovation is Driven by Incentive

By introducing an incentive innovation, Bitcoin provided a practical solution to the Byzantine Generals’ Problem. In fact, much of crypto is about remixing existing technology with new incentives to create powerful new paradigms. DAOs are the natural frontier of incentive design on the web.

Capital Power

The DeFi ecosystem, with $250 billion in total value locked (TVL), is the current “super-app” of web3. While only $10bn of DeFi TVL (4%) is currently held in DAOs, this number will likely increase exponentially as more and more DeFi protocols progressively decentralize governance. More money, more power — as capital power grows, DeFi Treasury DAOs have the potential to massively influence Web3 in 2022 and beyond.

Web3 Promise

If the promise of web3 (versus web2) is to reduce centralized power in private, opaque corporate structures, then functional, community-led DAOs are a key prerequisite for the web3 promise to be fulfilled.

Why do DAOs matter?

Crypto is a hotbed of live experimentation, and it’s exciting to see a multi-billion dollar protocol actively run by its community. But in the long run, why do DAOs matter? At the highest levels, DAOs are enabling new forms of economic coordination and decision-making in networks, organizations, and communities. Here are three ways to categorize and understand the implications of DAOs:

The Network View: Creating User-Centric Networks

The digital world is dominated by powerful networks. Facebook, for example, has nearly 40% of the human population as monthly active users.

Traditional networks typically follow a standard trajectory: acquire users for the network by adding value; reach critical network effects; start extracting value.

At any network’s terminal point, the corporate model of maximizing shareholder profit is fundamentally at tension with increasing user benefit. Hence, at its current scale, Facebook’s priorities are to increase ad revenue by increasing engagement. We have seen multiple scandals and evidence for why engagement and revenue increases may be detrimental to user value. Facebook may not be prioritizing its users’ privacy, or prioritizing content that is healthy but yields lower engagement.

In Web3, the hypothesis is to create a different framework for network evolution. In a web3 network’s terminal point, a user/community-led governance structure can better align incentives between the network and the user. Rather than extracting value, the network should continue to align with creating community value as it matures, especially if tokens are held primarily by active users rather than financial investors or other stakeholders.

The Organization View: Creating Autonomous Legal Entities

Corporations are legally-recognized organizations that enjoy a certain set of rights and perform a certain set of actions. However, we rely on a host of intermediaries for corporations to function: lawyers, corporate registrars, boards of directors, etc.

Relative to other legal structures, DAOs purport to be:

  • more permissionless. A broader base of people can participate.
  • put into actionDecisions are enforced via self-executing smart contracts rather than human intervention.
  • Censorship Resistant Decisions made by the DAO cannot be censored.

I use the word “purport” because, in actuality, DAOs have limited legal standing as of today. While forward-looking geographies such as Wyoming have legislation that allows for the legal incorporation of a DAO and thereby legal rights for DAO entities, most geographies across the world have not adopted any such stance.

I assume that with formal regulation, it will be difficult, if not impossible, to ensure perfect permissionlessness, autonomous implementation, or censorship resistance. While DAOs may be, relative to other structures, still stronger in these aspects, regulations would certainly place outer-bound limits on each of these parameters.

The Community View: Enabling Grassroots Organizations

In the past year, DAOs have especially been used by creators to create novel forms of digital action. ConstitutionDAO, for instance, was set up for the sole purpose of bidding for one of the two remaining original copies of the US Constitution. Within 12 hours, nearly $40 million was raised by the DAO, with an average ticket size of $200. Many participants were buying and sending crypto for the first time. Not only did ConstitutionDAO participants own a fractional piece of the DAO that could buy the constitution, but DAO token holders also had rights to vote on aspects of the asset, such as where it would be stored, how it would be viewed, etc.

One of the most beautiful things about the Internet is its collection of weird, passionate communities — from the arts to activism. DAOs create another option or tool for these communities to organize, raise funds, allocate funds, and take collective decisions.

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