Rapture #101: Just how Decentralized are DAOs?

Rapture #101: Just how Decentralized are DAOs?

Lately, many people have been asking me questions regarding DAOs. Each DAO has governance tokens that allow the holders to vote upon specific policies; but just how much power do these token holders have?

One of the crucial areas that needs to be understood, and differentiates DAOs, is how much power the governance token holders hold in voting decisions.

Off-Chain Governance: Not Very Decentralized

Homepage on Snapshot

Yearn, SushiSwap, OlympusDAO, and many others primarily utilize off-chain governance for their voting mechanisms, primarily through the sentiment signaling tool Snapshot. Snapshot allows users to proportionally vote on various proposals based on the number of governance tokens they have without the vote occurring on-chain.

There are some distinct benefits to this model. First, off-chain voting saves users a significant amount of money, considering any vote on-chain is a transaction and thus requires gas fees. Theoretically, the fact that users don’t have to pay gas means that there should be more voter participation. Second, utilizing snapshot is relatively easy (at least for a crypto application). Third, since the voting happens off-chain, there are no governance contracts that can be exploited, which leads to users losing funds.

Yet there is one glaring problem with only having off-chain voting: the proposals are not binding. Just because a proposal passes on Snapshot, does not mean that it is implemented into the protocol. In fact, there have been many instances where a vote has occurred but was not actually implemented by the development team and multi-sig admin key holders. For example, the Yearn community voted to burn the mint key in the middle of last year, meaning that no more YFI could be created. This vote was not followed by the development team and multi-sig admin key holders, and furthermore, was removed from their Snapshot UI. Since the teams control the UI of Snapshot, they can remove any votes they do not like.

Having off-chain voting is more like democratic voting in Russia. There are votes, but they don’t matter as the people in control will regardless do what they want. It is decentralization theatre to convince regulators that there is no centralized business entity.

On-Chain Governance: More Decentralized

Example of code written into proposal

Yet off-chain voting that relies on Snapshot is not the only option for a DAO. In fact, many DAOs opt to have their governance performed on-chain, where the actual code changes are written into the proposals themselves and are executed upon the proposal passing. Compound, Uniswap, and Aave are examples of protocols that utilize on-chain governance, meaning that if a proposal passes, then the changes in the proposal will automatically be executed by a smart contract. Compound and Uniswap both utilize the Governance Bravo contract as their framework, which is emerging as an industry standard.

While on-chain governance does allow for more decentralization, there are some pitfalls. Because there is not any sort of admin key that can alter a protocol, if a proposal passes and a bug arises because of its passage, which happened with Compound, the protocol can be exploited with no recourse.