Aspects of this article reference possible legal risks and strategy. I am not a lawyer and none of this is legal advice. Please consult your counsel as you make these decisions.
In 2017, the common token model was the infamous “utility token,” now known as the “futility token.” This model fell to the wayside for two main reasons. Firstly, most of the projects did not offer any real utility and the token could easily be subbed out for a stablecoin. Secondly, regulatory cracked down hard on this, since it looked a lot like a security via the promise of revenue sharing.
Due to these concerns, in the current market token models have largely adopted the “governance token” approach,” since it is network specific and not necessarily a security. As such, crypto projects are launching governance tokens and integrating DAOs into their model more than ever before.
However, projects now need to answer a few questions:
-What does good governance look like?
-What does their token govern?
-What does their DAO do?
-How do we launch a governance system?
This article is part of a series covering these questions. Today we will focus purely on what good governance looks like.
A critical part of good governance is a fair token distribution. This question largely balances the interests of the core team, investors, community, and incentive pools.
Ultimately, the distribution needs to offer short-term incentives to the core team to build the project and investors to fund the project development versus any of the other projects in the market. However, for the project to be viable long-term, there needs to be significant allocation for the community to take over governance and development, plus incentivize real user adoption.
Generally, a good rule of thumb is to keep the core team and investors to about 20-40% combined. This ensures they have real stake in the game, but leaves 60-80% for the broader community, allowing for true decentralized governance.
It is becoming common practice for protocols to create committees in charge of allocating a portion of the community funds. This may look like a grants committee, which can more effectively get proposals passed for smaller initiatives. It can also be a working group that is allocated a budget for a specific project. Generally, these will reduce friction in the process of putting the community funds to work, rather than requiring a total vote on each action.
Finally, it is also important to evaluate the role of incentives. With respect to decentralization, if the core team + investors get 40%, but can also tap into a 30% incentive pool, they may be able to break 50% ownership. More commonly seen, is the impact of yield farmers mining the incentive pool and then dumping on the community. Both instances can be incredibly detrimental to a governance ecosystem, as it destroys incentives for good governance to occur.
Governance voting models are a very hot subject currently, with a few major models being implemented. It is important to remember that each model comes with tradeoffs and that there is no perfect voting model. Think through each option and identify which one makes the most sense for your situation.
One-Token-One-Vote: This is the most commonly used voting model. As those with more token have more at stake with the protocol, it can make sense to offer them more say in the protocol direction. However, the biggest drawback here is that it often allows for whales to get a disproportionate say in protocols. Many times, the early investors and core team accumulate a large stake at cheap valuations, and any late-comers have a significant barrier of entry to get a meaningful stake.
One-Person-One-Vote: While not too many projects use this model, it is often cited as a more egalitarian alternative to OTOV. It enables all voices to have equal say in the decisions, but also allows for trolls and those with not much as stake to sway votes. Additionally, the implementation can be tricky, as it is prone to a Sybil attack, where people create many wallets to get more votes.
Delegation: Popularized by the Compound Governor Alpha contracts, voting delegation implements a republican democracy, where individuals can choose delegates to vote on their behalf and can change their delegation at any time. One of the largest critiques of this model is that it starts to centralize the voting system. Decentralization of delegation models can be evaluated through: ease of evaluating delegates, concentration of voting power in (top) delegates, and token voting participation. Particularly when large early stake hold large stakes of the project, governance delegation can improve decentralization.
Quadratic Voting: This model offers more voting power for token held, but diminishes the additional power as the position gets larger. For instance, a wallet with 1 token gets 1 vote, a wallet with 2 tokens gets 1.9 votes, etc. No major protocol has tested this model, but it tries to balance the benefits of OTOV and OPOV so whales do not have as much say. The issue that needs to be addressed here, is to create the curve such that whales are not incentivized to create many wallets to increase their total voting power.
