What if your fellow investors could simply vote to take away your shares, with no compensation and no legal recourse? What if they could choose to empty your bank account by majority vote? How about if they could do it with a plurality of just 25%?
Welcome to the exciting new world governed by decentralized autonomous organizations (DAOs), where JUNO cryptocurrency holders just stripped a fellow investor of almost $120 million worth of tokens for allegedly cheating — or at least acting unfairly — in a token “airdrop” that in some ways resembles a stock split.
See also: DeFi’s Achilles’ Heel on Display: Vote Could Take $100M in Crypto from an Investor
Decentralized autonomous organizations, or DAOs, are the smart-contract-controlled, voting-based governance mechanisms that allow decentralized (DeFi) projects to be managed with no centralized human input.
Thanks to the pseudo-anonymity of cryptocurrencies and the global decentralization of blockchains, they are also largely outside the jurisdiction of any court or government. This is why DeFi-based, DAO-controlled decentralized exchanges, or DEXs, generally have no anti-money-laundering (AML) controls.
Read more: PYMNTS DeFi Series: Unpacking DeFi and DAO
Ruthless competition
While they’re fairly new, blockchain believers argue that DAOs will soon make their way into mainstream businesses.
DAOs “are only just starting to increase their impact on how the world’s organizations govern themselves,” Paul Brody, global blockchain leader at global consulting and auditing firm EY, opined in a March 16 CoinDesk column. “As DAOs spread, they will usher in a new way of working and a fierce new era of digital competition, and in doing so, transform traditional organizations.”
That’s not necessarily a bad thing, he adds, pointing to a DAO vote that terminated members of a project team — hired by DAO vote — that had not produced any notable results over a long period.
“I tried to sort through the claims and counterclaims and wasn’t successful,” Brody said, noting that “the debate on the proposal ended up being highly subjective.”
However, “the team had few clear, published success metrics,” he said. “We remain in the early days of these kinds of governance battles, but my immediate take-away was that, if I was working for a DAO, I’d want to have clear metrics and good documentation. Such extreme transparency would help make people more responsive. A ruthless and never-ending feedback cycle is one of the reasons why ride-sharing services are consistently good, despite being crowdsourced.”
What is fair?
Was ruthless transparency what happened to the JUNO whale?
The issue that caused the March 16 JUNO vote arose over an airdrop, which is a fairly common method of rewarding early investors in a cryptocurrency for backing a fledgling and unproven project. Once a project is succeeding and the value of its tokens is rising, a “snapshot” of all digital wallets holding those tokens at an earlier date is taken. More tokens are given to those wallets, generally from a cache set aside for that purpose.
You can read more about the details of the argument and vote in the article linked above — note that the amount involved changed because the price of Juno climbed over the past few days — but core of the accusation, made and argued about at some length on social media channels for blockchain development project Juno, was this: The owner of a large number of tokens — a whale — had split them among 50 wallets in anticipation of an airdrop.
However, the terms were reportedly that a maximum of 50,000 JUNO would be airdropped to one wallet or person.
The alleged finagling — unfairly exploiting a flaw in the governing smart contract — was noticed when the tokens from those 50 airdropped wallets were transferred to a single wallet. A proposal to strip all but 50,000 JUNO from that wallet failed initially, gaining just 10% of the vote. Among other things, the whale claimed the wallets was consolidating tokens on behalf of a group of investors.
By the numbers
That highlights another problems with DAO governance: low voter turnout.
It has already led to other questionable financial decisions.
In 2020, a flaw in the smart contracts governing DeFi lending platform MakerDAO was exposed when a steep price-drop in ethereum saw the collateral borrowers had locked into secure loans liquidated for zero-dollar bids, leaving a group of customers out more than $8 million.
While an initial DAO vote approved compensating them for their losses, a second vote called for and dominated by large MKR token holders reversed that. Only 38 votes were cast, and less than 9% of all tokens voted.
Unideal
This all points to a big problem with the idea — or ideal — of decentralized governance: In a company without human managers and with most small token holders unwilling or unable to vote — to say nothing of even becoming aware that a vote is being called — you return to centralized control by a small group of large shareholders.
The only difference is that they are — in theory — unconstrained by the laws and regulations of an incorporating jurisdiction. And have no formally appointed managers for authorities to coerce.
The reality isn’t there yet. DAOs are new enough that there are still often traditionally incorporated foundations that hold a large percent — even a majority — of the tokens. And there leaders can be held to account, or at least ordered or empowered to act.
The borrowers who lost out to MakerDAO sued the MakerDAO Foundation, and entered court-ordered arbitration.
But for a look at the flaws inherent in a system of DAOs, look at another blockchain project, the aptly named Bribe Protocol. It offers payment to token holders who delegate their voting power to a buyer — essentially pay-to-play “decentralized” governance.
It’s motto? “Where DAO token holders get paid to govern.”
So how does capitalism work in a system that gives companies the freedom to be what amounts to autonomous corporate states governed only by their own rules? Where vote-buying is a business and big investors control outcomes like oligarchs?
If EY’s Brody is right, we’re going to find out.
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