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Why DAOs Fail and How to Fix Them: A Guide to Next-Gen Governance

Why DAOs Fail and How to Fix Them: A Guide to Next-Gen Governance
Paul L.

Decentralized Autonomous Organizations (DAOs) have pioneered a new governance paradigm where all stakeholders can meaningfully and easily participate in every influence of the organization. At their core, they are novel governance structures coded into blockchain protocols. DAOs allow for transparent and effective collective decision-making for operational changes, financial allocations, partnerships, and more. By moving beyond centralized boardrooms, this type of governance gives more legitimacy to organizations and empowers every member, contributing to growth and longevity. 

The potential is great, but DAOs are not living up to that potential or behaving as decentralized organizations. Why is it that the DAO organizational form so often fails to deliver?

The Numerous Applications of DAOs

It’s important to understand that the applications of DAOs are not confined to any single sector. Around 40% focus on DeFi (decentralized finance) in order to disrupt centralized financial systems, opening financial services to more people.

However, DAOs are already proving applicable to numerous industries, such as NFTs (17%), gaming (5%), politics (4%), and the arts (6%). DAOs’ promises of transparency and decentralization are just a few advantages over traditional management models.

By distributing the power to make decisions among everyone rather than just a few at the top, DAOs give everyone a voice, making the system more fair and open. The best part is that DAO decisions are meant to be carried out automatically via self-executing smart contracts, taking human error out of the equation.

By giving every member the power to govern, DAOs leverage the skills, experience, and passion of every organization member. Instead of all the ideas coming from the CEO or a handful of executives, the organization has a much broader and more diverse pool to draw from. DAOs also allow a much greater plurality of viewpoints, ensuring one person’s take on a situation doesn’t supersede everyone else’s. 

Yet, with all these apparent advantages, very few DAOs use the opportunity.

Why do DAOs Fail Conceptually?

The irony of DAOs is that a system designed for decentralization is centralized in many significant ways, such as voting power concentration, multi-sig wallet signers for executing decisions, voting activity, treasury control, and more. Worse yet, since most DAOs are ‘forked’ versions of existing projects, they can inherit these same problems.

  • Poor Tokenomics Design: If the majority of tokens are given to team members and early investors, the DAO instantly becomes centralized, which in turn discourages those with little voting power from participating at all. 
  • Indecision: Baked-in centralization is made worse when a vote has a quorum too high to be reached or too low for people to care about voting for. Low-stake technical votes can have a low quorum to encourage fast execution, while high-stake voting should have a high quorum to prevent abuse. Current DAOs have no such flexibility.
  • Imbalance of Voting Power: Small token holders don’t usually vote if a larger entity like the team or a big investor has enough to sway the decision. A study from Chainalysis shows that 1% of token holders often control 90% of voting power due to skewed token distribution, leading to voter apathy. Plus, on-chain voting costs significant gas fees, making it unaffordable to many. 
  • Complexity and Confusion of Governance: Even if the voting power was well balanced, the actual governance process is unnecessarily complicated because each aspect of governance has its own tool. Discussions started on Discord, proposals made elsewhere, voting on or off-chain, and notifications sent to emails are all examples of fall-throughs in the voting process. Governance systems should be designed for simplicity and action rather than complexity.
  • Low Expertise and Motivation: When one token equals one vote, someone who knows nothing has the same power as someone who is an expert in DAO governance or a specific topic, such as compliance, tech, or marketing. Similarly, if people know that voting for every proposal without thinking is enough to qualify for airdrops or other rewards, it destroys any motivation for thoughtful and nuanced participation.
  • Nonexistent or Centralizing Delegation: Not everybody has the time to vote in every DAO. Yet, where delegates do exist, they can amass vast voting power by using their social media following or other populist methods, resulting in a centralized governance structure that lacks a true plurality of voices.
  • Treasury Draining: DAO treasuries can be quickly depleted by the few active players who dominate governance, rendering the organization financially unstable. 
  • Scams and Sybil Attacks: The same centralization issues lead to security vulnerabilities that can make DAOs susceptible to fraudulent activities or governance hacks, compromising integrity and trust within the system. BonqDAO experienced a smart contract exploit earlier this year, resulting in a $120 million loss. 

A Roadmap to Reform

While the challenges faced by DAOs are complex, they aren’t insurmountable. The fundamental issue boils down to the absence of a robust infrastructure that can support genuine decentralization and autonomy. Such infrastructure does exist, often under one roof, such as the case with the DeXe DAO Studio. There are a number of elements a unifying platform can have to bring DAOs closer to their mission.

  • Nonlinear Voting Mechanisms: Even simple nonlinear mechanisms like quadratic voting can automatically slow down pooling voting power for those holding many tokens. These mechanisms would provide a more balanced landscape with more people having enough voting power to influence decisions collectively. DeXe DAO Studio gives more voting power to tokens delegated to DAO-approved experts while also slowing down the voting power and rewarding multipliers for those delegates who accumulate a lot of voting power. This prevents centralization and encourages a plurality of voices.
  • Incentive Programs for Quality Proposals: DAOs should create structures that encourage members to bring high-quality ideas to the table. The same goes for contended proposals — if every decision is unanimous, there is little point in going through a proposal process. By tying rewards to each proposal’s usefulness to the DAO, individual actions can be aligned with the DAO’s mission and objectives.
  • Delegate motivation: Currently, delegates could play a big role in governance yet receive no rewards. Such rewards could be material, such as a small cut to voting rewards for each token delegated or reputational, like a ranking system, reputation score, or public acknowledgment. Similarly, token holders should be rewarded for delegating, especially to a plurality of delegates, since that combats centralization. The approach of DeXe DAO Studio of rewarding delegates and delegators is an encouraging sign for the industry.
  • Treasury control: Give DAO members control over all governance decisions, including the distribution of funds from the treasury. The term “money is power” applies here, especially as it can fund incentives, partnerships, integrations, and a number of other initiatives that can help the DAO grow in a robust and sustainable manner.
  • Radical Transparency: Making on-chain voting cheap enough not to be a burden makes it easier to create fully transparent governance activity and helps members easily find reputable delegates they can trust. 
  • De-burden the Governance Process: The governance process can’t feel like a stressful and time-consuming maze. DAOs need governance in a single place, without significant learning curves, with relevant and noticeable notifications, and to make governance attractive. There are several approaches to this. For example, the DeXe DAO Studio’s approach is to make sure no coding is required, that all the settings are flexible, that useful governance gets financially rewarded, and that notifications go to where people spend their time, like social media. 

DAO Governance that Works

The evolution of DAO governance is currently in a critical phase. The potential is there. The problems and possible solutions are clear. Will DAOs overcome the issues and become DAOs in how they operate? There seems to be enough frustration with the current situation and a desire to change it to suggest people in blockchain are ready to create real DAOs. Current DAO members are prepared to evolve theirs to actual DAO status. With powerful tools emerging, there is now the desire, the ability, and the opportunity to create DAO governance that works as a DAO. 

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Paul L.