Time-Weighted Voting: Time-weighted voting is utilized by a few communities including Frax Finance. In this system, voters are required to lock their token. The longer they lock their token, the more they are invested in the long-term success and so they receive a multiplier to their voting power. This model doesn’t necessarily solve some of the issues with OTOV, but does help incentivize long-term participants. Two concerns to evaluate are, finding the optimal multiplier curve and thinking through the case where token is locked but new votes pop-up. Largely, this model is good for ongoing votes, like setting protocol parameters.
Qualities of Good Governance
Now that we walked through the initial distribution of tokens and some of the ways to enable their voting power, let’s look specifically at what good governance means. Since these qualities have tradeoffs we will go into how they should be prioritized over the lifespan of a project.
Transparency is one of the most crucial components of good governance as it allows for there to be trust in the system. Without true transparency into the open discourse, voting, and funding the community may be exposed to oligarchs or systemic fraud. In crypto governance, this involves tying all discussion threads to specific wallet addresses for tracking. Additionally, it involves thorough discussion and communication about all activities the community and its leaders undertake.
The need for transparency will increase as the project grows. In the early days, when the core community may be able to conduct its operations in a group chat without excluding anyone, working in public does not necessarily mean a public forum with trackable addresses. Around 50-100 community members, it becomes more important to establish transparent forums and discussion channels that can grow with the project.
2. Ease of access
One of the largest issues in crypto and crypto governance is ease of access. Many people do not know how to buy crypto or set-up wallets, let alone navigate governance forums, Snapshot votes, and on-chain governance. Even more so, many communities set token requirements for creating proposals. Also, on-chain votes can be prohibitively expensive in gas costs.
A good analogy here is with traditional voting in the United States. Many states require government ID cards, registering to vote far in advance, voting from a specific polling center, etc. With each of these added requirements, there is tradeoff in the accessibility of voting that leads to bias in the results. For instance, those who must commute long distances for work, often are unable to vote due to the polling place being located near their residence and only open during working hours.
Communities need to actively think about all the ways they currently inhibit ease of access and come up with solution to make the UI/UX of crypto governance more user friendly. In the early days of a project, closing off governance entrance from outside contributors can prevent growing essential early members. As the project continues to grow, removing barriers is essential for expanding the community size and contributor count.
3. Voter Efficacy
For any governance system to work, voters need to believe that they can make a difference by participating. Communities should consistently monitor their voter efficacy through voter turnout and community surveys.
Looking back at American politics, voter efficacy is currently low due to the power of the two-party system (Republicans and Democrats have large strongholds around the country) plus the power of big money in politics. Billions of dollars are spent on Presidential campaigns each cycle, which drives much of the sway in undecided voters. As such, many people choose not to vote and generally become apathetic about governance.
Crypto faces these issues when community participants are vastly out-numbered by whales or large delegates and do not believe their vote matters. Furthermore, it can be difficult to join the community discussion when many discussions are made in private chats, forums are fragmented, and noisy discussion masks the voice of new-comers.
4. Accurate, Speedy Results
Finally, good governance systems need to quickly implement the will of the community. The balance here is to allow for transparent, ample discussion before votes are made. Once votes are made, the results should get executed correctly and quickly.
Currently, communities enact this through either a multi-sig for more ambiguous changes and cheaper votes or on-chain execution for specific code adjustments. While these processes work for the specific vote-to-execution stage, there are many other considerations that need to be addressed.
Without a proper structure to the governance discourse, the process of discussion-to-vote-to-execution can see delays. Often votes include quorum requirements to pass and token requirements to propose. These can lead to delays if set too high and sometimes will require either a re-vote or simply waiting for whales to get onboard.
Furthermore, conversations can get lost in discussion or simply bogged down by “too many cooks in the kitchen” and not get pushed to a vote quick enough. Communities need to actively find the right amount of discussion that needs to be had before pushing an item to a vote. They also need a means to tracking all the topics that get brought up, to not let issues fall through the cracks.
Overall, governance quality is a spectrum and requires lots of consideration during set-up plus ongoing analysis to maintain good governance.